International finance Flashcards
how to calculate bid-ask spread
ask-bid
———- x 100
ask
there should be two answers for this. one should have ask as the denominator and the other should have the bid
what is the bid ask spread
the difference between the bid and ask price
what is the bid price
the highest point a market maker (banker or broker) is willing to buy
what is the ask (offer) price
the lowest point the market maker (banker or broker) is willing to sell
what is the cross rate
an exchange rate between a currency pair to which neither currency is compared to the US
what is the forward premium
when the expected future price of a currency is above spot price which indicates a future increase in the currency price.
how to calculate the forward premium
spot- forward
——————– X 360/180 (annualise)
spot
what is the forward discount
when the forward rate is less than the spot rate
when you take a short position what does it mean.
It means you are expecting stock price to fall
you borrow shares now and pay them back at a later date.
when you take a long position what does it mean
it means you are expecting stock price to rise
you buy shares now and sell them at a later date
what the difference between the forward and future contract
forwards- OTC and personalised contract
forwards need to be individual when they are attacking
futures- standardised and regulated contracts
what is a call option
an option contract with an opportunity to buy
what is a put option
an option contract with an opportunity to sell
what does an X or an E mean when we are talking about forward contracts
strike price-
For call options, the strike price is where the security can be bought by the option holder; for put options, the strike price is the price at which the security can be sold.
long call contract owner has an obligation or a right to buy
has the right to buy. Because he is in the option market he is not forced to buy when the contract expired
does a short call seller have an obligation or right to sell
is obliged to sell the contract if the option is exersized
does a long call option owner have an obligation to sell or the right to sell
has the right to sell
what does it mean when an option is classed as on the money
the strike= spot
what is the difference between a European contract and an American forward contract
an American contract is free and can be exercised at any point up until the expiration date.
European contract can only be exercised at the expiration date
what does it mean when an option is classed as out of the money
call= strike price is greater than spot
put= strike price is less than the spot
what does it mean when an option is in the money
call= strike is lower that the spot. exercise the option to buy the stock for less than the market and immediately sell it at the higher market price.
put= strike price is higher than the spot
giving the holder the right to sell the option above the current market price
why would a trader engage in an out of the money contract
because these contracts may have time value.
More time that remains until expiration generally means a greater time value of the option. Investors are willing to pay a higher premium for more time because the contract will have longer to profit from a favorable move in the underlying asset.
when a price increase is expected what shall i do
Long call
buy call option.
sell put option
when a price decrease is expected what shall i do
sell the call options.
the option seller will keep the premium if the price closed below the strike price.
buy put option. sell now
what is included in the balance of payments current account
a record of a country’s international transactions with the rest of the world.
Imports and export
Unilateral transfer (aid or gifts)
what is included in the balance of payment capital account
shows the investments and income flow between countries
The transfer of ownership of fixed assets and of funds received for the sale or acquisition of fixed assets
Gift and inheritance taxes
Death levies, patents, copyrights, royalties
Uninsured damage to fixed assets
what does a capital account deficit show
that there is more money flowing out
what does the financial account on the balance of payments show
- domestic ownership of foreign assets.
- the foreign ownership of domestic assets.
describe the binomial model
binomial models are used to price options.
the assumptions are that there are two possible outcomes—price moves up, or a move down.
When the pay off in both outcomes is equaly that is the price of the option.
what is interest rate parity
difference between interest rate of 2 countries should be equal to the forward rate discount or premium of the foreign currency
How can i profit of IRP differences
- does irp hold
spot X interest a/ interest b
=theoretical forward rate. - borrow currency
- trade at spot
- invest at higher interest
- sell at forward
what coniditions are required for IRP to hold.
1.easy capital mobility.
2.substitutability of assets
what is the difference between uncovered and covered interest rates.
Covered- the difference between two international rates should be equal to the forward premium or discount.
Uncovered- the difference between two interest rates should be equal to the rate of change in exchange rates.
(doesn’t use derivatieves)
both have NO arbitrage theory – no profit could be made on the foreign exchange market
what is the law of one price (LOOP)
a price of a good should be the same in all countries (once measured in a common currency)
what is the purchasing power parity.
the exchange rate in which you would be able to buy an identical basket of goods for the same price.
why may purchasing power parity not hold.
- trade restrictions
- services like haircuts are less substitutable and easily traded.
- countries highly dependant on oil may be prone to inflation or sudden price changes.
how to calculate purchasing power parity.
cost of good in county 1
—————————–= exchange rate
cost of good in country 2
what is the difference between absolute purchasing price parity and relative purchasing price parity.
Absolute PPP price ratio level of exchange rates should be aligned
Relative PPP- rate of change in exchange rate should equal inflation rate
country a has a lower interest rate than country b. Does this mean there should be a forward premium or discount for currency of country a
there should be a forward premium.
According to IRP theory the currency of a country with a lower interest rate should be trading at a forward premium in terms of the currency with the higher rate.
what forward strategy do i need to do to mitigate against currency risk
buy a put option Look this up
what is the difference between a bullish and a bearish investor
bullish- assumes the stock price will rise
bearish- assumes prices will fall.
the chicago bulls win everything
explain a short call.
a short call is a trading strategy used to profit a future fall in underlying value.
we sell the option to buy. If market prices is lower than the exercise price on the date of expiration a buyer will have no incentive to exersize the contract and the seller will profit from the future premium.
explain a long put.
a long put is a trading strategy used to profit from a future fall in underlying value.
we buy the option to sell. If market prices are lower than the strike price we can sell our asset at the (higher) strike price.
explain a short put.
a short put strategy is used to profit from a future increase in price of an underlying asset
we sell the option to sell. If the future spot is higher than the exercise price then it makes no sense for a seller to exercise the contract. In this case we benefit from the premium.
explain a long call.
a long call strategy is used to profit from a future increase in the price of an underlying asset
we buy the option to buy. if the future spot price is higher than the exercise price we can buy at the cheaper strike price.
which trading strategies profit off the futures premium.
short call and a short put
what did the Bretton Woods Agreement establish
The IMF came into formal existence in December 1945, when its first twenty-nine member countries signed its Articles of Agreement.
The countries agreed to keep their currencies fixed but adjustable (within a 1 percent band) to the dollar, and the dollar was fixed to gold at $35 an ounce. (1944)
what is the direct interest rate.
how many dollars i need to buy a foreign currency
The quote is direct when the price of one unit of foreign currency is expressed in terms of the domestic currency.
USD/GPB
When it is direct domestic comes first.
what is a cross currency exchange rate
The exchange rate between two currencies where neither currency is the US dollar
what is the indirect exchange rate
how much foreign currency do i need to buy one dollar
when the price of one unit of domestic currency is expressed in terms of Foreign currency.
GPB/ USD.
Indirect prioritises foreign
if €1 = $1.25 which is the denominator
dollar is the denominator. 1 is always the value on the top.
if you want to express the value of the dollar in terms of pounds which is the denominator
GPB/ USD
You want to express the value of the dollar in pound so this number will be different to 1.
