Foreign Currency Risk (4) Flashcards
What are currency options?
A right of an option holder to buy (call) or sell (put) a quantity of one currency in exchange for another, at a specific exchange rate on or before a future expiry date
What are over the counter or negotiated options?
A tailor-made currency option from a bank, suited to the company’s specific needs
What do currency options allow the holder?
Enjoy the upside without a risk of suffering the downside of exchange rate movements
What does obtaining a currency option involve?
Paying a premium upfront to the option seller
What if exchange rate moves favourably in options?
The option will not be exercised
What does the option act as?
Insurance policy and can be used by the purchaser to compensate for adverse exchange rate movements
Advantage of option (period of time)
Exchange-traded options are valid for a period of time. More flexible than a forward, which is only valid on a specific day
Advantage of option (sold)
Exchange traded options can be sold on if not needed
Advantage of option (exchange rate)
Any type of option allows a company to benefit from favourable exchange rate movements
Disadvantage of option (contract size)
Exchange-traded options are only available in large, standard, contract sizes, and for a narrow range of currencies
Disadvantage of option (premium)
Any type of option needs to be purchased, and premium can be expensive
What is a currency swap?
A formal agreement whereby two organisations cotnractually agree to exchange payments on different terms
What happens in a currency swap?
Parties agree to swap equivalent amounts of currency for a period
What happens to the liability on the main debt?
Transferred and the parties are liable to the counterparty risk
What happens if other party defaults on the agreement to pay interest (currency swap)
But in borrowings are denominated in the currency of its homecountry
