EFB240 - W8 Q&A's
What is the rule for calculating forward discount/premium?
(Forward - Spot)/Spot - Note: Spot should be converted annually
Differentiate between a currency call option and a currency put option.
- Call option allows firms the right but not obligation to buy a foregin currency at a specified price up to a specified date - Put option allows firms the right but not obligation to sell a foregin currency at a specified price up to a specified date.
List the factors that affect currency call option premiums and briefly explain the relationship that exists for each. Do you think an at-the-money call option in euros has a higher or lower premium than an at-the-money call option in Mexican pesos (assuming the expiration date and the total dollar value represented by each option are the same for both options)?
- Higher existing spot rate relative to the strike price = greater call option value, other things equal. - Longer period prior to the expiration date = the greater call option value. - Greater variability of the currency = greater call option value ** Note: Only first point changes for put options - euro should have a lower premium as it should be less volatile then peso
List the factors that affect currency put options and briefly explain the relationship that exists for each
- Lower existing spot rate relative to the strike price = greater put option value, other things equal. - Longer period prior to the expiration date = the greater put option value. - Greater variability of the currency = greater put option value ** Note: Only first point changes for call options
How can currency futures be used by corporations?
- Used to hedge risk by locking in the price of a future currency by selling currency futures. - If they wanted to lock a price to purhcase currency they would buy currency futures - Take an opposite position to what product they are selling to minimie cash flow volatility
What is a forward contract?
- an agreement between a corporation and financial insituation to exchange a currency, at a specified rate (forward rate) on a specified date -Forwards have a credit risk and are largely unregulated.
Explain why an MNC use forward contracts to hedge committed transactions and use currency options to hedge contracts that are anticipated but not committed.
- forward contracts are smarter for commited as they are cheaper and it is garunted to be payed - Currency options are perfect for anticiapted as they can be removed and money lost is only premium per option
What are the advantages and disadvantages to a U.S. corporation that uses currency options on euros rather than a forward con¬tract on euros to hedge its exposure in euros?
A: Currency options give US firm the right but not obligation to sell/buy euro's in the event it depreciates = more flexability to lock in price D: US firm pays a premium for this right above the exercise price specified in the contract to cover risk. - Forward contract locks the US firm into their hedge, but avoids paying a premium rate.
Compare and contrast forward and futures contracts.
Because currency futures contracts are standardized into small amounts, they can be valuable for the speculator or small firm (a commercial bank's forward contracts are more common for larger amounts). However, the standardized format of futures forces limited maturities and amounts.
When should a speculator purchase a call option on Australian dollars? When should a speculator purchase a put option on Australian dollars?
Call if appreciated expected Put if depreciated expected
What is a futures contract?
Takes palced on an organised exchange, everything formalised besides price. - Futures have no credit risk as a clearing house garuntess both sides - Standardised into small amounts, meaning to suited for large invesotrs/companies
How can currency futures be used by speculators?
They bet on a price rise or fall by buying or selling futures. - If it is expected to rise they buy futures, and if fall they sell futures
