Hedging Flashcards
WHAT IS A FORWARD?
Binding agreement to exchange a set amount of goods at a set price agreed today.
WHAT ARE THE 3 TYPES OF FOREIGN CURRENCY RISK?
Transaction risk - risk of adverse exchange rate movements
Translation risk - risk that the organisation will make exchange losses when the accounting results of its foreign branches or subsidiaries are translated into home currency.
Economic risk - effect of exchange rate movements on the international competitiveness of a company
WHAT ARE THE ADVANTAGES AND DISADVANTAGES OF FORWARDS?
ADVANTAGES
- both parties have certainty so are better enabled to budget
- eliminates risk completely
- no downside risk
DISADVANTAGES
- no upside potential
- risk re-exposed if transaction falls through
WHAT IS A FUTURES?
A commitment to an additional transaction in the future that limits the risk of existing commitments.
WHAT ARE THE ADVANTAGES AND DISADVANTAGES OF FUTURES?
ADVANTAGES
- eliminates risk completely
- no downside risk
DISADVANTAGES
- no upside potential
- can only be bought in standard contracts for set dates, perfect hedge may not be
achieved
TO PROTECT AGAINST A PRICE RISE DO YOU BUY OR SELL FUTURES?
Buy
TO PROTECT AGAINST A PRICE FALL DO YOU BUY OR SELL FUTURES?
Sell
WHAT IS AN INDEX FUTURES AND DO YOU BUY/ SELL THEM?
They are used to protect against falls in values of portfolio shares.
You would sell future contracts today as we are protecting against a price fall.
WHAT IS AN INDEX OPTION AND DO YOU BUY/ SELL THEM?
Used to protect against a fall in value of portfolio of shares.
You would sell put options today.
HOW DO YOU CALCULATE THE CONTRACT SIZE OF AN INDEX OPTION?
Exercise price x £10
HOW DO YOU CALCULATE THE CONTRACT NUMBER ON INDEX OPTIONS?
Current portfolio value / contract size
HOW DO YOU CALCULATE THE PREMIUM ON AN INDEX OPTION?
Points (per table) x £10 x # contracts
WHAT IS A CALL OPTION?
Buy shares
WHAT IS A PUT OPTION?
Sell shares
WOULD A BORROWER BUY OR SELL TODAY?
Sell today (put option)
WOULD A LENDER BUY OR SELL TODAY?
Buy (call option)
HOW DO YOU CALCULATE THE PROFIT OR LOSS ON A INTEREST RATE FUTURES?
Interest on loan (% x £ x months) (X)
Futures outcome:
Opening rate 100 - i
Closing rate 100 - i
# x contract size /4 x contract # X
__
Net effect X
DO YOU ADD OR DEDUCT THE FOWARD RATE FROM THE SPOT RATE WHEN IT IS QUOTED AT A
1) PREMIUM
2) DISCOUNT
Premium = deduct Discount = add
WOULD AN EXPORTER BUY OR SELL FUTURES TODAY?
Sell futures
WOULD AN IMPORTER BUY OR SELL FUTURES TODAY?
Buy futures
FOR A MARKET HEDGE, WHAT WOULD YOU DO IF YOU WERE TO RECEIVE $ IN THE FUTURE?
Borrow $ and covert to £ = buy put options.
Pay $ interest and receive £ interest.
FOR A MARKET HEDGE, WHAT WOULD YOU DO IF YOU WERE TO PAY $ IN THE FUTURE?
Borrow £ and covert to $ = buy call options.
Pay £ interest and receive $ interest.
