Risk Management (5)

Question 1

What is a futures contract

Answer 1

A standardised contract between buyer and seller, in which the buyer has a binding obligation to buy a fixed amount, on a fixed date of some asset via an exchange

Question 2

What can a company choose with future contracts?

Answer 2

Whether to buy or sell futures; and
which delivery date to use

Question 3

What does the price of a currency futures contract represent?

Answer 3

The forward exchange rate for the currencies specified in the contract.

Question 4

What is the basis of a futures contract?

Answer 4

The difference between the futures price and the spot exchange rate

Question 5

What is the initial margin in a futures contract?

Answer 5

When a currency futures contract is bought or sold, the buyer or seller is required to deposit a sum of money with the exchange

Question 6

If losses are incurred in a futures contract

Answer 6

The buyer or seller may be called on to deposit additional funds (variation margin) with the exchange

Question 7

What is market to market in futures contract?

Answer 7

Any profits are credited to the margin account on a daily basis

Question 8

What is always the case in a futures contract?

Answer 8

There is always physical delivery

Question 9

What is the basis risk in futures contract?

Answer 9

The result of a futures hedge cannot therefore be known for sure in advance

Question 10

What if a futures hedge is correctly performed?

Answer 10

Any gain made on the futures transactions will offset, to some degree, a loss made on the spot currency markets

Question 11

What is a currency swap?

Answer 11

An agreement between two parties to exchange principal and/or interest payments in different currencies over a stated time period

Question 12

What happens on commencement of the swap?

Answer 12

An exchange of agreed principal amounts, usually at the prevailing spot rate

Question 13

What happens over the life of the swap?

Answer 13

An exchange of interest payments

Question 14

What happens at the end of the swap?

Answer 14

A re-exchange of principals, usually at the original spot rate. This reduces foreign currency risk

Question 15

Why may a company be particularly concerned about rising interest rates? (floating)

Answer 15

If it has a significant proportion of floating (i.e. variable) interest rate debt, as this obviously leads to lower profits

Question 16

Why may a company be particularly concerned about rising interest rates? (surplus cash)

Answer 16

If a significant amount of surplus cash has been invested in fixed interest rate securities

Question 17

Why may a company be particularly concerned about falling interest rates? (fixed)

Answer 17

If it has a significant proportion of fixed interest rate debt and therefore does not participate in the benefits of falling rates

Question 18

Why may a company be particularly concerned about falling interest rates? (floating)

Answer 18

If it holds significant floating rate investments