FX Risk Management

Question 1

EUR/USD

Answer 1

Eur would be the base currency

Usd would be the underlying currency

Question 2

Distinguishing bid/offer rates

USD/EUR .8570-.8600

Answer 2

The market maker always buys the underlying at the high rate(.8600)converting EUR to USD.
Always sell the underlying at the lower rate(.8570)converting USD to EUR

Question 3

Spot rate

Answer 3

Buying or selling a currency on the day it is required or received. Rate that applies for a deal that will be settled in the same day or within two working days.
Will settle the transaction within two business days

Question 4

Forward contracts

Answer 4

Advantages
Simplicity
Availability in most currencies
Quite small sums can be protected
Certainty:the customer knows exactly what they will get

Disadvantages
Forward contracts are of limited flexibility, being legally binding
The customer dosent have an opportunity to profit from favorable exchange movements as contracts cant be cancelled. This is called opportunity cost

Question 5

Forward rate determination factor

Answer 5

It is founded on logical arbitrage principles based in the periodic interest rate differentials between the two currencies

Question 6

American options

Answer 6

These are where the option may be exercised any time before the option matures

Question 7

European options

Answer 7

These may only be exercised on the maturity date

Question 8

Call option

Answer 8

These give the customer/purchaser the right to buy the underlying currency
Customer wants spot rate to go up
Banks wants the spot rate to go down

Question 9

Put option

Answer 9

These give the customer/purchaser the right to sell the underlying currency
The customer wants the spot rate to do down
The bank wants the spot rate to up

Question 10

FX Translation exposure

Answer 10

Accountancy treatment of changes in the reported values of foreign currency denominated assets, liabilities and profits

Question 11

FX Economic exposure

Answer 11

Effect of long-run changes in foreign exchange rates on the competitiveness of a business

Question 12

FX Transaction exposure

Answer 12

Relates to the effects of changes in foreign currency rates on cash flows or profits of a business

Question 13

Sensitivity analysis

Answer 13

Show the effect on cash flow or profits of a given change in the exchange rate.
Using technique called VaR value at risk-forecast the probability of the change applied in the sensitivity analysis occurring