Hedging Flashcards
Pros of forwards?
1) Tailored
2) No risk of hedge efficiency (futures)
Cons of forwards?
1) Legally binding, can’t be dissolved
2) Not tradeable
3) Subject to risk of your receipt not paid (if receipt)
4) Used on large transactions only
5) Limited currencies
6) No potential upside
Pros of futures?
1) Tradable
2) Use for smaller transactions
3) Flex using no. of contracts
Cons of futures?
1) Can be inefficient hedge > part unprotected
2) No potential upside
3) Limited currencies
Pros of OTC options?
1) Tailored
2) Benefit from upside
Cons of OTC options?
1) Not tradable
2) Expensive premiums
Pros of options?
1) Benefit from upside
Cons of options?
1) Expensive premiums
Pros of swaps?
1) Both parties benefit “comparative advantage”
2) Arrangement costs < than terminating existing loan and taking out new
3) Make interest rate savings
4) Available for longer periods of time
5) Flexible
Cons of swaps?
1) Risk the counter party will default
2) Risk of an adverse movement in interest/exchange rates
3) Risk that the accounts may be misleading
What is the definition of “real options”?
- “Real” because it usually for projects involving a tangible asset instead of financial instrument
- Not a derivative, but for actual opportunities a business may take advantage or may realise
What is the mnemonic for real options?
FLexibile
Abandonment
Timing
FOllow on
Growth
If you are a borrower do you buy or sell FRAs?
Buy
If you are a lender do you buy or sell FRAs?
Sell
If you are a borrower do you buy or sell futures?
Sell
