BUSFIN 4250: Ch 5 Active Learning

FORWARD MARKET

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true for forward foreign exchange contracts

They can be used for both speculation and hedging.

What does the spot exchange rate refer to in foreign exchange markets?

The current exchange rate at which a currency can be exchanged for another within two business days

forward exchange rate

The rate agreed upon today for exchanging currencies at a future date

the primary difference between the spot exchange rate and the forward exchange rate

The spot rate is applied for immediate delivery of a currency, while

the forward rate is applied for future delivery of a currency

spot rate is applied for

immediate delivery of a currency

forward rate is applied for

future delivery of a currency

Why do companies commonly use forward exchange contracts?

To hedge against the risk of future exchange rate fluctuations

Forward Exchange Contract

A binding agreement to exchange a specific amount of currency at a fixed rate on a future date

What does it mean when a currency is said to be trading at a forward premium?

Its forward rate is higher than the spot rate

FUTURES

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Comparing "forward" and "futures" exchange contracts, we can say that

• futures contract is traded on an organized exchange, while

• forward contract is tailor-made by an international bank for its clients and is traded over the counter (OTC).

• Futures profit/loss is realized daily, and

• forward profit/loss is realized at maturity.

• futures contract is traded on an

• Futures profit/loss is realized

• organized exchange,

• daily

• forward contract is

• forward profit/loss is realized at

• Tailor-made by an international bank for its clients and is traded over the counter (OTC).

• maturity

A firm sells a currency futures contract and then decides before the settlement date that it no longer wants to maintain such a position. It can close out its position by

buying an identical futures contract. WHY?

foreign exchange futures contract

A standardized contract traded on an exchange to buy or sell a currency at a future date at a fixed rate STANDARDIZE?

Which of the following participants is most likely to use the foreign exchange futures market?

An individual investor speculating on short-term currency movements.

• Explanation: Foreign exchange futures are standardized, exchange-traded contracts

  commonly used by speculators and occasionally by hedgers who are

  comfortable with standardized terms. In contrast, multinational corporations

  often prefer forward contracts due to their customizable features.

How does an investor close out a futures contract before its maturity date?

By buying or selling an identical contract with the same maturity date in the opposite direction

• To close out a futures contract, an investor takes the opposite position of

  their original trade (e.g., if they initially bought the contract, they would sell

  an identical one). This effectively cancels the original position and locks in

  any profit or loss. Futures contracts are typically settled through this

  offsetting process rather than through the physical delivery of the

  underlying asset

Which of the following situations would most likely result in a loss for a trader in the foreign exchange futures market?

A trader buys a euro futures contract expecting the euro to rise, but the euro depreciates before contract expiration

• Explanation: “In this case, the trader expected the euro to rise in value, but it declined

  instead. Consequently, the futures price fell, resulting in a loss for the

  trader

The shorter the time to the expiration date for a currency, the ____ will be the premium of a call option, and the ____ will be the premium of a put option, other things being equal.

lower; lower

OTHER ACTIVE LISTENING

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The buyer of a call option is out-of- the-money, when on the settlement date, 

The spot exchange rate is less than the exercise price (S < X)

Which of the following scenarios would increase the price of a currency call option (the premium paid by the buyer of the call option)?

• An increase in the foreign currency’s spot rate above the strike price

• EXPLANATION: A call option becomes more valuable when the underlying

  currency appreciates above the strike price

Which of the following best describes a key characteristic of an American option compared to a European option?

It can be exercised at any time up to and including the expiration date.

Which of the following is a characteristic of an OTC (Over-the-Counter) option?

It has customizable terms tailored to the needs of the parties involved.

How does the time to maturity generally affect the premium of a call option, all else being equal?

The premium generally increases with longer time to maturity due to higher time value. AI

Why might an MNC purchase a foreign currency put option?

To hedge against a potential depreciation of a foreign currency it will receive in the future.

An MNC based in the U.S. is planning to import goods from Europe in three months and pay in euros. How can a euro call option help the MNC?

It gives the MNC the right, but not the obligation, to buy euros at a fixed price if the euro strengthens

A speculator believes the Canadian dollar will weaken against the U.S. dollar in the next 30 days. Which strategy is most appropriate?

Buy a Canadian dollar put option.

Why might an MNC purchase a foreign currency put option?

To hedge against a potential depreciation of a foreign currency it expects to receive