Chapter 17 - Financial Risk Management Flashcards
(150 cards)
1
Q
Three Financial Risks for Treasury to Manage
A
- Interest Rate Risk
- FX Risk
- Commodities Risk
2
Q
Interest Rate Risk
A
Changes in investment values and borrowings costs due to changes in interest rates
3
Q
FX Risk
A
As exchange rates fluctuate, so too does a firm’s value
4
Q
Three Types of FX Risks
A
Economic Risk (Operational)
Transaction Risk
Translation Risk
5
Q
Economic Risk
(FX Risk)
A
Risk of long-term effects on the present value of future cash flows
Even those that are domestic only will be impacted by currency appreciation or depreciation
6
Q
Transaction Risk
(FX Risk)
A
Risk exposure arising from receivables, payables, or other future cash flows in a foreign currency
7
Q
Implicit Risk
(Transaction FX Risk)
A
Cash flow exposure
Value of future transactions will change due to changes in exchange rates
Exposure from the time that a sale is expected until it occurs
8
Q
Explicit Risk
(Transaction FX Risk)
A
Balance sheet exposure
Risk that occurs due to changes in FX rate between the time a transaction occurs and when it settled
Accounts receivables in foreign currency
9
Q
Translation Risk
(FX Risk)
A
Assets or liabilities are in currencies other than the functional currency
Impacts consolidation process
10
Q
Timelines associated with Implicit and Explicit FX Risk
A
Implicit – exposure from the time that a sale is expected until it occurs
Explicit – exposure from the time a transaction occurs and when it is settled
11
Q
Accounting Exposure
A
Translation risk from consolidation process
12
Q
Positive vs. Negative Exposure
A
Positive = foreign currency assets greater than liabilities
Negative = foreign currency assets less than liabilities
13
Q
FX Appreciation and FX Depreciation for Positive and Negative Exposures
A
FX Appreciation
* Positive = gain
* Negative = loss
FX Depreciation
* Positive = loss
* Negative = gain
14
Q
Commodity/Input Price Risk
A
Risk that a change in the price (input price) of a raw material will impact the income and value of the company
15
Q
Factors that can impact commodity prices include:
(review)
A
Political and regulatory changes
Weather
Technology
Market conditions
16
Q
Two Types of Commodity Risk
A
Price Exposure Risk – price increases will lead to financial loss
Delivery Exposure Risk – regular supply of the commodity is crucial for operations
17
Q
Natural Hedging involves doing what?
A
Identifying correlations between different variables and incorporating those correlations into a hedging strategy
18
Q
Active Hedging
A
Process of using various financial instruments to manage risks associated with future cash flows or assets/liabilities
19
Q
Speculation
A
Using derivative products to make a profit
20
Q
Arbitrage
A
Process by which an asset is purchased in one market and simultaneously sold in another market to produce a riskless profit
21
Q
Covered Interest Arbitrage
A
Investor takes advantage of differences in interest rates in two different currencies by using a forward contract to eliminate any exposure to changes in the currencies
22
Q
Interest Rate Parity
A
The difference in interest rates between two countries is offset by the difference between the forward exchange rate and the spot exchange rate
23
Q
Less Variability in Expected Future Cash Flows increases a firm’s value in four ways:
(review)
A
Greater predictability makes the company more attractive to shareholders
Company gains enhanced borrowing advantage
Probability of financial distress decreases
Company can prepare more accurate budgets
24
Q
Derivative Instrument
A
Financial product that acquires its value by inference through a connection to an underlying asset
25
Options for underlying assets for derivatives
Financial instrument
Currency
Commodity
26
Added costs to consider when executing derivatives contracts:
Tax
Regulatory
Reporting
27
Components of ISDA
Master Agreement
Schedule
Definitions
Credit Support Annex (CSA)
Trade confirmation
28
Once an ISDA is signed, which contracts will it govern? Past and/or future?
All past and future transactions
29
Underlying assets for forwards can be what options?
Financial instruments, a currency, or a commodity
30
Forwards vs. Option
| (must vs. may)
Forward contracts must occur
Option contracts may occur
31
Delivery Price
Pricing stated in forward contract
32
Long Position vs. Short Position in FX Forward
Long Position = impending purchase at a specified price
Short Position = impending sale at a specified price
33
Over the Counter (OTC)
Speaking and executing with a counterparty
Transaction recorded on both parties’ books as a contractual obligation
34
What are the two most common types of forwards?
Interest rates and foreign currency
35
Differences between FX Forwards and Futures
Standardized contracts traded on organized exchanges
The exchange is counterparty to all futures contracts
36
What does having the exchange as the counterparty in futures contracts do?
Increases the liquidity of the contract and virtually eliminates counterparty risk
37
Which two items are standardized for futures contracts?
Contract size
Delivery dates
38
Which contract is easier and less expensive to acquire, a forward contract or a futures contract?
Futures contract
39
A futures contract will require what type of an account to be setup?
A margin account
40
Maintenance Margin
Specified amount in margin account at which the account holder must deposit cash to cover the shortfall
41
Are most futures contracts settled by delivery?
No, they are typically closed out with the counterparties prior to maturity
42
Swap
Agreement between two parties to exchange cash flows at a future point in time
43
Interest Rate Swaps
Agreement to exchange of streams of cash flows on different interest rates on a mutually agreed-upon principal amount
44
Notional Principle
Agreed-upon principal amount in an interest rate swap
45
Currency Swaps
Convert an obligation in one currency to an obligation in another currency
46
Commodity Swaps
Exchange of the market price of a commodity for another price (usually fixed price on same commodity)
Commodity is not actually exchanged
47
Strike Price for Option
Fixed price to buy or sell at
48
Writer
Counterparty of the option (receives the premium)
49
Two Venues for Trading Options
Exchange-Traded
OTC
50
Date of Exercise and Size of Premium for Options listed below
* American Option
* Bermudan Option
* European Option
American Option = any time on or before delivery date; high
Bermudan Option = at specified dates over the option’s life; medium
European Option = on delivery date only; low (least likely to be exercised)
51
Call Option vs. Put Option
Call = Buy
Put = Sell
52
The Premium paid for an Option is comprised of two factors:
Intrinsic Value – relationship between the strike price and the price of the underlying instrument in the open market (“in the money”, “at the money”, etc.)
Time Value – probability that the value of the underlying asset will increase or decrease over the life of the contract and that the investor will be able to be in a profitable position; positively correlated with volatility
53
Is the time value positively or negatively correlated with volatility?
Positively
54
Why will an American Option have a higher time value premium than a European Option?
The American Option can be executed at any point in time up to the delivery date, so it provides more flexibility
55
What is the overall relationship between Time Value and Intrinsic Value over time?
If the time horizon is very short, the Time Value factor is relatively small
The Time Value factor decreases as the time window shortens
56
The Time Value factor for option pricing will result in pricing above or below the Intrinsic Value?
Higher
57
How are options typically settled?
Sold and its value is used to offset losses if the asset price is higher or lower than the strike price
58
When you are “at the money” for an option contract, what is the profit / loss?
The premium amount paid for the option
59
Two primary benefits of using options
Safeguard profit margins
Protect contingent positions
60
Key Items for Interest Rate Swaps
* Purpose
* Structure
* Contract & Trade Origination
* Settlement
* Settlement Date
**Purpose** – asset/liability management with bond portfolio managers reducing or extending the average maturity or exposure
**Structure** – primarily fixed-to-floating swaps (vanilla or plain vanilla swap) based on notional amount
**Contract & Trade Origination** – ISDA; OTC or exchange-traded
**Settlement** – Netting between the calculated cash flows between Party A and Party B
**Settlement Date** – likely align with regularly scheduled interest payments
61
Hedging Interest Rates with Forwards is called a what type of agreement?
Forward Rate Agreement (FRA)
62
FRA
Derivative that hedges a floating-rate benchmark at some point in the future for a specific short-term interest period
63
Treasury Locks or Cash-Settled Forward Starting Interest Rate Swaps are also known as…
Rate locks
64
Key Items for Forward Rate Agreements
* Purpose
* Structure
* Contract
* Settlement (FRA vs. Forward Starting Swap)
* Settlement Date
* Settlement Amount
* Settlement Payment
* Risks
Purpose – firm forecasts short-term funding requirement and wants to fix the future cost of borrowing
Structure – parties agree that a certain interest rate will apply to a certain notional principal at a future date
Contract – ISDA
Settlement (FRA vs. Forward Starting Swap) – FRAs are cash settled; forward starting swaps are not and instead start to accrue interest
Settlement Date – forward date of the contract plus two business days
Settlement Amount – Difference between the benchmark rate on the trade date and the benchmark rate on the forward settlement date, adjusted for present value considerations
Settlement Payment – Payment depends on whether the original contractual rate is higher or lower than the settlement rate
Risks – Basis Risk, missed opportunity cost, credit risk / nonperformance, documentation risk for commercial contractual terms that result in unexpected termination
65
Market Convention for FRAs
**AxB**
* A = number of months
* B = A + interest period of the underlying benchmark
66
How would you interpret 4x7 for an FRA?
4 month term using 3 month SOFR
67
Settlement Rate vs. Contractual Rate
| (Interest Rate Forwards)
Settlement = SOFR at forward date
Contractual = SOFR at start date
68
How many cash flows do each of the following usually have associated with them?
* FRA
* Cash-Settled Forward Starting Swap
FRA = one cash flow
Cash-Settled Forward Starting Swap = multiple interest periods with multiple periods to discount
69
If the contractual rate for a forward rate agreement is lower than the settlement interest rate, what happens?
The buyer of the contract will receive a payout since rates have moved unfavorably since entering into the contract
70
Key Items for Interest Rate Futures
* Where are these traded?
* Purpose
* Structure
* Contract
* Settlement Date
* Settlement Amount
* Settlement Payment
Exchange-traded
Purpose – allow protection against open positions typically to hedge derivatives trading positions
Structure – contracts on an underlying asset or reference rate whose price is dependent solely on the level of interest rates
Contract – like other futures, they are exchange traded and require a margin account
Settlement – most futures contracts are cash-settled while some require physical delivery of the underlying note or bond
Settlement date – settled on dates specified by the exchange and determined by the expiration date
Settlement amount – sold in standard denominations and settlement is based on the difference between the contractual rate and the reference rate
Settlement payment – if the reference rate is higher than the contractual rate, the holder of the future will pay the seller the difference
71
Pricing Format for Interest Rate Futures
100 minus the expected rate
72
Realized Value for Interest Rate Futures
100 minus the rate at maturity
73
Interest Rate Options Settlement
| (when might the premium be paid)
Premium is paid up front but may be deferred until the option settlement date
74
Four Ways Interest Rate Options are Used
* Caps
* Floors
* Collars
* Swaptions
| (and when they are generally used)
**Caps** – lock in maximum interest rates (usually borrowers as buyers)
**Floors** – lock in minimum interest rates (usually investors as buyers)
**Collars** – combine floors and caps to provide a range of borrowing costs; buy cap and sell floor
**Swaptions** – right, but not the obligation, to enter into a swap
75
Interest Rate Caps
Ensure the borrower of a floating-rate loan pays no more than a predetermined maximum rate
76
Cap Rate or Cap Strike
Maximum interest rate level for interest rate options
77
Caplets
Used for longer-term interest rate cap options
Series of short-term options on a floating benchmark settling each month until maturity
78
Why are Interest Rate Collars less than an interest cap?
The proceeds from the sell of the interest floor offset the premium cost of buying the cap
79
Interest Rate Collar
Combination of interest rate cap and an interest rate floor
80
Costless Collar
No premium is paid
Income received from selling the floor matches the premium paid for the cap
81
What is the “cost” in a costless collar situation?
The potential to forego a lower rate should rates fall
82
If a borrower already has an interest rate floor built into their loan, does an interest rate floor from a collar make sense?
No
Pricing under the floor would require payments to the bank but not decrease interest costs on the underlying agreement
Normally, this payment out to the bank would be offset by a favorable rate movement below the existing loan's floor
83
Who typically invests in interest rate floors and who typically invests in interest rate caps?
Floors = lenders and investors
Caps = borrowers
84
In which situation would the individual with the contract get paid out using the contracts below:
* Cap Interest Rate Option
* Floor Interest Rate Option
**Cap Interest Rate Option** = rate goes above that amount
**Floor Interest Rate Option** = rate goes below that amount
85
Payor Swaption vs. Receiver Swaption
**Payor** = make fixed-rate payments and receive floating rate payments
**Receiver** = right to make floating rate payments and receive fixed-rate payments
86
Swaptions offer what kinds of benefits in relation to interest rate swaps?
More flexibility due to right but not obligation
87
Concept of “Disaster Insurance” or “Tail Risk” for Swaptions
Companies may use swaptions in tandem with other products to protect against large swings in the market
88
Economic FX Risk is also known as what type of risk
Operating risk
89
Which interest rate hedging instrument can be used to better match the particular needs of a company and hedge against changing interest rates? For example, if a company has floating interest rate investments and fixed long-term debt interest expense, which instrument would be most beneficial?
Interest rate swap
90
When thinking about interest rate futures, how should the value be understood for purposes of computing who pays?
Remember the formula to calculate the contract value and realized value
Compare those two values to determine if the value of the contract went up or down
91
If someone has entered an interest rate swap agreement and will pay fixed rates, what does that imply will also happen to that counterparty?
They will receive floating interest rate payments
92
Interest Differential vs. Settlement Amount for Interest Rate Forward Contracts
Interest Differential = interest difference between the contract rate and settlement date rate
Settlement Amount = incorporates present value
93
Can interest rate floors be purchased for fixed rate debt?
No, it’s only able to be used for floating rates
94
If you conduct business globally but all in your functional currency, have you eliminated FX risk exposure? How would this impact implicit and explicit risk?
No, you have instead pass this on to your global trading partners who will incorporate it into their decision making process
Limits the explicit risk on the balance sheet but there is still an implicit risk that can reduce the market competitiveness of their products
95
Two Ways to Quote FX Rates from the US
USD Equivalent = XXX/USD
Foreign Currency Equivalent = USD/XXX
96
Most currencies are quoted using which format?
European quotation convention = foreign currency equivalent
97
American Quotation Convention
XXX/USD
98
American vs. European Quotation Convention
American = XXX/USD
European = USD/XXX
99
FX Bid/Offer Quotation Notation
XXX/YYY Bid Rate – Offer Rate
100
Settlement Risk
Risk that one party will not pay on the agreed upon date
101
How have banks helped to reduce settlement risk on FX transactions?
Implementing continuous linked settlement (CLS)
102
Continuous Linked Settlement (CLS) for FX Transactions
Intermediary to ensure that transactions are settled simultaneously and that one party is not left paying but not receiving funds
If one party fails to deliver, the transaction is cancelled
103
Trading Concepts for FX as it relates to Forward Points
* Par
* Discount
* Premium
* Points
Par – spot rate and forward rate are the same; yield curve is the same
Discount – worth less in forward market than spot market; currency with higher interest rate will trade at a discount
Premium – worth more in the forward market than spot market; currency with the lower interest rate will trade at a premium
Points – premiums are added to the forward points and discounts are subtracted from the forward points
104
The difference between spot and forward market rates represents what? What is it not?
It reflects the change in economic conditions that are driving each currency’s interest rates
It is not a reflection of where the spot rate is likely to go
105
Risk Profile of Exotic Currencies
| (review)
Free-floating currencies traded with some degree of transparency
Trade subject to strict regulations imposed by monetary authorities within the country
Currencies pegged to another currency
Currencies that trade within a band against other currencies
Currencies that are not freely convertible
106
Exotic Currencies Characteristics
| (review)
Illiquid
Volatility
Reduced transparency
Limited derivative availability
Capital controls
Government intervention in FX markets
Heightened carrying risk
Pricing distortions
Limited risk-sharing options
Minimal internal hedging alternatives
Transfer risks
107
Implications of Trading in Exotic Currencies
* Cost of Transactions
* Volatile Currency Values
* Availability of Hedging Transactions
* Settlement Risk
Cost of Transactions – wide bid-offer spread due to lower trading volumes; may require multiple transactions
Volatile Currency Values – low transactions make prices highly volatile, companies should avoid becoming market makers
Availability of Hedging Transactions – hedging instruments are less available
Settlement Risk – CLS is not generally available for exotic currencies
108
Key Features of Currency Forwards
* Purpose
* Structure
* Contract
* Settlement
* Settlement date
* Settlement amount
* Settlement payment
Purpose – managing currency exposure by exchanging uncertainty for a certain outcome; best suited for known exposures
Structure – commitment to buy or sell a specified amount of foreign currency on a future date at a fixed rate
Contract – usually requires an ISDA, but many different counterparties
Settlement – settled on the settlement date
Settlement date – maturity of contract
Settlement amount – forward rate
Settlement payment – settlements are known
109
Forward points are also known as
Pips
110
Types of Currency Forwards
* Window Forwards
* Average-Rate Forwards
* Non-Deliverable Forwards (NDFs)
Window Forwards – similar to a standard forward but allows for settlement during a time period; more expensive than a standard forward
Average-Rate Forwards – Hedger will be trading funds at some point in the future, but the date and volume is unknown; lock in forward points and spot rate and then observe average spot rates that are compared to determine payout (net positive or negative)
Non-Deliverable Forwards (NDFs) – principal derivative of choice for exotic currencies; considered synthetic because it is settled in a major base currency; will utilize a proxy hedge and settle without exchanging any of the exotic currency
111
Proxy Hedge
Concept from NDF where a hedge in an alternate currency that is actively traded will move in the same direction as the desired currency
112
Currency Futures Key Features
* Purpose
* Structure
* Contract
* Contract sizes
* Settlement
* Settlement date
* Settlement amount
Purpose: Fix the effective FX rate for the term of the contract; flexibility to close out position with opposite transaction; requires margin account
Structure: traded on organized exchanges
Contract: requires margin account that can be used to borrow money from the broker to buy futures contracts and repay the loan on settlement
Contract Sizes: standard contract sizes depending on the currency pair
Settlement: most will settle prior to maturity date
Settlement date: positions not closed out will settle one of four settlement dates annually
Settlement amount: pay value of the contract to the seller
113
Gains or losses in the contract value on currency futures will impact the margin account value how?
Gains will be added and losses will be subtracted
Compare to minimum to determine if additional funding is required
114
Regardless of whether a gain or loss is realized on a futures contract at maturity, what is the net impact to cash?
The value of the original contract
Gains offset additional cost and losses offset favorable movements on cost
115
Currency Swaps Key Features
* Purpose
* Structure
* Contract
* Settlement
* Settlement amount
Purpose: used to manage currency risk associated with a series of anticipated cash flows without any natural hedges; can be used to change the value date of a currency forward
Structure: exchange of a cash flow in one currency for a cash flow in another currency; rate can be fixed or floating
Contract: OTC under an ISDA
Settlement: schedule of payments; usually an exchange of principal up front and at the end with periodic payments in-between
Settlement amount: principal amounts that are similar in value using exchange rates at the contract’s inception; periodic payments are determined by agreed upon interest rates
116
Why are rates on currency swaps for the currencies different?
They are based on the appropriate rates for each country
117
What can be used to change the value date of a currency forward contract?
A currency swap
118
What is an example of where a currency swap would make sense?
Company doing a foreign multi-year project where it is more advantageous for them to borrow in their home market rather than abroad
119
Currency Options Different Types
* Caps
* Floors
* Collars
* Non-deliverable Currency Options (NDOs)
Caps – maximum exchange rate for a particular transaction (limit cost)
Floor – minimum exchange rate for a particular transaction (protect FX cash flow)
Collars – band within which an exchange rate may fluctuate; reduce the cost of either a cap or a floor
Non-deliverable Currency Option – right but not the obligation to buy or sell at a specified price
120
How should premium be interpreted for currency options?
Incorporate into the cost of the FX rate
Add for call options and subtract for put options
For example, a EUR/USD strike price of 1.20 with a 0.10 premium will result in a maximum price of 1.30
121
Currency Cap Option
Call option to buy at a specified price
122
Currency Floor Option
Put option to sell at a specified price
123
How do you calculate the band of FX pricing for a currency collar?
The premium to purchase the cap option should be offset by the cost of selling the floor options. Therefore, the cap would be the cap's contract price and the lower range would be determined by the market to equate the premium paid for the cap option.
124
What is the primary difference between NDFs and NDOs?
NDOs provide the right, but not the obligation to buy or sell, which can provide additional flexibility
125
For currency options, what happens to the time value of an option as the premium rises?
Time value of an option will generally decline as the premium rises due to increased risk with paying a higher price
126
Transfer risks and volatility are characteristics of what?
Exotic currencies that would be more difficult to manage risk
127
If the spot rate at the time of an interest payment on a foreign currency swap is not provided, how should the answer be presented?
Foreign currency amount of interest paid plus the USD equivalent that is known
128
All of the following are greater challenges in international/global treasury management compared to domestic treasury management that require the use of legal and/or FSPs with expertise except which one?
* Foreign Exchange (FX) Risk
* Derivative Complexity
* Cash Flow Complexity
* Tax Issues
Derivative Complexity
All other examples are explicitly noted in the book as requiring additional assistance and guidance
129
When comparing bid-offer quotations in one currency format to another, what is the easiest way to convert?
As an example, the bid quote in a USD equivalent rate format is the same as the offer quote in a foreign currency equivalent rate format (and vice-versa)
130
Commodity Price Exposure – Oil ***Seller*** Example
Use a collar strategy for making sure oil can be sold at a minimum price
Buy a put option at the minimum price threshold and sell a call option at the market price
131
Derivatives for controlling commodity price exposure are effective in the short-term, long-term, or both?
Only the short term to protect budget rates
More expensive to enter into derivatives for longer periods due to uncertainty
Decide to assume commodity price risk or pass along increases to customers
132
What is the best derivative tool to use to manage the uncertainty around the change in the price of a commodity?
A costless collar
133
Hedging and Fair Value Considerations are contained where for US GAAP and IFRS?
**US GAAP**
* ASC 820 – Fair Value Measurement
* ASC 815 – Derivatives and Hedging
**IFRS**
* IFRS 9: Financial Instruments
134
What was the primary concern legislators and regulators identified in the aftermath of the 2007-2009 financial crisis?
Financial derivatives market had grown beyond the oversight of central banks and other regulators
134
Both US GAAP and IFRS will require what to be done in order to qualify for hedge accounting?
Test and demonstrate hedge effectiveness
135
Primary objectives of Dodd-Frank Act
Bring more transparency and accountability to the derivatives market
136
Key Components of Dodd-Frank Act
* Closes Regulatory Gaps
* Requires Central Clearing and Exchange Trading
* Requires Market Transparency
* Adds Financial Safeguard
* Sets Higher Standards of Conduct
**Closes Regulatory Gaps** – SEC and CFTC authority to regulate OTC derivatives
**Requires Central Clearing and Exchange Trading** – all should be cleared or settled through exchanges; regulators can decide what needs to clear; exemptions for non-financial institutions using derivatives for hedging
**Requires Market Transparency** – data collection and publication through clearinghouses or swap repositories
**Adds Financial Safeguards** – ensure dealers and participants have access to financial resources; regulators can impose capital and margin requirements
**Sets Higher Standards of Conduct** – establishes code of conduct for all registered swap dealers and major participants; assumption of independent representative advising for government and funds
137
European Market Infrastructure Regulation (EMIR)
Primarily focused on OTC derivatives
Implements reporting and clearing requirements similar to Dodd-Frank
138
Markets in Financial Instruments Directive (MiFID) II
Enhancing transparency and reducing the shadow banking system in Europe
Enhances reporting to reduce the use of “dark pools”
FIs must charge for research and transaction processing separately
139
Three Requirements for Exemption on Central Clearing Requirement under Dodd-Frank
Not a financial entity
Derivatives must be used for hedging
User must satisfy reporting requirements established by CFTC
140
Ideally, which groups within the entity should be tasked with (1) approval and (2) implementation of a hedging policy statement.
Approval = board of directors
Implementation = Treasury
141
Key Areas to include in Hedging Policy Statement
| (review)
**FX Hedging**
* Known foreign currency exposures on the balance sheet
* Balance sheet exposures
* Cash flow exposures (forecasted)
* Net equity investment exposures
* Translation exposures
**Interest Rate Hedging**
* Known interest rate exposures on existing S/T investments and borrowing
* Known interest rate exposures on existing L/T investments and borrowing
* Interest rate exposures on forecasted investments and borrowing
**Commodity Hedging**
* Known and forecasted exposures related to commodity pricing
* Known and forecasted exposures related to commodity availability
142
Time Value Component for Options
The additional amount buyers are willing to pay for the possibility that the option will become profitable before expiration
143
How would you determine if forward points should be added to or subtracted from the spot rate?
If the variable currency’s interest rate is higher, the base currency should trade at a premium and it should be added
If the variable currency’s interest rate is lower, the based currency should trade at a discount
144
Dodd-Frank allowed regulators to impose margin requirements on which parties?
Not end users
Dealers and major participants
145
What is the primary mechanism that ensures efficiency in financial markets?
Arbitrage because it directly exploits and eliminates price discrepancies between currency pairs across different markets or venues
146
Even in an environment where derivative instruments have caused macroeconomic financial problems, why is it a good idea to utilize NDFs for exotic currencies?
Organizations can introduce greater elements of financial uncertainty when they fail to take adequate measures to address FX related risk
147
For each of the following, describe what position would be taken as it relates to derivatives:
* A speculator believes the price of an asset will fall.
* A speculator believes the price of an asset will rise
**A speculator believes the price of an asset will fall.**
* Short position, will ultimately sell at a more favorable rate
**A speculator believes the price of an asset will rise.**
* Long position, will ultimately buy at a more favorable rate
148
How are zero-cost collars structured for buyers and sellers?
**Buyers** – Sell floor (put option) and buy ceiling (call option)
**Sellers** – Buy floor (put option) and sell ceiling (call option)
149
Is continual market-to-market considered an advantage for forward contracts?
No
