Foreign Exchange RIsk Movement OT Flashcards
Transaction risk?
We buy goods in a different currency. But I won’t pay these goods for another month and exchange rate might change for better or worse
What is a translation risk?
I work in pounds but I have factory that uses dollars. Need to do SFP in pounds (needs book gain or loss)
What is an economic risk?
Harder to collect money from customers in a foreign country
Political risks in a foreign country
How are exchange rates in decimal places?
To four decimal places
When we receive money?
Bank makes the profit
Issue with invoicing in home currency?
A big customer that insists on invoicing in dollars but we’re based in the UK. There’s eschange rate movements
What is leading and lagging?
If I own money in a foreign currency, either pay quickly or delay paying which way we expect exchange rate to move
What is netting?
Use dollar receipts to make dollar payments. Only at risk on net amount
What is matching?
Create an expense in dollars to cancel the income in dollars. Trying to remove foreign exchange risk
What is a forward contract?
A rate quoted today to apply to a fixed amount on a fixed future date
Why is premium subtracted?
As the dollar is strengthening, one pound will buy you fewer dollars
Calculated forward?
Spot - premium
What happens with a discount in forward contracts?
Spot + discount
What happens in money market hedging (receive money)?
Borrow $’s now. Then convert to £’s now at spot. We then deposit the £s for 3 months
What happens when deposit matures in money market hedging?
We receive £3m fixed in 3 months
Process when receiving money in a hedge
Borrow
Convert
Deposit
Futures and forwards similarity
Rate converted now that converts money on a future date
What is futures?
Rate quoted now that applies to a transaction at a fixed rate (e.g. a quarter)
How are futures trades?
On an exchange. Can be traded like shares (buy and sell, usually for speculative purposes)
How can financial managers use hedging?
To remove the risk from transactions
Why leave transaction at risk in futures?
Convert at whatever spot is on 10th August
When spot rate goes up and down (futures)?
So does the futures
What are options?
An option is the right to convert at fixed rate on a future date.
Choice in options?
Choice on date of transaction whether to exercise the right or to convert at spoit
Forward rates and choice?
Have to convert at the forward rate. There is no other option
Disadvantage of option?
Need to pay for the option (premium) whether or not we exercise it
What is a call option?
The right buy a currency at a fixed rate
What is a put option?
The right to sell $s at a fixed rate
