F3 - 11. Risk Management & Currency Risk Flashcards

1
Q

What is financial risk?

A

Risk of future financial conditions being different to those expected

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2
Q

What are the 4 main categories of financial risk?

A
  1. Currency risk
  2. Interest rate risk
  3. Credit risk
  4. Political risk
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3
Q

What 4 actions could a government take that would lead to political risk?

A
  1. Impose quotas (limits) between parents and subsidiaries
  2. Impose import/export tariffs
  3. Nationalisation
  4. Non-tariff barriers e.g. extra quality or safety checks
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3
Q

What are the 3 measures for managing political risk?

A
  1. Negotiations
  2. Production location strategies
  3. Use of JV with domestic companies
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4
Q

What are the 3 categories of currency risk?

A
  1. Transaction risk
  2. Economic risk (longer term)
  3. Translation risk
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5
Q

What is the balance of payments?

A

The difference between a country’s overseas earning and spending

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6
Q

If a country imports more than it exports, what will happen to the currency strength?

A

Weaken

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7
Q

What is purchasing power parity theory?

A

FX rates between two countries are influenced by their respective inflation rates - the country with lower inflation will have its currency strengthen

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8
Q

What is interest rate parity theory?

A

A fair forward exchange rate between two countries can be determined by the spot exchange rate and respective interest rates - the country with lower interest will have its currency strengthen

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9
Q

What is the international fisher effect?

A

The only reason that nominal interest rates in two different countries are different is due to differing inflation

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10
Q

What are 5 factors that will influence currency fluctuations?

A
  1. Relative inflation levels
  2. Relative interest rates
  3. Political stability
  4. Debt ratings
  5. Government policies
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11
Q

What are the 4 main internal hedging techniques?

A
  1. Invoicing in domestic currency
  2. Matching receipts and payments in a foreign account
  3. Leading and lagging (chasing exchange rate)
  4. Multilateral netting (intra-group netting centre)
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12
Q

What is a forward exchange contract?

A

A binding agreement to buy or sell an amount of a currency in the future at a set price on a set date

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13
Q

What are FX forwards used for?

A

To eliminate transaction risk

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14
Q

How do you treat the discount/premium on a forward spot price?

A

Add a discount, deduct a premium

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15
Q

What are the 2 pros of FX forwards?

A
  1. Lock in price - hedge downside risk
  2. Tailored to the investor
16
Q

What are the 2 cons of FX forwards?

A
  1. Lose upside potential
  2. Difficult to unwind the hedge