Foreign Currency Risk (3)

Question 1

What are currency futures?

Answer 1

A contract to purchase or sell a standard quantity of a currency by an agreed future date or specified exchange rate

Question 2

Similarity to currency futures and forward contracts?

Answer 2

They fix the exchange rate to use in the future

Question 3

How are currency futures traded/

Answer 3

On a market and mainly available from US markets

Question 4

Currency future characteristics?

Answer 4

Contract fixes the exchange rate on a large amount of currency

Contract expire at the end of each quarter but can be used on any date up to the expiry date

Question 5

SHow does a futures contract differ from a forward?

Answer 5

A futures contract is separate from the actual transaction

Question 6

What if company makes an exchange loss on a transaction?

Answer 6

It will make a profit in futures market to compensate for this

Question 7

What if company makes an exchange profit on a transaction?

Answer 7

It will make a loss in the futures market

Question 8

When there’s fluctuatuing exchange rate in currency futures?

Answer 8

The outcome is fixed

Question 9

First step in foreign currency receipt in a futures transaction?

Answer 9

Enter into futures contract to sell foreign at a fixed rate

Contracts should be due to be fulfilled on a standardised date after transaction date

Question 10

Second step in foreign currency receipt in a futures transaction?

Answer 10

Complete the actual transaction on the spot market

Question 11

Third step in foreign currency receipt in a futures transaction?

Answer 11

Entering into contract to buy foreign

Question 12

Any profits or losses arising in the future?

Answer 12

Will offset the impact of exchange rate movements on actual transaction that is being hedged. Outcome is fixed whatever happens to exchange rate

Question 13

What if foreign devalues in a futures?

Answer 13

Gain in future but there’s exchange loss in actual transaction

Question 14

What if foreign increases in value in a futures?

Answer 14

Loss on the future but there’s exchange gain in actual transaction

Question 15

Advantage of currency futures (fliexibility)?

Answer 15

Future are valid for a specific period of time. More flexible than forward as forward is only valid for one day

Question 16

Advantage of currency futures (counterparty)?

Answer 16

Counterparty risk is lower as futures guarantee a transaction

Question 17

Disadvantage of currency futures (Size)?

Answer 17

Only available in large, standard, contract sizes. Currency futures are less suitable for small transactions

Question 18

Disadvantage of currency futures (Deposit)?

Answer 18

Futures required to place a deposit to cover potential losses. This may need to be topped up on a daily basis if contract is incurring losses

Question 19

Disadvantage of currency futures (exchange rate movement)?

Answer 19

Future exchange rates don’t move exactly in line with spot exchanges rates so hedge is not effective