FX derivitaves

Question 1

What is a short position in a FX forward ?

Answer 1

A short position in the forward contract means the party will sell the foreign currency at a certain date

Question 2

What is the payoff for the long position

Answer 2

Question 3

In this example draw a graph to show the long position of the corporation

Answer 3

Question 4

Can you draw a graph showing the short position of the bank ??

Answer 4

Question 5

What is the relationship between spot and forward rates ??

Answer 5

Question 6

What formula lets you work out how much you pay more/less in future compared to the spot rate

Answer 6

It is the percentage by which the forward rate exceeds (or lower than) the spot rate at a given point in time.

Question 7

What is a non-deliverable contract ??

Answer 7

This does not result in an actual exchange of currencies, instead one party makes a net payment to the other based on a market exchange rate on the day of settlement

Essentially a contract that closes out at the maturity date

Question 8

Why do companies use NDF

Answer 8

To generate a net-zero or close to outcome

Question 8

What are currency future contracts ??

Answer 8

Contracts specifying a standard volume of a particular currency to be exchanged on a specific settlement date

Question 9

What do futures and forwards have in common ??

Answer 9

Similar obligation - a specified amount of a specified currency at a specified exchange rate on a specific future date

Question 9

What differences does forwards and futures have ??

Answer 9

Future contracts can be traded by firms or individuals through brokers on the trading floor of an exchange (e.g. Chicago Mercantile Exchange), automated trading systems (e.g. GLOBEX), or the over-the-counter market.

Forward contracts are tailor made between two parties

Question 9

How can futures be used to hedge foreign currency exposures ??

Answer 9

Question 10

How can futures be used to speculate FX movements ?

Answer 10

Question 11

Answer 11

Question 12

What does a futures contract specify ?

Answer 12

Question 13

Who has made a gain and who has made a loss ?

Answer 13

Question 14

What does the clearing house do in the futures market ?

Answer 14

Question 15

How does the clearing house minimise credit risk ??

Answer 15

They impose margin requirements to cover fluctuations in the value of a contract, meaning the participants must make deposits with their respective brokerage firms when they take a position

Question 16

What are the 2 types of margin deposits ??

Answer 16

-Initial Margin
-Variation Margin

Question 17

What is the buyers and sellers margin at the end of the day ??

Answer 17

Question 18

What are currency options ??

Answer 18

They provide the right to purchase or sell currencies at specified prices, they are classified as calls or puts

Question 19

Whats the differences between American and European options ??

Answer 19

European: only exercise on maturity date
Americans: can be exercised anytime

Question 20

What is a currency call option ???

Answer 20

A currency call option grants the holder (by paying a premium) the right to buy a specific currency at a specific price (called the exercise or strike price) within a specific period of time.

Question 21

When is the call option said to be in the money, at the money and out of the money ??

Answer 21

Question 22

Draw a graph to show the position of the call option

Answer 22

Question 23

What determines the premium ??

Answer 23

A call option premium is influenced by the probability of a payout, Greater the likelihood of payout, the higher the premium

Question 24

When is the call option premium higher ??

Answer 24

-Difference between spot FX rate and strike rate (𝑆−𝑋) is larger -Time to expiration date (𝑇) is longer -Volatility of the currency (𝜎) is greater

Question 25

What profit would a speculator make if they purchase call options on a currency they expect to appreciate ??

Answer 25

Question 26

What profit would a speculator make if they were to sell call options on a currency that they expect to depreciate ??

Answer 26

Question 27

What is the profit of the buyer of this call option ???

Answer 27

Question 28

Could you show this on a graph from the buyers perspective ?

Answer 28

Question 29

What profit would a seller make ??

Answer 29

Question 30

Could you show this on a graph from the sellers perspective

Answer 30

Question 31

What is a currency put option ??

Answer 31

A currency put option grants the holder (by paying a premium) the right to sell a specific currency at a specific price (called the exercise or strike price) within a specific period of time.

Question 32

With a put option with a strike price of £0.60/$ when is the put option in, at or out of the money

Answer 32

Question 33

What is the put option premium ??

Answer 33

Question 34

The put option premium is higher when:

Answer 34

-Difference between strike rate and spot rate (𝑋−𝑆) is larger -Time to expiration date (𝑇) is longer -Volatility of the currency (𝜎) is greater

Question 35

What profit would a speculator make if they were to purchase put options on a currency that they expect to appreciate ??

Answer 35

Question 36

What profit would a speculator make if they were to purchase put options on a currency that they expect to depreciate ??

Answer 36