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
2
Q
How to eliminate currency transaction risk?
A
Eliminates the currency transaction risk
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
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
5
Q
Can the currency options be exercised or lapsed?
A
Yes
6
Q
Should a money market hedge give approximately the same result as a forward contract?
A
Yes
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
8
Q
What does the outcome of a money market hedge depend on?
A
Difference between the interest rate on each currency
9
Q
What is meant by an appreciation of a domestic currency?
A
The domestic currency becomes stronger
10
Q
What can appreciation of currency cause the country’s exports to do?
A
More expensive and less competitive
11
Q
What can appreciation of currency cause the country’s imports to do?
A
Cheaper which tends to reduce inflation
12
Q
What type of risk is gains or losses arising on the consolidation of foreign-denominated assets of liabilities
A
Translation risk
13
Q
What type of risk is impact on cash flows of the long-term exchange rate trend
A
Economic risk
14
Q
What type of risk is impact on cash flows of a short-term change in the exchange rate
A
Transaction risk
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
16
Q
What risks are associated with revenues being affected by long-term exchange rate trends?
A
Transaction and economic risks
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
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
19
Q
What types of contracts are OTC options?
A
Not exchange-traded and can be customised
20
Q
What types of contracts is a forward rate agreement?
A
A bespoke contract rather than a stan dardised contract
21
Q
What does liquidity preference theory suggest?
A
Investors prefer to have their cash returned to them sooner rather than later
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
23
Q
What does expectations theory suggest?
A
Shape of the yield curve depends on the expectations of investors regarding future interest rates
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”
25
What is an interest rate floor?
Protects its holder from falling interest rates but allows participation in rising interest rates
26
Which of derivative instruments are characterised by a standard contract size?
Futures contract
Exchange-traded option
27
What does interest rate parity theory link?
The one-year forward exchange rate and the current spot exchange rate
28
What is the foreign nominal interest rate greater than in interest rate parity theory?
Domestic nominal interest rate
29
When is a 3 v 9 FRA appropriate?
Borrowing intends to make three months from now for a further period of six months.
30
What is meant by a gap exposure?
The difference between the amounts of interest-sensitive assets and liabilities
31
What derivative instruments are characterised by a standard contract size?
Futures contract
Exchange tradable option
32
What is meant by smoothing?
Holding a balanced mix of both fixed and floating rate debt
33
Benefits of smoothing?
Will reduce the effects of an interest rate change but not eliminate it completely
34
Interest payments and smoothing?
Interest payments will still increase following a rise in rate
35
What is agreed in an OTC option?
An agreement with a financial institution and an immediate premium is payable on taking out the option
36
What is meant by an interest rate cap?
To limit the maximum interest rate
37
What is meant by an interest rate collar?
A combination of a cap and a floor and could be used to protect both against increase and decrease in interest rates
38
Is a money market hedge used for hedging foreign exchange risk or interest rates?
Foreign exchange risk
39
Which derivatives are standardised in nature?
Derivative hedging instruments that are traded on an exchange or market
40
Are exchange-traded options standardised?
Yes
41
What is a forward rate agreement?
An agreement between a bank and a customer to fix an interest rate on an agreed amount of funds for an agreed future period
42
Are swaps standardised in nature?
No, as they are tailored to customer's needs
43
Are futures contracts relatively cheap?
Yes, as they are subject to a brokerage fee only
44
Is it possible to purchase futures contracts from every currency to every other currency?
No
45
Are futures contracts for standardised amounts?
Ues, so may not match the size of the transaction being hedged precisely
46
What does the international fisher effect assume?
Real interest rates are the same
47
What to do to hedge against interest rate increased?
Interest rate futures should be sold now
48
Debt portfolio in smoothing?
Consists of a mixture of fixed and floating rate debt
49
Interest payments in smoothing?
Will still increase if the interest rate rises
50
When can an inverted yield curve arise?
If government policy is to keep short-term interest rates high to bring down inflation
51
What is meant by a gap exposure?
Difference between amount of interest-sensitive assets and liabilities
52
Does forward contract have a standard contract size?
No
53
Does forward rate agreement have a standard contract size?
No
54
Does futures contract have a standard contract size?
Yes
55
Does swap have a standard contract size?
No
56
Does OTC have a standard contract size?
No
57
Does exchange tradable option have a standard contract size?
Yes
58
What form of settlement date to currency futures have?
A fixed settlement date
59
What does buying a currency option involve (premium)?
Paying a premium to the option seller (fee is non-refundable)
60
What can currency swaps be used for?
To hedge exchange rate risk over longer periods than the forward market
61
When there's longer the term to maturity, how does this effect interest?
The higher the rate of interest
62
Why does longer term loan notes require a higher yield?
Longer term is considered less certain and more risky
63
Result of governments can keep interest rates low by selling short-dated government bills in the money market?
Reduces money supply and could put upward pressure on interest rates
64
Fall in country's exchange rate effect on exports and imports?
Exports are cheaper and imports are more expensive
65
Are forward contracts traded over counter or exchange traded?
Traded over the counter
66
Are currency futures traded over counter or exchange traded?
Exchange traded
67
Are forward contracts available in any currency?
Yes
68
Are currency futures available in any currency?
Only in a limited range of currencies
69
What are expected future spot rates based on?
Relative inflation rates between two countries
70
What are current forward excchange rates based on?
Relative interest rates between two countries
71
Where does PPP tend to hold?
For the longer term
72
Does transaction risk affect cash flows?
Yes
73
Does translation risk directly affect shareholder wealth?
No
74
Wgere do standard contract sizes only apply to?
Tradable options, not OTC options which will be tailored to needs of the customer
75
What can cause a kink in the normal yield curve be due to?
Differing yields in different market segments
76
How can asset and liability management hedge interest rate risk?
By matching the maturity of assets and liabilities
77
What is smoothing?
Maintaining a balance between fixed-rate and floating-rate debt
78
How can interest rate risk be hedged on borrowing?
By selling interest rate futures now and buying them back in the future
79
What does an interest rate swap only involve?
Swapping the interest payments
80
Do options have to be exercised by their expiry date?
No, this is optional
81
How to hedge interest rate risk?
Need to buy a cap and sell a floor
82
Which is more cost effective, interest rate collar or interest rate floor?
An interest rate floor
83
What happens to price of interest rate if interest rates rise in interest rate futures?
It decreases
84
Why is there no translation risk for limiting its overseas operations to exp[orts to foreign countries?
There is no foreign subsidiary or foreign-denominated assets or liabilities
85
What happens if forward exchange rate is greater than current spot exchange rate in interest rate parity theory?
The variable "foreign" nominal interest rate is greater than the base "domestic" nominal interest rate
86
What does the term matching refer to?
The balancing of receipts and payments in the same currency
87
Do nothing for three months and then buy euros at thespot rate (would this provide cover for exchange rate exposure)?
Would not provide cover
88
Pay in full now, buying euros at today’s spot rate (would this provide cover for exchange rate exposure)?
Would provide cover
89
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)?
Would provide cover
90
Arrange a forward exchange contract to buy the eurosin three months’ time (would this provide cover for exchange rate exposure)?
Would provide cover
91
Is lagging a hedging technique?
No, lagging does not guarantee a lowering of risk
92
What exposure does matching receipts and payments reduce?
Transaction exposure
93
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)
Gain
94
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)
No effect
95
What is meant by basis?
The difference between the price of a futures contract and the spot price on a given date
96
What can currency swaps be used for (exchange rate risk)
Can be used to hedge exchange rate risk over longer periods than theforward market
97
Is the close out date already set for currency futures when purchased?
Yes
98
Are forward contracts binding?
Yes and will not be allowed to lapse by the bank
99
When are options paid for?
When they are taken on
100
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)
Loss as they have to pay more £ to purchase C$ payable
101
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)
No effect as it invoices in local currency
102
Are exports given a stimulus for when there is a fall in the value of a country's currency?
Yes
103
When does demand-pull inflation arise?
When demand for locally produced goods is high
104
When does cost-push inflation arise?
When the domestic producer's costs goup and they have to increase prices to remain profitable
105
What are the effects on imports and exports if a coutnry's currency falls?
Great for exports but it makes imports more expensive
106
What can create cost-push inflation?
Any business that usesimported materials in its production will see its costs go up
107
What is a put option?
The right to sell an asset at a fixed price
108
What is the aim of a forward rate agreement (FRA)?
To lock the company into a targetinterest rate and hedge both adverse and favourable interest rate movements
109
Why is an interest rate guarantee (IRG) more expensive than an FRA?
One has topay for the flexibility to be able to take advantage of favourable interest rate movements
110
What happens when you sell a futures contract?
You have a contract to borrow money (not lend)
111
Amount in interest rate futures contact?
Each contract is for a standardised amount with a set maturity date
112
What does liquidity preference theory help explain?
An upward sloping curve
113
What does expectations theory help explain?
An upward sloping curve indicates that interest rates will rise in the future
114
What does market segmentation theory help explain?
There may be different shapes to thecurve at the long-term and short-term ends
115
Does a flat yield theory influence the yield curve?
NO
116
What is shown by a yield curve?
The relationship between time to maturity and the return to bond investors
117
What does an option give fliexibility for?
To protect against unfavourable movements, but take advantage of favourable one
118
Why does the normal yield curve slope upwards?
To reflect increasing compensation to investors forbeing unable to use their cash now
119
What type of policy is raising interest rates?
A contractionary monetary policy that would stifle spending
120
Does expectations theory relate to future interest rates or inflation rates?
Future interest rates
121
Limitation of interest rate parity theory (government)
Government controls on capital markets
122
Limitation of interest rate parity theory (currency)
Controls on currency trading
123
Limitation of interest rate parity theory (foreign)
Intervention in foreign exchange markets
124
What is basis risk relevant to?
One of the reasons for an imperfect currency futureshedge
125
Benefit for a floor being a minimum rate?
It is useful for hedging against falls in rates for a deposit
126
Issue with the standardised nature of future contracts?
Over-or under-hedging is very likely (an imperfect hedge)
127
When is the premium on an option payable?
When the option is purchased
128
What is the cost of an interest rate floor higher than?
The cost of an interest rate collar
129
What is meant by smoothing?
Holding a balanced mix of both fixed and floating rate debt
130
What does smoothing reduce?
Effects of an interest rate change but not eliminate it completely
131
Interest payments and smoothing?
Will still increase following a rise in rates
132
What sort of strategy is financing fixed cash flow investments with fixed rate debt?
A matching strategy, not smoothing
133
Why won't fill benefit not be obtained from a fall in rates (debt portfolio)
Due to the fixed element of the debt portfolio
134
Do exchangeable tradeable options have a standard contract size?
Yes
135
Do futures contracts have a standard contract size?
Yes
136
Do forward contract have a standard contract size?
No
137
Do forward rate agreement have a standard contract size?
No
138
Do swap have a standard contract size?
No
139
Do OTC have a standard contract size?
No
140
What is an OTC option?
An agreement with a financial institution and an immediatepremium is payable on taking out the option
141
When can an OTC option only be exercised?
If actual interest rates are less favourable
142
Can an OTC option be traded?
No
143
What can be done to reduce risk of euro value dropping relative to dollar before 750000 euros is received?
Enter into a forward contract to sell 750000 euros in 6 months
144
Benefit of currency swaps over forward market?
Currency swaps can be used to hedge exchange rate risk over longer periods than the forward market
145
What settlement date does a currency futures have?
A fixed settlement date
146
What does buying a currency option involve?
Paying a premium to the option seller
147
What sort of fee is on a currency option?
A non-refundable fee which is paid when the option is acquired
148
Shape of the normal yield curve?
Slopes upward to reflect increasing compensation to investors for being unable to use their cash now
149
Why does long-term require a higher yield?
As it is considered less certain and more risky
150
When governments sell short-dated government bills in the money market?
Puts upward pressure on interest rates as it reduces money supply
151
Imports and exports when there's a fall in a country's exchange rate?
Exports are cheaper
Imports are more expensive
152
Are futures contracts tailored to user's needs?
No, they are standard contracts
153
Forward contracts (traded)
Traded over counter
154
Forward contracts (price)
Contract price is in any currency offered by the bank
155
Futures contracts (traded)
Exchange traded
155
Futures contracts (price)
Only available in a limited range of currencies
156
How is expected future spot rate calculated?
On relative inflation rates between two countries
157
How are current forward exchange rates set?
On the relative interest rates between them
158
Why is expected spot rate and current forward rate the same?
Expectations theory states that there is an equilibrium between relative inflation rates and relative interest rates
159
Does transaction risk affect cash flows?
Yes
160
Does translation risk directly affect shareholder wealth?
No
161
Does diversification of supplier and customer base across different countries reduce which risk?
Economic risk
162
Examp,e of hedging a translation risk?
By matching the currency of assets and liabilities
163
Issue of payment of the option premium upfront?
Makes the option the more expensive means of hedging
164
Where do standard contract sizes only apply to?
Tradeable options, not OTC options
165
Difference between forward contract vs money market hedge? (time difference)
Forward contract receiving dollar equivalent of MS receipt in 3 month's time
Money market hedge provides dollar receipts today
166
What causes a kink in the normal yield curve?
Can be due to differing yields in different market segments
167
Result of government action to increase long-term borrowing?
Likely to increase long-term interest rates
168
What is smoothing?
Involves maintaining a balance between fixed-rate and floating-rate debt
169
How can asset and liability management hedge interest rate risk?
By matching the maturity of assets and liabilities
170
Do options have to be exercised?
No, it is optional
171
What does an interest rate swap only involve?
Swapping the interest payments
172
How can company hedge interest rate risk on borrowing when using derivatives?
By selling interest rate futures now and buying them back in the future
173
What does expectations theory suggest? (interest rates)
Current long-term interest rates can be used to predict future short-term interest rates
174
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?
Translation losses
175
Why is a currency option a particularly suitable device to reduce exposure tocurrency movements when tendering for a contract priced in a foreign currency?
You may not get the contract and therefore the currency
176
Are options expensive or cheap?
Expensive
177
What is a method of forward contract guarantee?
The cash to be paid/received up front so would be classed as less risky than an option
178
Do options provide you with right or obligation to exchange currencies?
Right
179
How does interest rate parity predict the forward rate?
Uses the current spot rate combined with the home and foreign currency interest rates
180
Interest rate futures (standard)
Amounts and periods are standardised
181
Interest rate futures (contracts)
Legally binding contracts
182
Interest rate futures (secondary)
They can be bought and sold on a secondary market
183
Interest rate futures (hedge)
Can be used both to hedge risks and to speculate on interest rate movements
184
Value of the receipt for an individual transaction relates to which risk?
Foreign exchange risk exposure
185
When invoicing in dollars, who does exchange rate risk pass to?
The customer
186
Is invoicing in dollars commercially acceptable to foreign customers?
No, as customers don't want to take on the exchange rate risk
187
What does M&M with tax say about gearing?
That companies should gear up as much as possible
188
Why is cost of debt lower than cost of equity?
Mainly due to lower investor risk and tax relief on interest
189
What does market segmentation theory help explain?
A wiggle on the yield curve
190
Contract sizes for FRAs and interest rate futures?
Standardised contract sizes
191
Real world borrowing for FRAs and interest rate futures?
Both result in a net gain or loss that can be offset against gain or loss associated with real-world borrowing
192
Why are futures not always a perfect hedge (risk)
Basis risk
193
How does a hedge and FRA/futures position combine?
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
What sort of instruments are FRAs?
OTC instruments arranged with a bank
195
What is the main reason for an inverted curve?
Interest rates are high but expected tofall
196
Yield curve and rising interest rates?
A upward sloping yield curve is more likely, all other things being equal
197
What are interest rate options?
The right to buy or sell interest rate futures
198
When is an interest rate option exercised?
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
What does an interest rate guarantee allow?
A company a period of time during which it has the option to buy an FRA at a set price
200
What does an interest rate swap involve?
Only the exchange of a floating stream of interest payments for a fixed stream of interest payments
201
What does an interest rate future lock a company into?
An effective interest rate
202
Lenders in a swap do?
Lenders set rates primarily based on risk assessments
203
What is a transaction risk?
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
What is a forward rate agreement used for?
Hedging against interest rate risk rather thanforeign exchange risk
205
What is not a suitable method for hedging a one-off transaction?
A currency swap
206
When will the country with the higher rate will see a depreciation of its currency?
Under both purchasing power parity and interest rate parity
207
What can company do in exchange for a premium?
Could hedge its interest rate risk by buying interest rate options is correct
208
Benefit of floors?
Good for deposits but not borrowing
209
When is matching only viable?
With a floating rate on an asset, not on another liability
210
What does purchasing power parity predict?
The future spot rate
211
What does the International Fisher effect equate?
Difference in interest rates between two countries to the difference in current and future spot rates
212
What does an upward sloping yield curve show? (yields)
Shows long-term yields as higher than short-term ones
213
What does liquidity preference theory state?
The investors would have to be persuaded to invest for longer time periods
214
How does compensation for default risk increase if default risk increases with duration?
Compensation for default risk increases with time and hence long-term bonds must offer higher yields than short-term ones
215
What is meant by smoothing?
An interest rate risk hedging technique which involves maintaining a balance between fixed-rate and floating-rate debt
216
Benefit of asset and liability managemetn for hedging?
Can hedge interest rate risk by matching the maturity of assets and liabilities
217
How can a borrower hedge interest rate risk?
By selling interest rate futures now and buyingthem back in the future
218
What is eschanged using an interest rate swap?
Only the interest, not the principal
219
How to set up an interest rate collar for borrowing?
Person would have to buy acap and sell a floor
220
What is translation risk?
The gain/loss arising from the retranslation of a foreign subsidiary's results
221
What is transaction risk?
Risk of a currency value changing between the transaction and settlement dates due to a movement in exchange rates
222
What is economic risk?
The risk of a variation in the value of the business due to unexpected changes in exchange rates
223
What is political risk?
Risk of the business being affected by political decisions and is unrelated to exchange rates
224
Issue with payment of the option premium upfront?
Will make the option the more expensive means of hedging
225
Standard contract sizes only apply to?
Tradeable options
226
Standard contract sizes don't apply to?
OTC options
227
What does a money market hedge bring?
The cash translation forward and will therefore provide $ today which could be spent rather than deposited
228
When are forward contracts settled?
At the set future date
229
When can interest futures be closed?
At any time
230
What is the ideal close out date for interest rate futures?
The expiry date
231
Are forward rate agreements long-term instruments?
No
232
WHat do caps and floors both make use of?
Interest rate options
233
Buying an interest rate option generates what?
A cap
234
Selling an interest rate option generates what?
A floor
235
Purchasing two options would generate (caps and floors)
Two caps rather than one cap and one floor (a collar)
236
What do forward exchange rates reflect?
Interest rate parity
237
Change in the spot rate is equal to what in the purchasing power parity?
States that the expected change in the spot rate is equal to the expected difference in inflation rate
238
What relates exchange rates and long-term interest rates?
Interest rate parity
239
Why are organisations which only operate in domestic markets are still subject to economic risks?
As long-term currency movements can make foreign exporters more competitive in the domestic market
240
Unanticipated changes in exchange rates are a cause of what risk?
Exchange rate risk
241
WHat does interest rate parity imply? (currency)
A currency with a high nominal interest rate will weaken over time against the counter-currency
242
How can the forward rate be calculated?
Multiplying the spot rate by the ratio of the interest rates on each currency
243
What can be used to hedge a foreign currency risk?
Invoice in euros
Leading or lagging
Currency futures
244
What are forward rate agreements used to hedge?
Interest rate risk, not currency risk
245
What can a currency swap be used for?
To effectively convert the euro-denominated loan note into a dollar denominated debt
246
WHen are forward contracts not usually available?
with delivery dates beyond two years
247
When can a currency swap be arranged?
Over several years if the counterparties are agreeable
248
Exports if the domestic currency becomes cheaper?
Country’s exports become more competitive
249
Imports if the domestic currency becomes cheaper?
More expensive and leads to higher inflation
250
What derivative could be used to hedge the future euro receipt?
Call options on the dollar
251
What is a floating exchange rate?
Where the central bank does not intervene in the currency markets and allows the exchange rate to be set by market forces
252
What can market segmentation theory explain?
Can explain
253
What can expectations theory explain?
A downward sloping yield curve
254
What if investors expect interest rates to fall in expectations theory?
They will buy long-term fixed interest loan notes, pushing up their price and reducing the yield
255
What do interest rate options allow the buyer to take advantage of?
Favourable interest rate movements
256
What does forward rate agreement not allow a borrower to benefit from?
A decrease in interest rates
257
Effect on futures if interest rates rise in price?
The price of futures falls
258
How to make gains on a falling price in interest rate futures?
Initially selling futures (a “short" position”), later closing the hedge through buying futures
259
How can asset and liability management hedge interest rate risk?
By matching the maturity of assets and liabilities
260
What can a kink in the normal yield curve be due to (segments)
Can be due to differing yields in different market segments
261
When is an inverted (i.e. falling) yield curve likely?
If interest rates are expected to decline
262
What can higher default risk cause? (yield curves)
Corporate yield curve to rise more steeply than the government yield curve
263
What is translation risk?
Gain/loss arising from the retranslation of a foreign subsidiary's results
264
What is an option more exepnsive to to set up compared to?
Forward contract or money market hedge
265
What does a money market hedge bring forward?
Cash translation, providing $s today that could be spent rather than deposited
266
Are FRAs long-term instruments?
No
267
Can interest rate futures hedges be closed at any time?
Yes
268
Why are organisations which only operate in domestic markets are still subject to economic risk?
As long-term currency movements can make foreign exporters more competitive in the domestic market
