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International Corporate Finance > Futures, Options and Swaps > Flashcards

Futures, Options and Swaps Flashcards

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1
Q

What is a futures contract?

A

Futures contracts are contracts that specify a standard volume traded of a particular currency to be exchanged on a specific settlement date.

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2
Q

Why is speculation hard to set up with forward contracts?

A

Speculation is usually difficult to set up with forward contracts with banks since agents might not have a working relationship with the bank. Also, usually the amounts traded in forward contracts are much higher than in future contracts.

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3
Q

What is the initial margin?

A

The initial margin is the amount that needs to be in the account balance when the futures contract is entered into.

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4
Q

What is the margin call?

A

The margin call is issued if the balance falls below the maintenance margin. If this happens, enough money must be added to the account so it goes back to the initial margin.

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5
Q

How are profits and losses of futures contracts paid?

A

Marking-to-market, meaning they are paid over every day at the end of trading.

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6
Q

What is an offsetting trade?

A

For example, if a company’s long position in euro futures has proved to be profitable, the company can sell futures contracts on a like amount of euros just prior to the maturity of the long position. The two cancel out.

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7
Q

What is the difference in regulation between futures and forwards?

A

Forwards are self-regulating, futures are regulated by the CFTC (Commodity Futures Trading Commission)

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8
Q

What is the difference in trading between futures and forwards?

A

forwards: electronic and telephone
futures: electronic and open outcry

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9
Q

What is the difference in the frequency of delivery between futures and forwards?

A

forwards: physical delivery, futures: offsetting trade

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10
Q

What is the difference in contract sizes between futures and forwards?

A

Futures contract sizes are standardised.

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11
Q

What is the difference in settlement between futures and forwards?

A

Forwards settlement is at maturity, futures daily mark-to-market

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12
Q

What is the difference in quotes between futures and forwards?

A

forwards: mostly european terms
futures: american terms

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13
Q

What is the difference in transaction costs between futures and forwards?

A

Forwards transaction costs are the bid-ask spread, futures transaction costs are the brokerage fees

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14
Q

What is the difference in margins between futures and forwards?

A

Forwards don’t require margins, futures do

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15
Q

What is the difference in delivery date between futures and forwards?

A

Forwards delivery date is at any date, futures have specific dates in a year

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16
Q

What is the difference in counterparty risk between futures and forwards?

A

forwards: loss could result if one party to the agreement defaults
futures: the exchange clearing house becomes the counterparty making the risk of default very small

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17
Q

What is an advantage of futures contracts?

A

An advantage of futures is the smaller size and the freedom to liquidate the contract at any time before its maturity.

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18
Q

What is a disadvantage of futures contracts?

A

A disadvantage of futures contracts is that they face limited number of currencies traded, limited delivery dates and rigid contractual amount of currencies.

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19
Q

True or false: the prices of future and forward contracts for a given currency and settlement date tend to be the same.

A

True

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20
Q

What are the uses of futures contracts?

A

Hedge risk and speculation

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21
Q

When can a firm use a futures contract to hedge risk as a long position?

A

If a U.S. firm expects to need €700,000 in one year, it could lock today the price to be paid for euros at a future settlement date by holding a currency futures contract.

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22
Q

When can a firm use a futures contract to hedge risk as a short position?

A

If a U.S. firm expects to receive €800,000 in one year, it could lock today the price to be received for euros at a future settlement date by selling a currency futures contract.

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23
Q

How can an agent speculate using a futures contract as a long position?

A

If an agent believes that the British pound will appreciate in the future, she could hold a futures contract that it would lock in the price at which she can pay for British pounds in the settlement date.

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24
Q

How can an agent speculate using a futures contract as a short position?

A

If an agent believes that the British pound will depreciate in the future, she could sell a futures contract that it would lock in the price at which she can sell British pounds in the settlement date.

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25
Q

What is the payoff at settlement date of a long position of futures/forwards?

A

et - ft

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26
Q

What is the payoff at settlement date of a short position of futures/forwards?

A

ft - et

27
Q

The long position in a EUR/USD forward will, at the settlement date, buy and sell what currency?

A

buy EUR and sell USD

28
Q

The short position in a EUR/USD forward will, at the settlement date, buy and sell what currency?

A

buy USD and sell USD

29
Q

Who is the long position on an option?

A

the owner, who has the right to buy (call) or sell (put) a currency in the future at a giver strike price

30
Q

What is the option premium?

A

option price

31
Q

True or false: buying a call option is similar to buying a futures or forward contract. The difference is that in the former the owner can let the option expire and in the latter the owner is required to trade.

A

True

32
Q

What is the difference between american style and european style options?

A

the holder of an american style option can exercise the option at any time up to the maturity date, european is only at maturity

33
Q

Where are currency options traded?

A

Currency options are traded on an organised exchange market or in the over-the-counter (OTC) market.

34
Q

What are exchange-traded options?

A

Exchange-traded options are standardised contracts with predetermined exercise prices and standard expiration months.

35
Q

What are OTC options?

A

OTC options are contracts whose specifications are generally negotiated.

36
Q

Who trades OTC options?

A

OTC options are traded by commercial and investment banks in virtually all financial centers.

37
Q

What sectors does the OTC options market has?

A

1) retail market (nonbank customers of banks)
2) “wholesale” market

38
Q

What is the profit of a long position option?

A

Profit = Payoff - Option premium (Ask rate)

39
Q

What is the profit of a short position option?

A

Profit = Payoff + Option premium (Bid rate)

40
Q

What happens to the option price if the spot price (e) increases?

A

Call: increases
Put: decreases

41
Q

What happens to the option price if the strike price (k) increases?

A

Call: decreases
Put: increases

42
Q

What happens to the option price if the maturity (T) increases?

A

Call: increases
Put: increases

43
Q

What happens to the option price if the volatility increases?

A

Call: increases
Put: increases

44
Q

When should a firm consider purchasing a call option for hedging? (EUR/USD)

A

A firm should consider purchasing a call option for hedging when, at the settlement date:
* A U.S. firm needs to make a payment in EUR; or
* A Euro zone firm expects to receive a cash flow in USD.

45
Q

When should a firm consider purchasing a put option for hedging? (EUR/USD)

A

A firm should consider purchasing a call option for hedging when, at the settlement date:
* A U.S. firm expects to receive a cash flow in EUR; or
* A Euro zone firm needs to make a payment in USD.

46
Q

When should a speculator purchase a call option on GBP?

A

A speculator should purchase a call option when she expects that the spot price of GBP/USD will increase, meaning that the GBP will appreciate in respect to the USD.

47
Q

When should a speculator purchase a put option on GBP?

A

A speculator should purchase a put option when she expects that the spot price of GBP/USD will decrease, meaning that the GBP will depreciate in respect to the USD.

48
Q

What is an interest rate swap?

A

An interest rate swap is an agreement between two parties to exchange USD interest payments for a specific maturity on an agreed-upon notional amount.

49
Q

What is the notional amount?

A

The notional amount is simply a reference amount against which the interest is calculated.

50
Q

What is the interval of time most transactions of interest rate swaps fall?

A

2-year to 10-year periods

51
Q

What is a coupon swap?

A

A coupon swap happens when one party pays a fixed rate, while the other party pays a floating rate that resets periodically throughout the life of the deal against a designated index.

52
Q

What is a basis swap?

A

A basis swap happens when the two parties exchange floating interest payments based on different reference rates.

53
Q

What is the most important reference rate in swap and other financial transactions?

A

SOFR (Secured Overnight Financing Rate)

54
Q

What is the SOFR?

A

The SOFR is a volume-weighted median that includes a broad measure of the cost of borrowing cash overnight collaterised by treasury securities.

55
Q

What does the SOFR include?

A

The SOFR includes all trades in the Broad General Collateral Rate plus bilateral Treasury repurchase agreement (repo) transactions cleared through the DVP (Delivery-vs-Payment) service offered by the FICC (Fixed Income Clearing Corporation), which is filtered to remove a portion of transactions considered “specials”.

56
Q

What is the LIBOR?

A

The LIBOR was the average interest rate offered by multinational banks in London for USD deposits.

57
Q

What was the LIBOR replaced by?

A

SOFR

58
Q

What is a currency swap?

A

A currency swap is an exchange of debt-service obligations denominated in one currency for the service on an agreed-upon principal amount of debt denominated in another currency.

59
Q

What are the economic advantages of swaps?

A

1) They allow firms to lower their costs of foreign exchange risk management by arbitraging their relative access to different currency markets.
2) Since they provide long-term financing in foreign currencies, they’re one vehicle providing liquidity in these markets.
3) They allow firms to engage in some form of tax, regulatory-system, or financial market arbitrage.

60
Q

What would happen to swaps if the world capital market were fully integrated?

A

If the world capital market were fully integrated, the incentive to swap would decrease because they would be fewer arbitrage opportunities.

61
Q

What is a forward interest?

A

A forward interest is a contract that fixes an interest rate today on a future loan/deposit. It specifies the interest rate, the principal amount of the loan/deposit and the start and ending dates.

62
Q

What is a Forward Rate Agreement (FRA)?

A

A FRA is a cash-settle, over-the-counter forward contract that allows the firm to fix an interest rate to be applied to a specific future interest period on a notional principal amount. Both parties on an FRA agree to exchange interest payments.

63
Q

In FRA, when is interest paid?

A

At the beginning of the period, that’s why it’s necessary to compute the present value of the difference in interests.

International Corporate Finance (10 decks)

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