Important Flashcards
Money market hedge - Payment to FX supplier
- Deposit payment amount in FX - Payment / (1+(FX dep interest x months/12))
- Buy FX at spot rate - Above / spot rate (left)
- Borrow £ for total payment - Above amount x (1+(£ borrowing rate x months/12))
Money market hedge - Receipt from FX customer
- Borrow receipt in FX - Receipt / (1+(FX borrowing interest x months/12))
- Sell FX at spot rate - Above / spot rate (right)
- Deposit £ for total receipt - Above amount x (1+(£ deposit rate x months/12))
Forward contract exchange rate
Spot rate + discounts - premiums
- receipts use spot rate on right
Exchange rate futures
- Buy/sell? FX payment = buy FX and Sell £
- When?
- How many? FX payment / current futures price
- Above / contract size
- Gain/Loss - Sell at current futures price - buy at what futures price will be
- Gain/Loss x contract size x no. contracts
- Net amount = (Original payment - gain) / spot rate
Exchange rate OTC currency options
- Buy/sell? FX payment – Buy FX – call option
- When?
- Exercise? If option to exercise price higher than spot rate, then exercise
- Calculate premium, plus interest (£ deposit)
- Payment amount / exercise spot rate + premium
What is Interest Rate Parity and how is it calculated?
Predicts the forward rate based on interest rates
Spot rate x (1+FX interest rate) / (1 + £ interest rate)
What is an economic risk?
Loss of international competitiveness due to exchange rates moving unfavourably
Can hedge risk through diversification
What is translation risk?
International operations lose value when revenue and assets translated back to company’s reporting currency for financial statements
Interest rate - no hedge
Loan amount x bank rate
Interest rate - Options
- If option rate is higher than bank rate for borrow – do not exercise.
- Loan amount x bank rate + premium - If option rate is lower than bank rate for borrow – exercise
- Loan amount x option rate + premium
Interest rate - forwards
- Calculate the loan interest from the bank
- Add gain/loss (Forward rate – bank rate) x Amount borrowed x months/12
- Check – Amount borrowed x forward rate x months/12
Interest rates - futures
- Buy/sell? Borrow = sell
- When?
- How many? Loan amount / contract size x loan months/3 months
- Gain/Loss - Strike price (sell) vs futures price (buy)
- Gain/Loss on futures - Gain/loss x contract size x no. contracts x months/12
- Interest on loan - Amount borrowed x interest rate x months/12
- Premium
- Interest cost = Interest paid on loan +gain/loss + premium
What does linear regression identify?
Independent variables associated with a change in a dependant variable
List some statistical bias
Selection bias: not representative of whole population
Observer bias: Researcher bias
Survivorship bias: some data already removed
What does standard deviation measure?
The variation in a data set (=STDEV funtion)
Higher = higher risk
What is the co-efficient variation?
Standard deviation / mean
Shows the significance of the variation.
What does correlation show?
How strong the relationship is between two variables (=CORREL function)
Positive: both increase (1 prefect)
What are real options?
NPV only considers identifiable cash flows. There could be other benefits in the future if certain courses of action are taken
Give examples of real options
Follow on: Opportunity to launch newer versions
Timing: Can decide when to commence
Abandonment: Opportunity to reduce capacity
List some risks of domestic trading
Physical: damage/stolen
Credit: customer default
List some risks of international trading
Political
Cultural
FX
List 7 things that can increase the PV of future cash flows
Sales (max)
Life of cash flows (max)
Operating margin (max)
Working capital (min)
Cost of capital (min)
Assets (min)
Tax (min)
List environmental costs
Conventional (raw mat etc)
Potentially hidden (general overheads)
Contingent (future)
Image & relationship (intangibles)
How do you calculate replacement analysis?
1 year replacement: PV of cash flows / annuity factor for 1 year
What is hard capital rationing?
When a company is forced to limit its capital due to external factors, while soft capital rationing is when a company chooses to limit its capital due to internal factors
Disadvantages of CAPM
Hard to identify risk-free rate, average market return and beta factors
Assumes all investors are diversified
Disadvantages of DVM?
Estimating g is difficult
Historic inputs: not indicator of future
Assumes perpetual dividend growth
How do you calculate cost of preference shares?
Kp = D / P
How do you calculate cost of Irredeemable debt?
Kd = I x (1-T) / P
How do you calculate interest cover?
Profit before interest / Interest
