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ICAS - AFin > Module 14 > Flashcards

Module 14 Flashcards

1
Q

Foreign exchange risk

A

Risk that exchange rates will move in such a direction as to cost a company

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2
Q

Bid rate

A

Buying

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3
Q

Ask rate

A

Selling

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4
Q

Spread

A

Difference between bid and ask

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5
Q

Reason exchange rates move

A

Purchasing power parity (PPP) theory

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6
Q

Money market hedging

A

Exchange our currency today when we know exactly what the exchange rate is. (Not a derivative)

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7
Q

Who hedges a foreign currency liability

A

Importers

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8
Q

Hedging a foreign currency liability > Step 1

A

Identify that a company has a foreign currency liability

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9
Q

Hedging a foreign currency liability > Step 2

A

Create a foreign currency asset by investing in a foreign currency today

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10
Q

Hedging a foreign currency liability > Step 3

A

Calculate how much to invest in the foreign currency

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11
Q

Hedging a foreign currency liability > Step 4

A

Translate at today’s exchange rate

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12
Q

Hedging a foreign currency liability > Step 5

A

Borrow the required amount in the UK today (which will incur interest during the term)

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13
Q

Who hedges a foreign currency asset

A

Exporters

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14
Q

Hedging a foreign currency asset > Step 1

A

Identify that the company has a foreign currency asset

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15
Q

Hedging a foreign currency asset > Step 2

A

Create a foreign currency liability by borrowing in a foreign currency

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16
Q

Hedging a foreign currency asset > Step 3

A

Calculate how much to borrow in the foreign currency

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17
Q

Hedging a foreign currency asset > Step 4

A

Translate at today’s exchange rate

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18
Q

Hedging a foreign currency asset > Step 5

A

Invest in the UK today (which will grow and earn interest during the term)

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19
Q

Derivative

A

Financial instrument that derives its value from the behaviour of the price of an underlying asset

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20
Q

Two ways derivatives are used

A
  • To make money (speculating)

- To reduce risk (hedging)

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21
Q

Four types of derivatives

A
  • Forwards
  • Futures
  • Options
  • Swaps
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22
Q

Forward contract

A

Agreement to buy or sell a certain amount of money at a set exchange rate at a specified time in the future

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23
Q

Forward contract - currency risk

A

Removed as the exchange rate is fixed

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24
Q

Forward contracts traded

A

Over the counter (not on exchange)

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25
Q

Forward contracts settlement

A

Gross settlement (one cashflow)

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26
Q

Forward points (pips)

A

Must be divided by 100

27
Q

Futures contracts

A

Contract to purchase or sell a standard quantity of a commodity at an agreed future date at a specified price

Aim to fix an outcome of a hedge

28
Q

Futures contract traded

A

On an exchange

29
Q

Futures contract settlement

A

Settled daily

30
Q

Today: if a company buying into foreign currency in the future (importer)

A

Enters into futures contract to buy foreign currency at fixed rate

31
Q

Today: If a company will be selling in a foreign currency in the future (exporter)

A

Enter into futures contract to sell foreign currency at the fixed rate

32
Q

Futures transaction > Step 1

A

(Today) Contracts should be due to be fulfilled on a standard date after the transaction date

33
Q

Futures transaction > Step 2

A

(In the future) Complete the actual transaction on the spot market

34
Q

Futures transaction > Step 3

A

(In the future) Close out the futures contract by doing the opposite of what we did in step 1

Profit or loss will arise as futures are settled

35
Q

If sell rate for the future contract currency > buy rate

A

Profit on future

36
Q

If sell rate for the future contract currency < buy rate

A

Loss on future

37
Q

Hedge efficiency =

A

Profit on future
___________ x 100
Loss on the spot rate

38
Q

Marking to market

A

Ensures that participants do not build up such large losses they are subsequently unable to pay - use ‘margin accounts’

39
Q

Maintenance margin

A

Minimum amount the account can reduce to before the investor will be required to restore the margin account

40
Q

Option contract

A

Contract which allows the holder the right but not the obligation to either buy or sell an asset at an agreed exercise price at or before a specified date

41
Q

Option to buy

A

Call option

42
Q

Option to sell

A

Put option

43
Q

Purchaser of any type of option must pay

44
Q

Option that will be exercised

A

In the money

45
Q

Option with a spot price equal to the exercise price

A

At the money

46
Q

Option that will not be exercised

A

Out of the money

47
Q

If buyer of call option, you have the right to buy an asset at agreed exercise price (if lower than market price)

48
Q

If the seller of call option sells to buyer

A

Short call

49
Q

Buyer of a put option buys the right to sell the shares at agreed exercise price

50
Q

Seller of put has sold the right to the other party for them to sell asset at agreed price

51
Q

Black Scholes model

A

Identifies components of pricing of premium of option:

  • Intrinsic value
  • Time value
52
Q

Currency options..

A

Protect buyer against movements in exchange rates but give buyer upside potential should exchange rates move in their favour

53
Q

Options exercised when..

A

They are in the money

54
Q

Options transaction > Step 1

A

Calculate the premium

55
Q

Options transaction > Step 2

A

Complete the actual transaction on the spot market

56
Q

Options transaction > Step 3

A

Decide whether to exercise the options contract

57
Q

Currency swap

A

Agreement between two counterparties which agree to swap their liabilities for loan repayments in different currencies over a period of time (usually 3 to 20 years)

58
Q

Currency swap > Step 1

A

Exchange of principles

59
Q

Currency swap > Step 2

A

Year end for years 1-X

60
Q

Currency swap > Step 3

A

Re-exchange of principal (at initial exchange rate)

61
Q

Call option benefit from price going

62
Q

Put option benefit from price going

63
Q

Swaps not suitable for

A

Hedging short term currency risk from importing or exporting

ICAS - AFin (21 decks)

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