Midterm Notes

Midterm Notes - Dollarization: The use of the U.S. dollar...

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Dollarization : The use of the U.S. dollar as the official currency of the country International Fisher Effect : If capital, by way of CIA, attempts to find higher rates of return internationally resulting from current interest rate differentials, the real rates of return between currencies are equalized. SWAP : purchase and sale of a given amount of foreign exchange for 2 given value dates Forward Rate as Unbiased Predictor: The forward rate is assumed to be an unbiased predictor if the future spot rate Arbitrage Rule of Thumb : If the difference in interest rates is greater than the forward premium (or expected change in the spot rate), invest in the higher interest yielding currency. If the difference in interest rates is less than the forward premium invest in the lower yielding currency. Chapter 6: The Foreign Exchange Market Functions of the Forex Market The Forex market is the mechanism by which participants transfer purchasing power between countries, obtain or provide credit for international trade transactions, and minimize exposure to the risks of exchange rate changes. Change in Spot Rate : Direct Terms: (end-begin)/begin Indirect Terms: (begin-end)/end Swap Rate : simultaneous purchase for one date and sale (reversing the transaction) for another (hedging purposes). The party with the higher interest currency pays the net interest differential to the other. Expressed as a point basis. Point Quotation: Difference between forward rate and spot rate for both bid and ask Chapter 7: Foreign Currency Derivatives Benefits of Derivatives: 1. Permit firms to achieve payoffs that they would not be able to achieve without derivatives, or could achieve only at a greater cost 2. Hedge risks that otherwise would not be possible to hedge 3. Make underlying markets more efficient 4. Reduce volatility of stock returns 5. Minimize earnings volatility 6. Reduce tax liabilities 7. Motivate management (agency theory affect) Foreign Currency Futures Futures Contract : an alternative to a forward contract that calls for future delivery of a standard amount of foreign exchange at a fixed time, place, and price.
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Most important futures market in U.S. is International Monetary Market (IMM) in Chicago Contract Specifications Size of Contract : Called Notional Principal ; trading must be done in an even multiple of currency units Method of Stating Exchange Rates : “American Terms” direct quote aka in $ Maturity Date : contracts mature of 3 rd Wednesday of Jan, March, April, June, July, Sept, Oct, Dec Last Trading Day : contracts may be traded through the 2 nd business day prior to the Wed. that they mature on aka Monday before maturity, unless there’s a holiday. Collateral & Maintenance Margins: Purchaser must deposit a sum as an initial margin or collateral, can be letter from bank, T-bill, or cash. Maintenance margin also required. Value of contract is market to market daily, and all changes in value are paid in cash daily, amount to be paid is called variation margin.
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This test prep was uploaded on 04/21/2008 for the course FI 351 taught by Professor Zampieron during the Spring '08 term at Bentley.

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Midterm Notes - Dollarization: The use of the U.S. dollar...

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