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FM (Test) > G Rote > Flashcards

G Rote Flashcards

1
Q

Which hedge is most appropriate for a US importer expects to pay a European supplier €500,000 in three months?

A

Buying call options on the euro

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2
Q

How to eliminate currency transaction risk?

A

Eliminates the currency transaction risk

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3
Q

What happens when inflation associated with a foreign economy increases in relation to a domestic economy?

A

Demand for foreign currency reduces and imports reduces, makes foreign products more expensive

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4
Q

What is meant by an interest rate swap?

A

Which it would pay another party a fixed rate of interest in exchange for receipt of a floating rate of interest

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5
Q

Can the currency options be exercised or lapsed?

A

Yes

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6
Q

Should a money market hedge give approximately the same result as a forward contract?

A

Yes

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7
Q

What is meant by interest rate parity theory?

A

Forward exchange rates are also based on the difference between the interest rate on each currency

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8
Q

What does the outcome of a money market hedge depend on?

A

Difference between the interest rate on each currency

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9
Q

What is meant by an appreciation of a domestic currency?

A

The domestic currency becomes stronger

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10
Q

What can appreciation of currency cause the country’s exports to do?

A

More expensive and less competitive

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11
Q

What can appreciation of currency cause the country’s imports to do?

A

Cheaper which tends to reduce inflation

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12
Q

What type of risk is gains or losses arising on the consolidation of foreign-denominated assets of liabilities

A

Translation risk

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13
Q

What type of risk is impact on cash flows of the long-term exchange rate trend

A

Economic risk

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14
Q

What type of risk is impact on cash flows of a short-term change in the exchange rate

A

Transaction risk

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15
Q

What happens when company will suffer an economic loss if it has net receipts of a variable currency and variable currency depreciates?

A

Company will suffer a loss

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16
Q

What risks are associated with revenues being affected by long-term exchange rate trends?

A

Transaction and economic risks

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17
Q

What is the effect on a UK-based company when a foreign competitor’s currency becomes weaker compared to sterling?

A

The foreign company will have an advantage in the UK market

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18
Q

What types of contracts are interest rate futures?

A

Contracts are exchange-traded and relate to a standard size of an underlying loan

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19
Q

What types of contracts are OTC options?

A

Not exchange-traded and can be customised

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20
Q

What types of contracts is a forward rate agreement?

A

A bespoke contract rather than a stan dardised contract

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21
Q

What does liquidity preference theory suggest?

A

Investors prefer to have their cash returned to them sooner rather than later

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22
Q

What happens if government monetary policy has increased short-term interest rates with the objective of reducing inflation? (for curve)

A

A yield curve is “inverted” when the yield on short-term debt is higher than the yield on longer-term debt

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23
Q

What does expectations theory suggest?

A

Shape of the yield curve depends on the expectations of investors regarding future interest rates

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24
Q

What does market segmentation theory suggest?

A

The borrowing market can be divided into segments (e.g. the short- and long-term ends) and that each investor has a “preferred habitat”

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25
Q

What is an interest rate floor?

A

Protects its holder from falling interest rates but allows participation in rising interest rates

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26
Q

Which of derivative instruments are characterised by a standard contract size?

A

Futures contract
Exchange-traded option

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27
Q

What does interest rate parity theory link?

A

The one-year forward exchange rate and the current spot exchange rate

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28
Q

What is the foreign nominal interest rate greater than in interest rate parity theory?

A

Domestic nominal interest rate

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29
Q

When is a 3 v 9 FRA appropriate?

A

Borrowing intends to make three months from now for a further period of six months.

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30
Q

What is meant by a gap exposure?

A

The difference between the amounts of interest-sensitive assets and liabilities

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31
Q

What derivative instruments are characterised by a standard contract size?

A

Futures contract

Exchange tradable option

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32
Q

What is meant by smoothing?

A

Holding a balanced mix of both fixed and floating rate debt

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33
Q

Benefits of smoothing?

A

Will reduce the effects of an interest rate change but not eliminate it completely

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34
Q

Interest payments and smoothing?

A

Interest payments will still increase following a rise in rate

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35
Q

What is agreed in an OTC option?

A

An agreement with a financial institution and an immediate premium is payable on taking out the option

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36
Q

What is meant by an interest rate cap?

A

To limit the maximum interest rate

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37
Q

What is meant by an interest rate collar?

A

A combination of a cap and a floor and could be used to protect both against increase and decrease in interest rates

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38
Q

Is a money market hedge used for hedging foreign exchange risk or interest rates?

A

Foreign exchange risk

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39
Q

Which derivatives are standardised in nature?

A

Derivative hedging instruments that are traded on an exchange or market

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40
Q

Are exchange-traded options standardised?

A

Yes

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41
Q

What is a forward rate agreement?

A

An agreement between a bank and a customer to fix an interest rate on an agreed amount of funds for an agreed future period

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42
Q

Are swaps standardised in nature?

A

No, as they are tailored to customer’s needs

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43
Q

Are futures contracts relatively cheap?

A

Yes, as they are subject to a brokerage fee only

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44
Q

Is it possible to purchase futures contracts from every currency to every other currency?

A

No

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45
Q

Are futures contracts for standardised amounts?

A

Ues, so may not match the size of the transaction being hedged precisely

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46
Q

What does the international fisher effect assume?

A

Real interest rates are the same

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47
Q

What to do to hedge against interest rate increased?

A

Interest rate futures should be sold now

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48
Q

Debt portfolio in smoothing?

A

Consists of a mixture of fixed and floating rate debt

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49
Q

Interest payments in smoothing?

A

Will still increase if the interest rate rises

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50
Q

When can an inverted yield curve arise?

A

If government policy is to keep short-term interest rates high to bring down inflation

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51
Q

What is meant by a gap exposure?

A

Difference between amount of interest-sensitive assets and liabilities

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52
Q

Does forward contract have a standard contract size?

A

No

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53
Q

Does forward rate agreement have a standard contract size?

A

No

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54
Q

Does futures contract have a standard contract size?

A

Yes

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55
Q

Does swap have a standard contract size?

A

No

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56
Q

Does OTC have a standard contract size?

A

No

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57
Q

Does exchange tradable option have a standard contract size?

A

Yes

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58
Q

What form of settlement date to currency futures have?

A

A fixed settlement date

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59
Q

What does buying a currency option involve (premium)?

A

Paying a premium to the option seller (fee is non-refundable)

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60
Q

What can currency swaps be used for?

A

To hedge exchange rate risk over longer periods than the forward market

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61
Q

When there’s longer the term to maturity, how does this effect interest?

A

The higher the rate of interest

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62
Q

Why does longer term loan notes require a higher yield?

A

Longer term is considered less certain and more risky

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63
Q

Result of governments can keep interest rates low by selling short-dated government bills in the money market?

A

Reduces money supply and could put upward pressure on interest rates

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64
Q

Fall in country’s exchange rate effect on exports and imports?

A

Exports are cheaper and imports are more expensive

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65
Q

Are forward contracts traded over counter or exchange traded?

A

Traded over the counter

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66
Q

Are currency futures traded over counter or exchange traded?

A

Exchange traded

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67
Q

Are forward contracts available in any currency?

A

Yes

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68
Q

Are currency futures available in any currency?

A

Only in a limited range of currencies

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69
Q

What are expected future spot rates based on?

A

Relative inflation rates between two countries

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70
Q

What are current forward excchange rates based on?

A

Relative interest rates between two countries

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71
Q

Where does PPP tend to hold?

A

For the longer term

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72
Q

Does transaction risk affect cash flows?

A

Yes

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73
Q

Does translation risk directly affect shareholder wealth?

A

No

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74
Q

Wgere do standard contract sizes only apply to?

A

Tradable options, not OTC options which will be tailored to needs of the customer

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75
Q

What can cause a kink in the normal yield curve be due to?

A

Differing yields in different market segments

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76
Q

How can asset and liability management hedge interest rate risk?

A

By matching the maturity of assets and liabilities

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77
Q

What is smoothing?

A

Maintaining a balance between fixed-rate and floating-rate debt

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78
Q

How can interest rate risk be hedged on borrowing?

A

By selling interest rate futures now and buying them back in the future

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79
Q

What does an interest rate swap only involve?

A

Swapping the interest payments

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80
Q

Do options have to be exercised by their expiry date?

A

No, this is optional

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81
Q

How to hedge interest rate risk?

A

Need to buy a cap and sell a floor

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82
Q

Which is more cost effective, interest rate collar or interest rate floor?

A

An interest rate floor

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83
Q

What happens to price of interest rate if interest rates rise in interest rate futures?

A

It decreases

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84
Q

Why is there no translation risk for limiting its overseas operations to exp[orts to foreign countries?

A

There is no foreign subsidiary or foreign-denominated assets or liabilities

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85
Q

What happens if forward exchange rate is greater than current spot exchange rate in interest rate parity theory?

A

The variable “foreign” nominal interest rate is greater than the base “domestic” nominal interest rate

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86
Q

What does the term matching refer to?

A

The balancing of receipts and payments in the same currency

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87
Q

Do nothing for three months and then buy euros at thespot rate (would this provide cover for exchange rate exposure)?

A

Would not provide cover

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88
Q

Pay in full now, buying euros at today’s spot rate (would this provide cover for exchange rate exposure)?

A

Would provide cover

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89
Q

Buy euros now, put them on deposit for three months, and pay the debt with these euros plus accumulated interest (would this provide cover for exchange rate exposure)?

A

Would provide cover

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90
Q

Arrange a forward exchange contract to buy the eurosin three months’ time (would this provide cover for exchange rate exposure)?

A

Would provide cover

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91
Q

Is lagging a hedging technique?

A

No, lagging does not guarantee a lowering of risk

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92
Q

What exposure does matching receipts and payments reduce?

A

Transaction exposure

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93
Q

A UK company has just despatched a shipment of goods to Sweden. The sale will be invoicedin Swedish kroner, and payment is to be made in three months’ time. Neither the UK exporternor the Swedish importer uses the forward foreign exchange market to cover exchange risk

(Gain or loss for UK exporter)

A

Gain

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94
Q

A UK company has just despatched a shipment of goods to Sweden. The sale will be invoicedin Swedish kroner, and payment is to be made in three months’ time. Neither the UK exporternor the Swedish importer uses the forward foreign exchange market to cover exchange risk

(Gain or loss for Swedish importer)

A

No effect

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95
Q

What is meant by basis?

A

The difference between the price of a futures contract and the spot price on a given date

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96
Q

What can currency swaps be used for (exchange rate risk)

A

Can be used to hedge exchange rate risk over longer periods than theforward market

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97
Q

Is the close out date already set for currency futures when purchased?

A

Yes

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98
Q

Are forward contracts binding?

A

Yes and will not be allowed to lapse by the bank

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99
Q

When are options paid for?

A

When they are taken on

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100
Q

Eady Co is a UK company that imports furniture from a Canadian supplier and sells itthroughout Europe. Eady Co has just received a shipment of furniture, invoiced in Canadiandollars, for which payment is to be made in two months’ time. Neither Eady Co nor theCanadian supplier use hedging techniques to cover their exchange risk. (Gain or loss for Eady Co)

A

Loss as they have to pay more £ to purchase C$ payable

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101
Q

Eady Co is a UK company that imports furniture from a Canadian supplier and sells itthroughout Europe. Eady Co has just received a shipment of furniture, invoiced in Canadiandollars, for which payment is to be made in two months’ time. Neither Eady Co nor theCanadian supplier use hedging techniques to cover their exchange risk. (Gain or loss for Canadian supplier)

A

No effect as it invoices in local currency

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102
Q

Are exports given a stimulus for when there is a fall in the value of a country’s currency?

A

Yes

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103
Q

When does demand-pull inflation arise?

A

When demand for locally produced goods is high

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104
Q

When does cost-push inflation arise?

A

When the domestic producer’s costs goup and they have to increase prices to remain profitable

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105
Q

What are the effects on imports and exports if a coutnry’s currency falls?

A

Great for exports but it makes imports more expensive

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106
Q

What can create cost-push inflation?

A

Any business that usesimported materials in its production will see its costs go up

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107
Q

What is a put option?

A

The right to sell an asset at a fixed price

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108
Q

What is the aim of a forward rate agreement (FRA)?

A

To lock the company into a targetinterest rate and hedge both adverse and favourable interest rate movements

109
Q

Why is an interest rate guarantee (IRG) more expensive than an FRA?

A

One has topay for the flexibility to be able to take advantage of favourable interest rate movements

110
Q

What happens when you sell a futures contract?

A

You have a contract to borrow money (not lend)

111
Q

Amount in interest rate futures contact?

A

Each contract is for a standardised amount with a set maturity date

112
Q

What does liquidity preference theory help explain?

A

An upward sloping curve

113
Q

What does expectations theory help explain?

A

An upward sloping curve indicates that interest rates will rise in the future

114
Q

What does market segmentation theory help explain?

A

There may be different shapes to thecurve at the long-term and short-term ends

115
Q

Does a flat yield theory influence the yield curve?

A

NO

116
Q

What is shown by a yield curve?

A

The relationship between time to maturity and the return to bond investors

117
Q

What does an option give fliexibility for?

A

To protect against unfavourable movements, but take advantage of favourable one

118
Q

Why does the normal yield curve slope upwards?

A

To reflect increasing compensation to investors forbeing unable to use their cash now

119
Q

What type of policy is raising interest rates?

A

A contractionary monetary policy that would stifle spending

120
Q

Does expectations theory relate to future interest rates or inflation rates?

A

Future interest rates

121
Q

Limitation of interest rate parity theory (government)

A

Government controls on capital markets

122
Q

Limitation of interest rate parity theory (currency)

A

Controls on currency trading

123
Q

Limitation of interest rate parity theory (foreign)

A

Intervention in foreign exchange markets

124
Q

What is basis risk relevant to?

A

One of the reasons for an imperfect currency futureshedge

125
Q

Benefit for a floor being a minimum rate?

A

It is useful for hedging against falls in rates for a deposit

126
Q

Issue with the standardised nature of future contracts?

A

Over-or under-hedging is very likely (an imperfect hedge)

127
Q

When is the premium on an option payable?

A

When the option is purchased

128
Q

What is the cost of an interest rate floor higher than?

A

The cost of an interest rate collar

129
Q

What is meant by smoothing?

A

Holding a balanced mix of both fixed and floating rate debt

130
Q

What does smoothing reduce?

A

Effects of an interest rate change but not eliminate it completely

131
Q

Interest payments and smoothing?

A

Will still increase following a rise in rates

132
Q

What sort of strategy is financing fixed cash flow investments with fixed rate debt?

A

A matching strategy, not smoothing

133
Q

Why won’t fill benefit not be obtained from a fall in rates (debt portfolio)

A

Due to the fixed element of the debt portfolio

134
Q

Do exchangeable tradeable options have a standard contract size?

A

Yes

135
Q

Do futures contracts have a standard contract size?

A

Yes

136
Q

Do forward contract have a standard contract size?

A

No

137
Q

Do forward rate agreement have a standard contract size?

A

No

138
Q

Do swap have a standard contract size?

A

No

139
Q

Do OTC have a standard contract size?

A

No

140
Q

What is an OTC option?

A

An agreement with a financial institution and an immediatepremium is payable on taking out the option

141
Q

When can an OTC option only be exercised?

A

If actual interest rates are less favourable

142
Q

Can an OTC option be traded?

A

No

143
Q

What can be done to reduce risk of euro value dropping relative to dollar before 750000 euros is received?

A

Enter into a forward contract to sell 750000 euros in 6 months

144
Q

Benefit of currency swaps over forward market?

A

Currency swaps can be used to hedge exchange rate risk over longer periods than the forward market

145
Q

What settlement date does a currency futures have?

A

A fixed settlement date

146
Q

What does buying a currency option involve?

A

Paying a premium to the option seller

147
Q

What sort of fee is on a currency option?

A

A non-refundable fee which is paid when the option is acquired

148
Q

Shape of the normal yield curve?

A

Slopes upward to reflect increasing compensation to investors for being unable to use their cash now

149
Q

Why does long-term require a higher yield?

A

As it is considered less certain and more risky

150
Q

When governments sell short-dated government bills in the money market?

A

Puts upward pressure on interest rates as it reduces money supply

151
Q

Imports and exports when there’s a fall in a country’s exchange rate?

A

Exports are cheaper

Imports are more expensive

152
Q

Are futures contracts tailored to user’s needs?

A

No, they are standard contracts

153
Q

Forward contracts (traded)

A

Traded over counter

154
Q

Forward contracts (price)

A

Contract price is in any currency offered by the bank

155
Q

Futures contracts (traded)

A

Exchange traded

155
Q

Futures contracts (price)

A

Only available in a limited range of currencies

156
Q

How is expected future spot rate calculated?

A

On relative inflation rates between two countries

157
Q

How are current forward exchange rates set?

A

On the relative interest rates between them

158
Q

Why is expected spot rate and current forward rate the same?

A

Expectations theory states that there is an equilibrium between relative inflation rates and relative interest rates

159
Q

Does transaction risk affect cash flows?

A

Yes

160
Q

Does translation risk directly affect shareholder wealth?

A

No

161
Q

Does diversification of supplier and customer base across different countries reduce which risk?

A

Economic risk

162
Q

Examp,e of hedging a translation risk?

A

By matching the currency of assets and liabilities

163
Q

Issue of payment of the option premium upfront?

A

Makes the option the more expensive means of hedging

164
Q

Where do standard contract sizes only apply to?

A

Tradeable options, not OTC options

165
Q

Difference between forward contract vs money market hedge? (time difference)

A

Forward contract receiving dollar equivalent of MS receipt in 3 month’s time

Money market hedge provides dollar receipts today

166
Q

What causes a kink in the normal yield curve?

A

Can be due to differing yields in different market segments

167
Q

Result of government action to increase long-term borrowing?

A

Likely to increase long-term interest rates

168
Q

What is smoothing?

A

Involves maintaining a balance between fixed-rate and floating-rate debt

169
Q

How can asset and liability management hedge interest rate risk?

A

By matching the maturity of assets and liabilities

170
Q

Do options have to be exercised?

A

No, it is optional

171
Q

What does an interest rate swap only involve?

A

Swapping the interest payments

172
Q

How can company hedge interest rate risk on borrowing when using derivatives?

A

By selling interest rate futures now and buying them back in the future

173
Q

What does expectations theory suggest? (interest rates)

A

Current long-term interest rates can be used to predict future short-term interest rates

174
Q

What type of risk is when exports and imports may face is that of exchange losses when accounting results of its foreign branches or subsidiaries are converted into home currency?

A

Translation losses

175
Q

Why is a currency option a particularly suitable device to reduce exposure tocurrency movements when tendering for a contract priced in a foreign currency?

A

You may not get the contract and therefore the currency

176
Q

Are options expensive or cheap?

A

Expensive

177
Q

What is a method of forward contract guarantee?

A

The cash to be paid/received up front so would be classed as less risky than an option

178
Q

Do options provide you with right or obligation to exchange currencies?

A

Right

179
Q

How does interest rate parity predict the forward rate?

A

Uses the current spot rate combined with the home and foreign currency interest rates

180
Q

Interest rate futures (standard)

A

Amounts and periods are standardised

181
Q

Interest rate futures (contracts)

A

Legally binding contracts

182
Q

Interest rate futures (secondary)

A

They can be bought and sold on a secondary market

183
Q

Interest rate futures (hedge)

A

Can be used both to hedge risks and to speculate on interest rate movements

184
Q

Value of the receipt for an individual transaction relates to which risk?

A

Foreign exchange risk exposure

185
Q

When invoicing in dollars, who does exchange rate risk pass to?

A

The customer

186
Q

Is invoicing in dollars commercially acceptable to foreign customers?

A

No, as customers don’t want to take on the exchange rate risk

187
Q

What does M&M with tax say about gearing?

A

That companies should gear up as much as possible

188
Q

Why is cost of debt lower than cost of equity?

A

Mainly due to lower investor risk and tax relief on interest

189
Q

What does market segmentation theory help explain?

A

A wiggle on the yield curve

190
Q

Contract sizes for FRAs and interest rate futures?

A

Standardised contract sizes

191
Q

Real world borrowing for FRAs and interest rate futures?

A

Both result in a net gain or loss that can be offset against gain or loss associated with real-world borrowing

192
Q

Why are futures not always a perfect hedge (risk)

A

Basis risk

193
Q

How does a hedge and FRA/futures position combine?

A

Hedge is constructed by borrowing at the market rate then FRA/futures position generate a gain/loss that can be offset against loss or gain on the associated real-world borrowing

194
Q

What sort of instruments are FRAs?

A

OTC instruments arranged with a bank

195
Q

What is the main reason for an inverted curve?

A

Interest rates are high but expected tofall

196
Q

Yield curve and rising interest rates?

A

A upward sloping yield curve is more likely, all other things being equal

197
Q

What are interest rate options?

A

The right to buy or sell interest rate futures

198
Q

When is an interest rate option exercised?

A

To make a profit on the futures, helps to mitigate any losses on a loan or deposit due to a rise in interest rates

199
Q

What does an interest rate guarantee allow?

A

A company a period of time during which it has the option to buy an FRA at a set price

200
Q

What does an interest rate swap involve?

A

Only the exchange of a floating stream of interest payments for a fixed stream of interest payments

201
Q

What does an interest rate future lock a company into?

A

An effective interest rate

202
Q

Lenders in a swap do?

A

Lenders set rates primarily based on risk assessments

203
Q

What is a transaction risk?

A

The risk of the cash value changing between the contract date and the date of the cash movement due to movements in exchange rates

204
Q

What is a forward rate agreement used for?

A

Hedging against interest rate risk rather thanforeign exchange risk

205
Q

What is not a suitable method for hedging a one-off transaction?

A

A currency swap

206
Q

When will the country with the higher rate will see a depreciation of its currency?

A

Under both purchasing power parity and interest rate parity

207
Q

What can company do in exchange for a premium?

A

Could hedge its interest rate risk by buying interest rate options is correct

208
Q

Benefit of floors?

A

Good for deposits but not borrowing

209
Q

When is matching only viable?

A

With a floating rate on an asset, not on another liability

210
Q

What does purchasing power parity predict?

A

The future spot rate

211
Q

What does the International Fisher effect equate?

A

Difference in interest rates between two countries to the difference in current and future spot rates

212
Q

What does an upward sloping yield curve show? (yields)

A

Shows long-term yields as higher than short-term ones

213
Q

What does liquidity preference theory state?

A

The investors would have to be persuaded to invest for longer time periods

214
Q

How does compensation for default risk increase if default risk increases with duration?

A

Compensation for default risk increases with time and hence long-term bonds must offer higher yields than short-term ones

215
Q

What is meant by smoothing?

A

An interest rate risk hedging technique which involves maintaining a balance between fixed-rate and floating-rate debt

216
Q

Benefit of asset and liability managemetn for hedging?

A

Can hedge interest rate risk by matching the maturity of assets and liabilities

217
Q

How can a borrower hedge interest rate risk?

A

By selling interest rate futures now and buyingthem back in the future

218
Q

What is eschanged using an interest rate swap?

A

Only the interest, not the principal

219
Q

How to set up an interest rate collar for borrowing?

A

Person would have to buy acap and sell a floor

220
Q

What is translation risk?

A

The gain/loss arising from the retranslation of a foreign subsidiary’s results

221
Q

What is transaction risk?

A

Risk of a currency value changing between the transaction and settlement dates due to a movement in exchange rates

222
Q

What is economic risk?

A

The risk of a variation in the value of the business due to unexpected changes in exchange rates

223
Q

What is political risk?

A

Risk of the business being affected by political decisions and is unrelated to exchange rates

224
Q

Issue with payment of the option premium upfront?

A

Will make the option the more expensive means of hedging

225
Q

Standard contract sizes only apply to?

A

Tradeable options

226
Q

Standard contract sizes don’t apply to?

A

OTC options

227
Q

What does a money market hedge bring?

A

The cash translation forward and will therefore provide $ today which could be spent rather than deposited

228
Q

When are forward contracts settled?

A

At the set future date

229
Q

When can interest futures be closed?

A

At any time

230
Q

What is the ideal close out date for interest rate futures?

A

The expiry date

231
Q

Are forward rate agreements long-term instruments?

A

No

232
Q

WHat do caps and floors both make use of?

A

Interest rate options

233
Q

Buying an interest rate option generates what?

A

A cap

234
Q

Selling an interest rate option generates what?

A

A floor

235
Q

Purchasing two options would generate (caps and floors)

A

Two caps rather than one cap and one floor (a collar)

236
Q

What do forward exchange rates reflect?

A

Interest rate parity

237
Q

Change in the spot rate is equal to what in the purchasing power parity?

A

States that the expected change in the spot rate is equal to the expected difference in inflation rate

238
Q

What relates exchange rates and long-term interest rates?

A

Interest rate parity

239
Q

Why are organisations which only operate in domestic markets are still subject to economic risks?

A

As long-term currency movements can make foreign exporters more competitive in the domestic market

240
Q

Unanticipated changes in exchange rates are a cause of what risk?

A

Exchange rate risk

241
Q

WHat does interest rate parity imply? (currency)

A

A currency with a high nominal interest rate will weaken over time against the counter-currency

242
Q

How can the forward rate be calculated?

A

Multiplying the spot rate by the ratio of the interest rates on each currency

243
Q

What can be used to hedge a foreign currency risk?

A

Invoice in euros
Leading or lagging
Currency futures

244
Q

What are forward rate agreements used to hedge?

A

Interest rate risk, not currency risk

245
Q

What can a currency swap be used for?

A

To effectively convert the euro-denominated loan note into a dollar denominated debt

246
Q

WHen are forward contracts not usually available?

A

with delivery dates beyond two years

247
Q

When can a currency swap be arranged?

A

Over several years if the counterparties are agreeable

248
Q

Exports if the domestic currency becomes cheaper?

A

Country’s exports become more competitive

249
Q

Imports if the domestic currency becomes cheaper?

A

More expensive and leads to higher inflation

250
Q

What derivative could be used to hedge the future euro receipt?

A

Call options on the dollar

251
Q

What is a floating exchange rate?

A

Where the central bank does not intervene in the currency markets and allows the exchange rate to be set by market forces

252
Q

What can market segmentation theory explain?

A

Can explain

253
Q

What can expectations theory explain?

A

A downward sloping yield curve

254
Q

What if investors expect interest rates to fall in expectations theory?

A

They will buy long-term fixed interest loan notes, pushing up their price and reducing the yield

255
Q

What do interest rate options allow the buyer to take advantage of?

A

Favourable interest rate movements

256
Q

What does forward rate agreement not allow a borrower to benefit from?

A

A decrease in interest rates

257
Q

Effect on futures if interest rates rise in price?

A

The price of futures falls

258
Q

How to make gains on a falling price in interest rate futures?

A

Initially selling futures (a “short” position”), later closing the hedge through buying futures

259
Q

How can asset and liability management hedge interest rate risk?

A

By matching the maturity of assets and liabilities

260
Q

What can a kink in the normal yield curve be due to (segments)

A

Can be due to differing yields in different market segments

261
Q

When is an inverted (i.e. falling) yield curve likely?

A

If interest rates are expected to decline

262
Q

What can higher default risk cause? (yield curves)

A

Corporate yield curve to rise more steeply than the government yield curve

263
Q

What is translation risk?

A

Gain/loss arising from the retranslation of a foreign subsidiary’s results

264
Q

What is an option more exepnsive to to set up compared to?

A

Forward contract or money market hedge

265
Q

What does a money market hedge bring forward?

A

Cash translation, providing $s today that could be spent rather than deposited

266
Q

Are FRAs long-term instruments?

A

No

267
Q

Can interest rate futures hedges be closed at any time?

A

Yes

268
Q

Why are organisations which only operate in domestic markets are still subject to economic risk?

A

As long-term currency movements can make foreign exporters more competitive in the domestic market

FM (Test) (8 decks)

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