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Questions and Answers
What is a key feature of futures contracts?
What is the primary purpose of corporations and governments accessing the international money market?
What is the main difference between a currency call option and a currency put option?
What is the future spot rate?
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Why has the international money market grown?
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What is a characteristic of currency options contracts?
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What is the primary purpose of using currency derivatives?
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What determines the value of a currency futures contract?
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What is the primary purpose of the foreign exchange market?
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What type of financial institutions serve as intermediaries in the foreign exchange market?
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What is the primary composition of the international money markets?
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What is the primary function of the international credit markets?
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What is an example of direct foreign investment?
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What is the primary purpose of the international money markets?
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What type of financial institutions are involved in the international credit markets?
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What is the primary difference between the international money markets and the international credit markets?
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What is currency risk primarily caused by?
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What does a direct quotation represent?
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What is a characteristic of a floating exchange rate system?
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What is the relationship between direct and indirect quotations?
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What is the role of foreign exchange dealers?
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What happens to the indirect exchange rate of the euro when the euro appreciates against the dollar?
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What happens to the indirect exchange rate of the euro when the euro depreciates against the dollar?
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What is the term for an immediate exchange of one currency for another?
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What is an example of a direct quotation?
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Where do banks trade with each other?
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What is an example of an indirect quotation?
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What is the commonly accepted medium of exchange in the spot market?
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What is the consequence of economic or political conditions on currency demand and supply?
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What is a characteristic of trading in the spot market?
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What is the benefit of more buyers and sellers in the spot market?
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What is the term for a telecommunications network where companies normally exchange one currency for another?
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What happens to aggregate demand for funds when economic conditions strengthen?
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What type of risk is associated with the potential for default?
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What is the primary reason for the value of bonds to decline in response to rising long-term interest rates?
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What type of risk is associated with the potential for the value of bonds to decline due to currency depreciation?
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What was the primary cause of the European bond crisis in 2010?
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What was the response to the Greek crisis in May 2010?
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Which of the following countries was NOT mentioned as being affected by the Greek crisis?
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What is the effect of a consistently active market for bonds on their value?
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Study Notes
Currency Derivatives
- Futures contracts are similar to forward contracts but are sold on an exchange, specifying a standard volume of a particular currency to be exchanged on a specific settlement date.
- The futures rate is the exchange rate at which one can purchase or sell a specified currency on the specified settlement date.
- The future spot rate is the spot rate that will exist at a future point in time and is uncertain as of today.
Currency Options Contracts
- A currency call option provides the right to buy currency at a specified strike price within a specified period of time.
- A currency put option provides the right to sell currency at a specified strike price within a specified period of time.
International Money Market
- Corporations or governments need short-term funds denominated in a currency different from their home currency.
- The international money market has grown because firms may need to borrow funds to pay for imports denominated in a foreign currency.
- The floating exchange rate system allows widely traded currencies to fluctuate in accordance with market forces.
Foreign Exchange Transactions
- The over-the-counter market is the telecommunications network where companies normally exchange one currency for another.
- Foreign exchange dealers serve as intermediaries in the foreign exchange market.
- A foreign exchange transaction for immediate exchange is said to trade in the spot market, where the exchange rate is the spot rate.
- Trading between banks occurs in the interbank market.
Spot Market
- The U.S. dollar is the commonly accepted medium of exchange in the spot market.
- Spot market time zones are limited to normal business hours in a given location, allowing for 24-hour foreign exchange trading.
- Spot market liquidity increases with more buyers and sellers.
Attributes of Banks That Provide Foreign Exchange
- Currency risk refers to economic or political conditions that cause the demand for and supply of the currency to change abruptly.
Interpreting Foreign Exchange Quotations
- Direct quotation represents the value of a foreign currency in dollars (number of dollars per currency).
- Indirect quotation represents the number of units of a foreign currency per dollar.
- Indirect quotation = 1 / Direct quotation
Interpreting Changes in Exchange Rates
- When the euro is appreciating against the dollar, the indirect exchange rate of the euro is declining.
- When the euro is depreciating against the dollar, the indirect exchange rate is rising.
Risk of International Bonds
- Credit risk represents the potential for default.
- Interest rate risk represents the potential for the value of bonds to decline in response to rising long-term interest rates.
- Exchange rate risk represents the potential for the value of bonds to decline because the currency denominating the bond depreciates against the home currency.
- Liquidity risk represents the potential for the value of bonds to decline because there is not a consistently active market for the bonds.
Impact of the Greek Crisis on Bonds
- Greece experienced weak economic conditions and a large increase in the government budget deficit in spring 2010.
- Concern spread to other European countries with large budget deficits.
- Many European countries and the IMF agreed to provide Greece with new loans in May 2010.
International Stock Markets
- Direct foreign investment involves the acquisition of foreign real assets.
- Short-term investment or financing involves foreign securities.
- Longer-term financing occurs in the international bond or stock markets.
International Capital Markets
- The international money markets are composed of several large banks that accept deposits and provide short-term loans in various currencies.
- The international credit markets are composed of commercial banks that convert some of the deposits received into loans (for medium-term periods) to governments and large corporations.
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Description
This quiz covers the basics of futures contracts, a type of currency derivative. Learn about the specifications and settlement dates of futures contracts.
