18 Questions
What is the primary benefit of hedging using the currency options market?
Protecting the downside while benefiting from the upside
What does the holder of an option have the right to do?
Buy/sell an asset at a pre-specified price on a pre-determined date without the obligation to do so
What is the cost to the hedger for using currency options?
The option premium
What is the hedger's situation in the given example?
An importer requiring USD 100,000
What is the purpose of buying a 'Put option' or 'Call option' in hedging?
To benefit from the upside but protect the downside
When does the payment to the US Exporter need to be made?
End-September
What is the main difference between a forward market hedge and a currency option hedge?
The forward market hedge only protects against the downside risk but not the upside risk, while the currency option hedge protects against both.
What would be the outcome if the Mexican firm had remained unhedged and the spot rate on 21st August turned out to be USD/MXN 19.00?
It would have realized 1.90 million MXN.
What is the key characteristic of a money market hedge?
It involves borrowing against future receivables today and exchanging the proceeds for another currency.
Why might a money market hedge and a forward market hedge not always be perfect substitutes?
Because of market imperfections.
What is the exchange rate risk that the US firm is exposed to in the example?
Transaction exposure to EUR.
How does the US firm realize USD 10,912 today in the money market hedge?
By borrowing in USD and exchanging it for EUR.
What is the purpose of entering into a forward foreign exchange contract in managing transaction exposure?
To avoid the risk of potential loss due to adverse exchange rate movements
What is the exchange rate at which the Mexican firm will sell the US Dollar 100,000 90 days forward in the given example?
USD/MXN 18.50
What is the amount of Mexican Pesos the Mexican firm will receive as per the forward contract?
MXN 185,000
What is the main advantage of hedging in managing transaction exposure?
It eliminates the possibility of potential losses due to adverse exchange rate movements
What is the term for the risk of potential loss due to adverse movement in the exchange rate between the time the foreign exchange exposure is created and the time the payment is received?
Transaction Exposure
What is the consequence of hedging in terms of potential gains?
It negates the possibility of potential gains
This quiz covers different hedging strategies in foreign exchange markets, including forward markets and money markets, to minimize potential losses.
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