2. Forwards, Foward Rate Agreements (FRAs) and Contracts for Difference (CFD)

Question 1

What is the definition of a forward

Answer 1

An agreement to buy (or sell) specified quantity, of a specified asset, on a specified future date for a price agreed today.

Question 2

The forward price in an FX forward is determined by what factors

Answer 2

The interest rate differential between the two currencies

Question 3

What are important factors in determining the price of a commodities forward

Answer 3

Current interest rate, cost of financing, and storage costs

Question 4

Equity forward contracts take into consideration what factors

Answer 4

Current interest rate and equity’s dividend yield.

Question 5

How are forward contracts usually traded

Answer 5

OTC

Question 6

Can any forward contracts be traded on exchange

Answer 6

Yes. The LME does trade some forwards on exchange for some nonferrous metals and steel

Question 7

Who are most forwards usually traded with

Answer 7

Banks and investment banks

Question 8

Outright forwards are a product most commonly traded in which market?

Answer 8

FX market

Question 9

What does a forward rate agreement (FRA) enable a company to do

Answer 9

Fix an interest rate in advance

Question 10

By fixing an interest rate in advance, an FRA enables a borrow (or lender) to take a view on what

Answer 10

Whether interest rates are rising or falling

Question 11

In an FRA is any principal amount actually borrowed or lent?

Answer 11

No

Question 12

In an FRA cash flows arise from the difference between what

Answer 12

The interest rate fixed at the outset (the fixed rate) and the level of the benchmark rate at a point in time in the future (the floating rate).

Question 13

What a the benchmark most often used in an FRA

Answer 13

LIBOR

Question 14

Summarise the six elements of an FRA

Answer 14

1. An agreement to buy (or sell)
2. An interest rate, which is fixed today,
3. Which will be revalued against prevailing market rates using a benchmark,
4. Starting on an agreed future date
5. For an agreed future period
6. Based on an agreed principal amount (nominal amount not transferred).

Question 15

The party that pays the fixed rate of an FRA is called what

Answer 15

The buyer

Question 16

The party that receives the fixed rate and pays the floating rating is called what

Answer 16

The seller

Question 17

On what date is an FRA settled

Answer 17

On the date when the FRA period starts

Question 18

Because an FRA is settle on the date the FRA period starts, what is it important to remember about the settlement amount

Answer 18

That is is discounted, at current market rates

Question 19

In an FRA the period over which the interest is calculated is known as the what

Answer 19

Calculation period

Question 20

Explain the calculation period, what dates does it include

Answer 20

The first day of the calculation period, up but excluding the last day

Question 21

What is the day count convention for EUR, USD and GBP in an FRA

Answer 21

USD & EUR = 360
GBP = 365

Question 22

Calculation of the FRA settlement can result in what figures

Answer 22

Positive and negative

Question 23

Explain a positive FRA figure

Answer 23

Think your rate (as buyer ie the fixed rate) is greater than the floating rate.
Fixed rate - floating rate = positive figure
When positive, you pay the seller

Question 24

Explain a negative FRA

Answer 24

Think your rate (as buyer ie the fixed rate) is less than the floating rate.
Fixed rate - floating rate = negative figure
When negative - the seller pays you

Question 25

Contracts for Difference (CFDs) enable the investor to gain from what

Answer 25

Capital gains from the underlying asset without actually physically owning it.

Question 26

CFDs do not but buy the underlying, but instead trade on what.

Answer 26

It’s price movements

Question 27

Investors in CFDs have one key decision to make, which is what?

Answer 27

Do they think the underlying asset is going to go up, or down.

Question 28

Are CFDs OTC traded or exchange.

Answer 28

OTC

Question 29

Why are CFDs cost efficient on a CFD on a share

Answer 29

The investor doesn’t need to pay stamp duty nor the brokers fee that would be associated with a share transaction

Question 30

As CFDs are based on margin trading, what can an investor do

Answer 30

Leverage their position

Question 31

With CFDs most brokers require what level of margin deposit

Answer 31

Between 10-30% of the contracts value

Question 32

What do most CFD trades include to minimise large losses

Answer 32

A stop loss

Question 33

Are most CFDs nominal intra-day trades or overnight? And why?

Answer 33

Intra-day since overnight trades incur interest charges