Essentials Flashcards
Forward contract
Customized contract between two parties to buy or sell an asset at a specified price on a future date.
Future contract
Futures are (standardized) derivative financial contracts that obligate (!) the parties to transact an asset at a predetermined future date and price.
Direct quotation
HC/FC: units of domestic currency per unit of foreign currency. Base currency= FC/Pricing currency= HC
Indirect quotation
FC/HC
Exchange rate name vs dimension (direct quotation)
FC/HC: value of the first currency expressed in the second currency –> S= HC/FC (direct quotation): units of HC per unit of FC
Bid rate
Rate at which the bank buys from you (bidding you money) - you sell!
Ask rate
Rate at which bank sells to you (asking you for money) - you buy!
Spread rate
Difference between ask and bid (ask > bid)
Primary rates
Exchange rates against the USD
Cross rates
Rates not involving the USD
Synthetic contract
Combination of two or more transactions that yields the same outcome as the originial contract (e.g. synthetic cross rate)
Exchange rate (S)
Price of one currency (base) in terms of another (pricing)
Swap rate
Difference between forward and spot rate (F-S)
Forward discount
Forward rates are below the spot rate at all maturities (discount for FC)
Forward premium
Forward rates are above the spot rate at all maturities (premium for fc)
CIP (covered interest rate parity)
Relationship between interest rates and spot and forward currency values of two countries are in equilibrium: (1+i)=(S/F)∗(1+i*)
- -> no opportunity for arbitrage using forward contracts
- -> CIP and UIP are the same when forward and expected spot rates are the same
UIP (uncovered interest rate parity)
The difference in interest rates between two countries will equal the relative change in currency foreign exchange rates over the same period: F0=S0∗(1+i1)/
(1+i2) –> higher interest rate at home predicts a depriciation of HC
Difference UIP and CIP
CIP involves using forward or futures contracts to cover exchange rates (hedging). UIP involves forecasting rates and not covering exposure to foreign exchange risk (no forward rate contracts, since it uses only the expected spot rate)
–> no theoretical difference between CIP and UIP when the forward and expected spot rates are the same
Meese-Rogoff-Result
Random walk is the best forecast model for exchange rates –> current exchange rate is “optimal predictor” of future spot rate and summarizes market expectations
Disconnect puzzle
Past and current macro fundamentals don’t explain/forecast exchange rates
Engel and West
Exchange rates as assets: Driven by current and expected future fundamentals. –> Thus, predictability does not mean that exchange rates are disconnected from fundamentals.
Call
Right (option) to buy a stock
Put
Right (option) to sell a stock
Long
Buying (e.g.option/forward). Betting on rising prices
Short
Selling (e.g. option/forward). Betting on falling prices
Long call
Buying the right (option) from someone to buy a stock for a given price
Long put
Buying the right (option) from someone to sell a stock for a given price
Short call
Selling the right (option) to someone to buy a stock from you for a given price (thus you are selling)
Short put
Selling the right (option) to someone to sell a stock to you for a given price (thus you are buying)
Strike price
Price at which a derivate contract can be bought
A/R
Accounts Receivable: money which is owed to a company –> right to receive those accounts because of former delivery of product/service
A/P
Accounts Payable: debts that a company must pay off –> e.g. short-term debt to suppliers
ATM
At the money: strike price is identical to the price of the underlying security
OTM
On the money: strike price is higher (lower) than the market price of the underlying asset for a call option (put option) –> no intrinsic value (worthless at expiry)
ITM
In the money: strike price is favorable in comparison to the market price of the underlying asset (call: buying below current price; put: selling above current price)
