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Hedging Flashcards

(22 cards)

1
Q

What is purchasing power parity

A

It claims that the rate of exchange between two currencies depends on the relative inflation rates within the respective countries

Higher inflation = depreciation in currency

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2
Q

How to estimate future spot rates with PPP

A

Current spot rate * 1+foreign inflation/1+uk inflation

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3
Q

What is interest rate parity theory

A

It claims that the difference between the spot and future exchange rates is equal to the differential between interest rates available in two currencies

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4
Q

How to estimate future spot rates with IRP

A

Current spot rate * 1+foreign interest rate/1+uk interest rate

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5
Q

Risks of overseas trade

A

Physical risk
Trade risk
Liquidity risk
Credit risk

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6
Q

Types of financial risk

A

Transaction risk
Economic risk
Translation risk

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7
Q

What is transaction risk

A

The risk that the exchange rate will change between date of contract and date of settlement

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8
Q

What is economic risk

A

Value of the business will be affected by long run changes in exchange rates

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9
Q

What is translation risk

A

Reported performance will be affected by exchange rate movements

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10
Q

How to manage economic risk

A

Diversify internationally

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11
Q

How to manage transaction risk

A

Invoice in sterling
Leading and lagging
Matching assets and liabilities
Foreign currency bank accounts

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12
Q

Forward advantages

A

Tailor made, any product any time
Avoid downside

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13
Q

Forward disadvantages

A

No upside
Binding agreement, must go ahead

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14
Q

Futures advantage

A

Contract and transaction seperate
Avoid downside

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15
Q

Futures disadvantage

A

No upside
Standard size contracts, not tailor made, can be imperfect

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16
Q

Option advantage

A

Don’t have to exercise
Flexibility
Avoid downside and benefit from upside

17
Q

Option disadvantage

18
Q

FRA 5-8 meaning

A

Forward rate agreement starting in 5 months for 3 months

19
Q

FRA priced at 3.2 - 2.6

A

Borrow 3.2%
Deposit 2.6%

20
Q

Advantage of swaps

A

Can run for 30 years
Transaction costs cheaper
Hedge against adverse movement

21
Q

Disadvantage of swaps

A

Counterparty risk
Market risk
Transparency risk