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The Derivatives Market > Forwards > Flashcards

Forwards Flashcards

1
Q

Largest market in Forward market:

A

Forward Foreign exchange market

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2
Q

Spot Market

A

Also called cash market.

Refers to transactions or deals that are settled at the earliest opportunity possible.

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3
Q

Derivatives market

A

Deals settled in future at prices determined now.

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4
Q

Spot deal

A

A contract between buyer and seller, undertaken on T+0, for the delivery of a security by the seller to the buyer and payment by the buyer to the seller in order to complete settlement of the deal at time T+0 or T+ a few days, depending on convenience.

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5
Q

Forward

A

A contract between a buyer and a seller that obliges the seller to deliver, and the buyer to accept delivery of, an agreed quantity and quality of an asset at a specified price (now) on a stipulated date in the future.

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6
Q

Advantages of forward markets

A
  • Flexibility with regards to delivery dates.

- Flexibility with regards to size of contract

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7
Q

5 Disadvantages of forward markets

A
  • The transaction rests on the integrity of the two parties.
  • Both parties are ‘locked in’ to the deal for the duration of the transaction.
  • Delivery of the underlying asset took place.
  • The quality of the asset may be different than what is expected.
  • Transaction costs are high.
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8
Q

3 Forward contract markets that are found in the debt market are:

A
  • Forward interest rate contract
  • Repurchase agreements
  • Forward rate agreements
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9
Q

Forward interest rate contract (FIRC)

A

The sale of a debt instrument on a pre-specified future date at a pre-specified rate of interest.

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10
Q

Repurchase Agreement (Repo)

A

A contractual transaction in terms of which an existing security is sold at its market value (or lower) at an agreed rate of interest, coupled with an agreement to be repurchase the same security on a specified, or unspecified, date.

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11
Q

The 6 key features of a repurchase agreement

A
  • Repos are structured as outright sales and repurchases.
  • Full legal title to securities and cash are transferred.
  • The buyer of the repo has an obligation to return equivalent securities.
  • There is provision for initial margin and top-up margin.
  • The equivalent of the coupon received from the issuer of the security is paid to the seller on the same day.
  • Legal title to collateral is robust, which overcomes doubts when an event of default occurs.
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12
Q

Open Repos

A

The buyer and the seller have the right to terminate the agreement at any time.
No maturity date is specified.
Rate is usually a floating rate.

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13
Q

2 Types of repurchase agreement

A
  • Open Repurchase agreement

- Fixed Term repurchase agreement

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14
Q

Fixed Term Repurchase Agreement

A

A repurchase agreements where the rate and the term are agreed at the outset of the agreement. The term of repos usually range from a day to a few months.

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15
Q

Why does the Reserve bank require banks to report repos on their balance sheet?

A

It is a method through which a bank can acquire funding.

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16
Q

Forward Rate Agreement

A

An agreement that enables a user to hedge itself against unfavorable movements in interest rates by fixing a rate on a notional amount that is (usually) of the same size and term as its exposure that starts sometime in the future.

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17
Q

Type of forward in the equity market:

A

Outright forward

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18
Q

Outright Forward

A

The sale of equity at some date in the future at a price agreed at the time of doing the deal

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19
Q

Foreign exchange

A

Deposits and securities in a currency other than the domestic currency, and an exchange rate is an expression of units of a currency in terms of one unit of another currency.

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20
Q

4 Types of forwards in the foreign exchange market:

A
  • Outright forwards
  • Foreign exchange swaps
  • Forward-forwards
  • Time options
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21
Q

Spot foreign exchange transaction

A

A deal done now (on T+0) for settlement on T+2 (an international convention), and essentially amounts to the exchange of bank deposits in two different countries.

22
Q

Forward foreign exchange transaction

A

A transaction that takes place (i.e. is settled) on a date in the future other than the spot settlement date of T+2, but the price and amount is agreed on the deal date (i.e. now – T+0).
Also called an outright forward.

23
Q

Outright forwards in the foreign exchange market.

A

Contracts in terms of which the banks undertake to deliver a currency or purchase a currency on a specified date in the future other than the spot date, at an exchange rate agreed upfront.

24
Q

Interest rate parity

A

The net rate of return from an investment offshore should be equal to the interest earned minus or plus the forward discount or forward premium on the price of the foreign currency involved in the transaction.

25
Q

Foreign exchange swap

Forex swaps

A

The exchange of two currencies now (i.e. spot) at a specified exchange rate coupled with an agreement to exchange the same two currencies at a specified future date at the specified exchange rate plus or minus the swap points.

26
Q

Forward-forwards

A

Swap deal between 2 forward dates.

27
Q

Time options

A

This instrument is the same as an outright forward with the maturity date specified, but the client has the option to settle at any time within a specified period. The specified period may be anytime during the period of the contract, or anytime between a future date and the expiry date of the contract.

28
Q

3 Main uses for the forward market:

A
  • Commercial covering
  • Hedging an instrument
  • Speculation
29
Q

The term ‘spot market’ refers to derivatives where payments are made in cash. True or false?

A

False. The spot market is also called the “cash market”, and it refers to transactions or deals (which are contracts) for the delivery of securities that are settled at the earliest opportunity possible.

30
Q

The motivation for a forward contract is usually that the spot price that will prevail in the future is uncertain. True or false?

A

True

31
Q

A seller who believes that the price of the underlying asset will decline, will enter into a forward contract to deliver the underlying asset. True or false

A

True

32
Q

The forward price can be calculated using the formula: FP = SP / [1 + (ir – t)]. True or false?

A

False. The correct formula is: FP = SP x [1 + (ir x t)].

33
Q

In a repurchase agreement the seller of the agreement agrees to resell the security at a later date. True or false?

A

False. In a repurchase agreement the buyer of the agreement agrees to resell the security at a later date.

34
Q

A 3 x 6 FRA (3-month into 6-month): the 3 in the 3 x 6 refers to 3 months’ time when settlement takes place, and the 6 to the maturity of the FRA deal, i.e. the rate quoted for the FRA is a 6-month rate at the time of settlement. True or false?

A

False. A 3 x 6 FRA (3-month into 6-month): the 3 in the 3 x 6 refers to 3 months’ time when settlement takes place, and the 6 to the expiry date of the FRA from deal date, i.e. the rate quoted for the FRA is a 3-month rate at the time of settlement.

35
Q

Swaps points are also called forward points and are quoted, for example, as 590 / 600. The left side is the rate at which the quoting bank will buy ZAR now for USD for resale after 60 days, and the right hand is the rate at which the quoting bank will sell ZAR now for USD for repurchase after 60 days. True or false?

A

False. The left side is the rate at which the quoting bank will buy back USD in 60 days for USD sold now, and the right hand is the rate at which the quoting bank will sell USD in 60 days for USD bought now.

36
Q

An example of a 60 day forward-forward is to sell USD 60 days forward and buy them back in 90 days’ time. True or false?

A

An example of a 60-day forward-forward is to sell USD 30 days forward and buy them back in 90 days’ time. It could also be to sell USD 60 days forward and buy them back in 120 days’ time.

37
Q

Define a forward market.

A

A forward market is a market (essentially a primary market) where a deal on an asset is concluded now for settlement at a date in the future at a price / rate determined now.

38
Q

Define a forward contract.

A

A forward is a contract between a buyer and a seller that obliges the seller to deliver, and the buyer to accept delivery of, an agreed quantity and quality of an asset at a specified price (now) on a stipulated date in the future.

39
Q

What are the main advantages of forward markets?

A

The main advantages that can be identified for forward markets are:
 Flexibility with regard to delivery dates
 Flexibility with regard to size of contract.

40
Q

What forward rate should a bank quote a client on R10 million 306-day NCDs delivered to a client in 50 days’ time; it will have 256 days remaining; the 50-day NCD rate = 5% pa and the 306-day NCD rate = 7% pa.

A

Slightly lower than the 7.34% pa break-even IFR in order to make a small profit.

41
Q

What will the bank do if a client accepts the quote given in question 12?

A

As soon as this deal is consummated, the banker will immediately purchase R10 million 306-day NCDs at the 306-day rate of 7.0% pa in order to hedge itself (and to make the profit).

42
Q

Define a repurchase agreement.

A

A repurchase agreement (repo) is a contractual transaction in terms of which an existing security is sold at its market value (or lower – to protect the buyer) at an agreed rate of interest, coupled with an agreement to repurchase the same security on a specified, or unspecified, date.

43
Q

A speculator who believes that bond rates are about to fall (in the next week) buys a 5-year bond to the value of R5 million at the spot rate of 10.2%. The speculator sells the bond to a broker-dealer for 7 days at 9.5% pa (the rate for 7-day money). Assume now that the 5-year bond rate falls to 10.1% on day seven and the bond’s value goes up by R50 000. What is the profit or loss of the speculator?

A

R40 890.41 [= 50 000 – (5 000 000 x 7/365 x 0.095)]

44
Q

R10 million (nominal value) NCDs with a maturity value of R10 985 000, and a market value of R10 500 000, were sold for seven days at a repo rate of 12.5% pa. What would be the interest payable on this repurchase agreement?

A

R25 171.23

45
Q

Define a forward rate agreement (FRA).

A

A forward rate agreement (FRA) is an agreement that enables a user to hedge itself against unfavorable movements in interest rates by fixing a rate on a notional amount that is (usually) of the same size and term as its exposure that starts sometime in the future.

46
Q

The treasurer of a company decides to deal at the 8.20% pa offer rate for the 6 x 9 FRA for an amount of R20 million, which matches the company’s requirement perfectly. The benchmark is the relevant JIBAR rate. On settlement date (at the “6” in the “6 x 9”) the benchmark 91-day JIBAR rate is 8.60% pa. How much does the bank that sold the FRA now owe the company?

A

R19 526.56 {= (20 000 000 x 0.004 x 91/365) x [1/(1 + (0.086 x 91/365))]}

47
Q

The rate now (spot rate) for 182 days is 9.0% pa and the rate now (spot rate) for 273 days is 10.5% pa, and we know that the latter rate covers the period of the first rate. What is the implied forward rate?

A

12.92% {= {[1 + (0.105 x 273/365)] / [1 + (0.09 x 182/365)] –1} x 365/91}

48
Q

Forward period = 60 days
Spot rate = R6.50 to one US dollar
Relevant interest rate on a dollar investment = 3.0%pa
Relevant interest on a rand investment = 6.0% pa
What is the price of a 60-day forward outright?

A

R6.53 to the dollar {= 6.50 x [1 + (0.06 x 60/365)] / [1 + (0.03 x 60/365)]}

49
Q

Dematerialization

A

The scrip no longer exists.

50
Q

Immobilization

A

The scrip exists but is placed in scrip depository which holds them on behalf of the investors.

The Derivatives Market (7 decks)

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