Risk Management (4) Flashcards
What is a forward exchange contract?
A legally binding agreement to buy or sell
Why is there no premium on forward conrtacts?
Needs to be paid to set up a forward hedge
What is the result of forward contracts not requiring any margin to be posted?
there will usually be a small arrangement fee to set up a forward contract and a creditworthiness assessment
What is the major disadvantage of forward contracts?
A physical delivery must occur
What is meant by a physical delivery in a forward contract?
Must physically exchange currency on the agreed date at the agreed rate
What is money market hedges?
Lock in the value of a foreign currency transaction in terms of organisation’s domestic currency using a combination of investing, borrowing and a spot currency exchange.
How is a money market hedge set up? (1st step)
Borrow dollars today at the company’s fixed-rate dollar borrowing rate
How is a money market hedge set up? (2nd step)
Exchange these dollars into sterling at the current spot rate
How is a money market hedge set up? (3rd step)
Invest the sterling received at the company’s fixed rate sterling investment rate
When are cuirrency options used?
It may consider buying a currency option
What are options an example of?
Derivatives
What can the owner of an option do?
Exercise their right
Allow it to lapse
How are premiums paid?
At the date the option is bought and are non-refundable
How may a company buy options?
On a derivatives market
Directly from a bank
What is a call option?
Gives its owner the right to buy the underlying asset
