FINC 327 Chapter 5: Currency Derivatives

Question 1

A forward contract

Answer 1

A forward contract is an agreement between a corporation and a financial institution (such as a
commercial bank) to exchange a specified amount of a currency at a specified exchange
rate (called the forward rate) on a specified date in the future.

Question 2

How could Multinational corporations use forward contracts to hedge their imports. (Making payments)

Answer 2

They can lock in at a LOWER rate at which they obtain a currency needed to purchase those imports.
Goal is to pay less for imports by using a depreciated currency
Short Spot in currency
Long forward

Question 3

How could Multinational corporations use forward contracts to hedge their exports. (receiving payments)

Answer 3

Hoping that the rate will be higher!!
to avoid currencies depreciating
Long in currency spot
Short forward

Question 4

Hedging

Answer 4

use futures to reduce risk on an existing position

Question 5

Speculation

Answer 5

use futures to take on risk in the hope of making profit

Question 6

Arbitrage

Answer 6

use the difference between spot and futures prices to generate risk free profit

Question 7

FORWARD speculation profits long and short sides

Answer 7

long side: upward sloping

short side: downward sloping

Question 8

premium and discount of forward rates

Answer 8

(Ft - So ) / S * 360/#of days

negative is discount
positive is premium

Question 9

SWAPs

Answer 9

spot transaction with a corresponding forward contract that will reverse the spot transaction

so i give you pounds and you give me dollars.
then we agree on forward contract to reverse this transaction so we both get exact money we started with. no profit gains or losses

Question 10

futures

Answer 10

standardized meaning they are tradable so future rates changes throughout the day.
long profit= (ft - Fo) * size