FIN 312- Exam 2 (section 16-21) Flashcards
The current exchange rates at which specific currencies can be bought or sold on currency exchange markets
Spot rates
(normally between 2 countries)
The rate at which one currency will be exchanged for another
exchange rate
(includes factors such as commissions and other costs associated with exchanging one currency for another)
- change in the differential between U.S. inflation and the foreign country’s inflation
- change in the differential between the U.S. interest rate and the foreign country’s interest rate
- change in the differential between the U.S. income level and the foreign country’s income level
- change in government controls
- change in expectations of future exchange rates
- Percentage change in the spot rate
factors that can influence a currency’s spot rate
methods available for forecasting exchange rates (4)
- technical forecasting
- fundamental forecasting
- market-based forecasting
- mixed forecasting
Involves the use of historical exchange rates data to predict future variables
Technical forecasting
Is based on relationships between economic variables and exchange rates
Fundamental forecasting
Uses market indicators and it is usually based on either 1) the spot rate or 2) the forward rate
Market-based forecasting
Because no single technique has been found to be consistently superior, it uses a combination of techniques
Mixed forecasting
forms of exchange rate exposure (3)
- transaction exposure
- economic exposure
- translation exposure
Sensitivity of the firm’s contractual transactions in foreign currencies to exchange rate movements
Transaction exposure
Sensitivity of the firm’s cash flows to exchange rate movements
Economic exposure
The exposure of the MNC’s consolidated financial statements to exchange rate fluctuations
Translation exposure
What does MNCs degree of translation exposure depend on?
- Proportion of business by foreign subsidiaries
- Locations of foreign subsidiaries
- Accounting methods
Hedging exposure to ____:
___: Forward and future contracts allow MNC to lock in a specific exchange rate at which it can purchase a specific currency
payables; Forward hedge
Hedging exposure to ____:
____: Future contracts are standardized and can be purchased on an exchange
payables; Future hedge
_____: The MNC borrows its home currency and convert the proceeds into the foreign currency that will be needed in the future
Money market hedge
(Hedging exposure to payables)
_____: it provides the right to buy a specified amount of currency at a specified price within a given period of time
Currency option hedge
(Hedging exposure to payables)
Hedging exposure to ____:
_____: Forward and future contracts allow MNC to lock in a specific exchange rate at which it can sell a specific currency
receivables; Forward hedge
Hedging exposure to ____:
_____: Future contracts are standardized and can be sold on an exchange
receivables; Future hedge
______: The MNC borrows the currency to be received and converts the funds into its home currency; receivables pay off the loan
Money market hedge
(Hedging exposure to receivables)
____: it provides the right to sell a specified amount of currency at a specified price within a given period of time
Currency option hedge
(Hedging exposure to receivables)
MNC’s management of its exposure to exchange rate movements can increase its value:
1) It may be able to increase its cash inflows or reduce its cash outflows by properly managing its exposure.
2) it may be able to reduce its _____, which lowers its cost of capital.
3) it may be able to stabilize its ___, which can reduce its ____ and therefore reduce its ____
financing costs; earnings; risk; cost of capital
They are any investment that falls beyond traditional long-only investments, such as stock and bonds
- primarily used to diversify an investment portfolio
alternative investments
- Low correlation to traditional investments like stocks and bonds
- Higher return potential than traditional investments
- More esoteric and oftentimes illiquid assets
- Longer lock-up of periods, meaning shares or interests may not be able to be redeemed/sold on a daily basis. This helps allow for exposure to less liquid assets
- Often complex investment structures and risk-return profiles Typically, higher minimum investment requirements
- Unique risk profile that should be understood prior to investing
key characteristics of alternative investments
What are the types of investors who may be suited to alternative investments?
most attractive and more suitable for more sophisticated and higher-net-worth investors
are natural resources or agricultural products that are grown, mined or processed and are critical inputs in the production of food, energy and clothing.
Commodities
Commodities are bought and sold in ___ ___ ___ in the same way as stocks and shares.
bulk on exchanges
two primary reasons for investing in commodities, particularly in times of economic volatility and high inflation:
1) A hedge against inflation
2) Portfolio diversification
- Inflation reduces the ‘real’ value of a currency over time
- Commodity returns have historically been positively correlated with high inflation, in other words, returns increase when inflation is high. This is not entirely surprising given that inflation measures incorporate the cost of commodities such as petrol and electricity in their ‘basket of representative items’
A hedge against inflation
Along with cash, shares, bonds and property, commodities are another form of asset that can help investors to ……. Diversification offers a form of protection against one asset class under-performing and may help smooth the overall volatility of your portfolio
Portfolio diversification
a basket of securities you buy or sell through a brokerage firm on a stock exchange
Exchange-traded fund (ETF)
- index ETFs
- Fixed-income ETFs
- Sector and industry ETFs
- Commodity ETFs
- style ETFs
- Foreign market ETFs
- Inverse ETFs
- Leveraged ETFs
- Actively managed ETFs
- Exchange-traded notes (ETNs)
- Alternative investment ETFs
types of ETFs
how do ETFs work
ETF are bought and sold like a company stock during the day when the stock exchanges are open.
- Easy to trade
- Transparency
- More tax efficient
- Trading transactions
Advantages of ETFs
- trading costs
- liquidity
- tracking error
- settlement dates
disadvantages of ETFs
a way to measure the performance of an investment by taking risk into account. It can be used to evaluate a single security or an entire investment portfolio.
sharpe ratio
Sharpe Ratio = ___ (equation)
(Rp – Rf) / Standard deviation
Rp: expected return
Rf: risk-free rate
Standard deviation: a measure of risk based on volatility
(Rp - Rf): market risk premium
the ___ the sharpe ratio, the better the investment in terms of risk-adjusted returns.
What are the ratings?
higher;
- a ratio between 1 and 2 = good
- a ratio between 2 and 3 = very good
- any result higher than 3 = excellent
- Sharpe ratio assumes that an investment’s average returns are normally distributed on a curve
- If standard deviation fails to accurately represent the risk assumed → sharpe ratio can be higher or lower than it should be
- The use of leverage increases the downside risks in an investment…. if SD rises too significantly, sharpe ratio will decline
The limitation to the sharpe ratio
debt an investor takes on to increase the potential return from an investment
leverage
the higher the Sharpe Ratio → the more attractive the _____ is relative to the risk taken, thus the more attractive the ______
return; investment
The alternation of economic expansion and contraction in business activities
Business cycle
business cycle stages:
___: strong consumer demand and confidence lead the economy to overheat and overproduce
____: represents the bleak reality of economic contraction and slowdown
peak; trough
business cycle stages:
____: marked by growing business activities and strong consumer confidence after a trough. The economic recovery and optimism lead companies to hire more workers and create more jobs. With more jobs, consumers have more money to spend.
____: business activities slow and profitability falls. Companies are forced to let go of their employees to cut costs. Many who can’t survive will file for bankruptcies, leading the economy to bottom at a trough
expansion; contraction
During expansion → technology stocks __ utilities
During contraction → technology stocks ____ utilities
outperform; decline more quickly than
(Investing in tech stocks during an expansion will provide higher returns than investing in sectors such as utilities)
____, such as utilities and consumer staples, have more steady performances across different stages of a business cycle
Defensive stocks
Stocks during ____ → have poor performances (bc businesses suffer lower demand and have to scale back their operations)
Bonds during ____ → outperform with its stable and predictable cash flow
During expansion → ___ rise quickly but ___ are less favored (due to its lack of growth potentials)
contractions; recession; stocks; bonds
When the market is ____ and the economy is at a ___, you might want to take a break before putting your hard-earned money into the market.
overheated; peak
- External shocks that are completely unforeseeable can affect a business cycle (COVID led to a recession)
- Assessing which stage of the business cycle we are in is not straightforward (most economic indicators like GDP is reported quarterly)
Limitations of business cycle investing
