Financial Risk Management Flashcards
When a company tries to mitigate transaction risk associated with AP, what are the options that can help? What is exactly the risk here?
Buy call option and forward futures contracts
Value of foreign currency increases then AP value goes up therefore liabilities goes up that decreases the equity and end up with a loss
When buy a call option to mitigate transaction risk associated with AP, in order to not end up with a net loss, how should the break even point of the deal be calculated?
BE= strike rate + cost paying for premium
When buying a put option to mitigate transaction costs with AR, how should Break even point to be calculated?
Risk is Price less than strike price
BE = strike price -cost
Steps to use money market hedge to protect against an unfavorable change in the exchange rate
1) determine the FV the balance
2) determine and calculate the present value based on the FV of the balance
PV = FV / periodic interest rate
What are the respective impact on the demand for a foreign currency when inflation associated with foreign economy increases and decreases?
When inflation of foreign economy increases, the purchasing power of the foreign currency decreases which means that less demand for the foreign currency and more demand for domestic currency which has higher purchasing power.
Therefore if inflation of foreign decreases, its purchasing power increases that the demand for foreign currency will be increasing
What is the most effective way to avoid overhedging?
The company should acquire the minimum amount required to hedge known transactions
What is the effect when a foreign competitor’s currency becomes weaker compare with the US money?
The foreign products become less expensive that will increase demand and result in advantage in US market
Relationships between depreciation or appreciation and net inflows/outflows
Foreign Domestic Foreign
Net inflows Net outflows
Appreciate depreciate gain loss
Depre. Appreciate. loss gain
What is a short position in a derivatives contract
Refers to the correct position to take when a company has sold goods and payment is coming due in a foreign country
