Risk Management (9) Flashcards
(22 cards)
What is Foreign Currency Exposure?
Risks that arise from changes in the relative valuation of currencies, it indicates that a currency depreciation will negatively affect the value of an organisation’s assets, investments and their related interest and dividend payment schemes.
What are the three levels at which Foreign Currency Exposure impacts a business?
Economic
Translation
Transactional
What is the difference between Economic, Translation and Transaction exposures?
Economic exposure is the risk that a company’s future cash flows and overall market value will be affected by long-term changes in exchange rates
Translation Exposure is are an accounting “on-paper-only” exposure. They are not cash losses but value gains and losses in the accounts.
Transaction exposure is day-today operational level exposure.
Explain how transaction exposure could occur?
If a company buys or sells on 30 days credit with a foreign currency, the transaction amount is subject to uncertainty such as changing exchange rates.
What is a derivative?
An asset whose performance is derived from the behaviour of an underlying asset
What is an option?
A contract giving one party the right to buy or sell a financial instrument, commodity or underlying asset at a given price at or before a specified date.
What is a call option?
A right to buy a fixed number of shares at a specified price at some time in the future.
Will purchasing a call option be more or less expensive if the exercise price is above the current share price?
Less expensive - lower premiums
What is the exercise price?
The exercise price is the fixed price at which the holder of an option can buy (in a call option) or sell (in a put option) the underlying asset when exercising the option.
What do we say if the share price goes below the exercise price?
The option has no intrinsic value and is worthless
What is a put option?
Gives the holder the right to sell a fixed number of shares at a specified price at some time in the future.
What are the variables for options?
C = value of call option
S = current market price of share
X = future exercise price
rf = risk-free interest rate (per annum)
t = time to expiry (in years)
σ = standard deviation of the share price
What is the minimum value of an option (C)?
Minimum value of 0
What is the equation for Market value of an option and what does this show?
Market value = Intrinsic Value + Time value
This means that the market value is always greater than intrinsic value at any time prior to expiry.
Does intrinsic value rise or fall as share price increases for a call option?
Intrinsic value increases
What is a factor that boosts time value of options?
Volatility of the underlying share price (σ)
What is a forward contract?
An agreement between two parties to undertake an exchange at an agreed future date at a price agreed now.
What does long position and short position mean?
The party buying the forward contract to exchange at a futures date takes the long position.
The counterparty which is delivering at the future date takes the short position.
What are forward rate agreements (FRAs)?
Agreements between two parties about the future level of interest rates.
What is a futures contract?
Similar to a Forward contract (undertake exchange at agreed future date and price).
However a futures contract has standardized contract terms, they are also less risky as now the contract is between the clearinghouse and counterparty.
What is a clearing house?
A clearing house is a financial intermediary that sits between buyers and sellers in a market to guarantee and settle trades, reducing the risk of one party defaulting.
What is the Margin Account?
An account set-up so that if the buyer fails to uphold the futures contract, the seller will still be compensated.
