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Questions and Answers
What does currency risk primarily relate to?
What does currency risk primarily relate to?
Which of the following is NOT a type of risk associated with exchange rates?
Which of the following is NOT a type of risk associated with exchange rates?
What factor is NOT considered to determine the degree of currency risk?
What factor is NOT considered to determine the degree of currency risk?
How is credit risk described?
How is credit risk described?
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What is an example of market risk?
What is an example of market risk?
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If the exchange rate were to drop by 1%, how much could Airbus potentially lose on the sale mentioned in the content?
If the exchange rate were to drop by 1%, how much could Airbus potentially lose on the sale mentioned in the content?
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What type of risk includes uncertainties regarding demand for products?
What type of risk includes uncertainties regarding demand for products?
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Which situation is characterized by low currency risk?
Which situation is characterized by low currency risk?
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What does a long position in the market indicate?
What does a long position in the market indicate?
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Which of the following is NOT a type of financial derivative used in hedging?
Which of the following is NOT a type of financial derivative used in hedging?
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Who participates in the spot market?
Who participates in the spot market?
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What is the bid price?
What is the bid price?
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What happens to the bid-ask spread as uncertainty increases?
What happens to the bid-ask spread as uncertainty increases?
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Which category does NOT belong to the main market participants?
Which category does NOT belong to the main market participants?
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What happens if all market participants have the same forecast?
What happens if all market participants have the same forecast?
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Which economic principle indicates that supply increases with price?
Which economic principle indicates that supply increases with price?
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What is triangular arbitrage used for in currency markets?
What is triangular arbitrage used for in currency markets?
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What does the ask price represent?
What does the ask price represent?
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Given the exchange rates S($/€) = 1.50 and S(¥/€) = 50, what is the implied $/¥ cross rate?
Given the exchange rates S($/€) = 1.50 and S(¥/€) = 50, what is the implied $/¥ cross rate?
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Which of the following best describes the bid-ask spread?
Which of the following best describes the bid-ask spread?
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What might indicate that an auction is necessary according to Arrow-Debreu?
What might indicate that an auction is necessary according to Arrow-Debreu?
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What is one of the first steps in executing triangular arbitrage?
What is one of the first steps in executing triangular arbitrage?
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Which mechanism is presumed to help achieve market equilibrium according to auction systems?
Which mechanism is presumed to help achieve market equilibrium according to auction systems?
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What does an increased bid-ask spread likely indicate about market conditions?
What does an increased bid-ask spread likely indicate about market conditions?
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What is a key difference between futures and forward contracts?
What is a key difference between futures and forward contracts?
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What mechanism is primarily used in futures contracts to avoid default risk?
What mechanism is primarily used in futures contracts to avoid default risk?
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In futures contracts, what is the term for the minimum amount required to maintain a market position?
In futures contracts, what is the term for the minimum amount required to maintain a market position?
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Which statement is true regarding the trading of futures contracts?
Which statement is true regarding the trading of futures contracts?
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What happens during daily settlements in a futures contract?
What happens during daily settlements in a futures contract?
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What type of position does a buyer of a futures contract hold?
What type of position does a buyer of a futures contract hold?
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Which of the following is NOT a characteristic of futures contracts?
Which of the following is NOT a characteristic of futures contracts?
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What is required to enter the futures market based on the margin system?
What is required to enter the futures market based on the margin system?
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What is the initial margin required for trading a CME S&P 500 contract?
What is the initial margin required for trading a CME S&P 500 contract?
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How much does a 1/32 price movement in the 10-year T-note lead to in mark to market per contract?
How much does a 1/32 price movement in the 10-year T-note lead to in mark to market per contract?
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If the dollar depreciates, what is the impact on Airbus's futures account based on the example given?
If the dollar depreciates, what is the impact on Airbus's futures account based on the example given?
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What is the tick size for contracts involving gold priced per troy ounce?
What is the tick size for contracts involving gold priced per troy ounce?
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What does it mean if a firm is long on the dollar in a futures market?
What does it mean if a firm is long on the dollar in a futures market?
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What is the relationship between Airbus and Delta Airlines in the context of futures trading?
What is the relationship between Airbus and Delta Airlines in the context of futures trading?
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In the given example, what is the loss calculated on the underlying position if the spot rate opens at 1.35 and the P future at 1.34?
In the given example, what is the loss calculated on the underlying position if the spot rate opens at 1.35 and the P future at 1.34?
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What does the term 'zero-sum game' imply in the context of futures trading?
What does the term 'zero-sum game' imply in the context of futures trading?
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What is the primary benefit of a currency swap for firms?
What is the primary benefit of a currency swap for firms?
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In a currency swap, how is the domestic currency loan typically converted?
In a currency swap, how is the domestic currency loan typically converted?
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Which of the following statements about implied forward rates in currency swaps is true?
Which of the following statements about implied forward rates in currency swaps is true?
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What market condition allows currency swaps to be useful?
What market condition allows currency swaps to be useful?
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What is one of the approaches to analyze exchange rate cycles mentioned?
What is one of the approaches to analyze exchange rate cycles mentioned?
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How many different moving averages should be calculated according to the exercise?
How many different moving averages should be calculated according to the exercise?
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What is the purpose of the Hodrick-Prescott filter in analyzing exchange rates?
What is the purpose of the Hodrick-Prescott filter in analyzing exchange rates?
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Which value of lambda is considered in one of the HP filter scenarios?
Which value of lambda is considered in one of the HP filter scenarios?
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Study Notes
Exchange Rate and the Firm
- Exchange rates affect financial sectors and non-financial firms. A crisis in one sector can impact others.
- Banking sector risks are linked to exchange rate expectations. Macroeconomic risks can affect firms' and government's financial stability.
- Risks include:
- Credit risk: Loss due to borrower default (banks, government, firms).
- Market risk: Changes in financial prices (currency, interest rate, equity, commodity).
- Liquidity risk: Inability to liquidate assets or roll over debt.
- Operational risk: System failures, management errors, fraud, human error.
- Legal and regulatory risk: Changes to laws, regulations, and codes.
- Business risk: Uncertain demand for products.
- Currency risk is the variability in an exposure's value due to exchange rate uncertainty.
- Currency risk depends on:
- Exchange rate volatility.
- Amount of exposure.
- Exposure:
- Long exposure: Assets exceeding liabilities in a particular currency.
- Short exposure: Liabilities exceeding assets in a particular currency.
- Example: Airbus selling planes in US dollars; A change in the exchange rate impacts the profit as liabilities and assets are denominated in different currencies.
Exposure
- Companies or individuals with assets or liabilities denominated in different currencies are exposed to exchange rate risk.
- A 'Brexit announcement' can be an example of an event that significantly impacts the exchange rate and business operations.
- Currency exposures depend on the volatility of exchange rates and the quantity of the exposure.
Foreign Exchange Rates and Hedging Strategies
- Hedging: Taking an opposite position to reduce macroeconomic risk, potentially involving costs or gains.
- Companies may have long or short positions in foreign currencies based on future expectations.
- Hedging can be done through futures, options, and swaps.
Spot Markets and Participants
- Foreign exchange markets have various participants (banks, individuals, etc.).
- There are wholesale and retail markets for large and small currency transactions.
Spot Rate Quotations
- Bid price: Price a dealer pays for an asset (e.g., currency).
- Ask price: Price a dealer expects from the buyer for an asset.
- Bid-ask spread: Difference between bid and ask prices. Bid-Ask Spread reflects the uncertainty.
Cross Rates
- Triangular arbitrage profits can be made if there are discrepancies between different currency exchange rates
- The risk-adjusted value determines the profit from cross rate analysis.
Hedging
- A future or forward contract is a promise to buy or sell an asset at a fixed price on a future date.
- A forward contract is customized, while a future contract is standardized.
- Margin calls can occur on futures contracts, guaranteeing contract performance.
- Options give the right, not the obligation, to buy or sell an asset at a certain price (strike price) on or before a date (expiration date).
- Call option: Right to buy.
- Put option: Right to sell.
- American options can be exercised any time before expiration, while European options only on the expiration date.
Currency Swaps
- A currency swap is an exchange of debt obligations denominated in different currencies.
- Firms use swaps to benefit from their respective borrowing advantages in different currencies.
- Investment banks facilitate currency swaps between parties, mitigating borrowing uncertainties.
Evolution of FX Markets
- Global FX market turnover increased over time.
- US dollar dominance persists in exchange rate transactions.
Exercises
- Several exercises involve analyzing exchange rates using different methods (moving averages, Hodrick-Prescott filter, etc.) to understand trends, interpret data, and apply trading strategies.
- Currency hedging strategies are considered in the exercises.
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Description
This quiz explores the critical impact of exchange rates on both financial and non-financial sectors. It examines various types of risks associated with currency fluctuations, including credit, market, liquidity, operational, legal, and business risks. Additionally, the quiz delves into how these risks affect the stability of firms and government financials.