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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
Forward contracts settlement
Gross settlement (one cashflow)
26
Forward points (pips)
Must be divided by 100
27
Futures contracts
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
Futures contract traded
On an exchange
29
Futures contract settlement
Settled daily
30
Today: if a company buying into foreign currency in the future (importer)
Enters into futures contract to buy foreign currency at fixed rate
31
Today: If a company will be selling in a foreign currency in the future (exporter)
Enter into futures contract to sell foreign currency at the fixed rate
32
Futures transaction > Step 1
(Today) Contracts should be due to be fulfilled on a standard date after the transaction date
33
Futures transaction > Step 2
(In the future) Complete the actual transaction on the spot market
34
Futures transaction > Step 3
(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
If sell rate for the future contract currency > buy rate
Profit on future
36
If sell rate for the future contract currency < buy rate
Loss on future
37
Hedge efficiency =
Profit on future ___________ x 100 Loss on the spot rate
38
Marking to market
Ensures that participants do not build up such large losses they are subsequently unable to pay - use 'margin accounts'
39
Maintenance margin
Minimum amount the account can reduce to before the investor will be required to restore the margin account
40
Option contract
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
Option to buy
Call option
42
Option to sell
Put option
43
Purchaser of any type of option must pay
Premium
44
Option that will be exercised
In the money
45
Option with a spot price equal to the exercise price
At the money
46
Option that will not be exercised
Out of the money
47
If buyer of call option, you have the right to buy an asset at agreed exercise price (if lower than market price)
Long call
48
If the seller of call option sells to buyer
Short call
49
Buyer of a put option buys the right to sell the shares at agreed exercise price
Long put
50
Seller of put has sold the right to the other party for them to sell asset at agreed price
Short put
51
Black Scholes model
Identifies components of pricing of premium of option: - Intrinsic value - Time value
52
Currency options..
Protect buyer against movements in exchange rates but give buyer upside potential should exchange rates move in their favour
53
Options exercised when..
They are in the money
54
Options transaction > Step 1
Calculate the premium
55
Options transaction > Step 2
Complete the actual transaction on the spot market
56
Options transaction > Step 3
Decide whether to exercise the options contract
57
Currency swap
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
Currency swap > Step 1
Exchange of principles
59
Currency swap > Step 2
Year end for years 1-X
60
Currency swap > Step 3
Re-exchange of principal (at initial exchange rate)
61
Call option benefit from price going
Up
62
Put option benefit from price going
Down
63
Swaps not suitable for
Hedging short term currency risk from importing or exporting

ICAS - AFin (21 decks)

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