International Finance Exam 2

What is the purpose of forward contracts for MNCs?

MNCs use forward contracts to hedge against currency fluctuations by locking in exchange rates for future transactions.

How do MNCs benefit from a long position in forward contracts?

A long position commits to purchasing currency at an agreed-upon rate, allowing profit when the spot rate exceeds the forward rate.

What is the profit formula for a long position in a forward contract?

Profit from buying = Spot rate at maturity - Forward rate.

What does a short position in a forward contract entail?

A short position commits to selling currency at an agreed-upon rate, allowing profit when the forward rate exceeds the spot rate.

What is the profit formula for a short position in a forward contract?

Profit from selling = Forward rate - Spot rate at maturity.

What is the bid/ask spread in forward rates?

The bid/ask spread is calculated as (Ask - Bid)/Ask, indicating the difference between buying and selling prices.

What is the formula for calculating the forward rate premium or discount?

F = S(1 + p), where F is the forward rate, S is the spot rate, and p is the premium.

What is a non-deliverable forward contract (NDF)?

An NDF is a contract where no physical delivery occurs; one party pays the other based on the future exchange rate.

How do firms use currency futures to hedge payables?

Firms purchase futures contracts to lock in the price at which they can buy a currency needed for future payables.

What is the primary difference between currency futures and forward contracts?

Currency futures are standardized contracts traded on exchanges, while forward contracts are customized agreements between parties.

What is the role of the Chicago Mercantile Exchange (CME) in currency futures?

The CME offers futures contracts for 19 currencies, specifying standardized volumes and facilitating trading through the Globex platform.

How do firms speculate using currency futures?

Speculators buy or sell futures contracts based on their expectations of future currency movements to profit from price changes.

What is the concept of a zero-sum game in currency futures markets?

In a zero-sum game, one party's gain is another party's loss, resulting in a net sum of zero across all positions.

What are currency call options?

Currency call options grant the right to buy a specific currency at a designated price within a specific time frame.

What factors affect currency call option premiums?

Premiums are influenced by the existing spot price relative to the strike price, time until expiration, and currency volatility.

How do MNCs use currency call options for hedging?

MNCs use call options to hedge future payables, locking in costs for projects or potential acquisitions.

What are currency put options?

Currency put options provide the right to sell a currency at a specified strike price within a designated period.

How do MNCs use currency put options for hedging?

MNCs use put options to lock in the value of expected future receivables, protecting against currency depreciation.

What distinguishes European currency options from American-style options?

European options must be exercised on the expiration date, offering less flexibility than American-style options, which can be exercised anytime before expiration.

What is a conditional currency option?

A conditional currency option has a trigger point that determines when the option can be exercised, often involving a premium.

What is the significance of the exercise price in currency options?

The exercise price (strike price) is the predetermined price at which the holder can buy (call) or sell (put) the currency.

What is the role of brokers in the currency options market?

Brokers facilitate the buying and selling of options for a commission, requiring a margin to be maintained during the contract's life.

What is the minimum size for currency options offered in the over-the-counter market?

The minimum size for currency options in the over-the-counter market is typically around $5 million.

What happens if the spot price exceeds the strike price for a currency call option?

The call option is considered 'in the money,' allowing the holder to buy the currency at the lower strike price.

What happens if the spot price falls below the strike price for a currency put option?

The put option is considered 'in the money,' allowing the holder to sell the currency at the higher strike price.

“At the money”

When the present exchange rate is equal to the strike price

“Out of the money”

When the present exchange rate is less than the strike price for a call option