A statement about the value of a variable that it

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A statement about the value of a variable that it will take on in some specific future time where this future value is unknown at the time the forecast is being made Why forecast? 1. Speculation 2. Firm’s financial decisions 3. Macroeconomics (RBA intervention) Risk Oxford: a change for a bad consequence Moosa: risk implies both favourable and unfavourable outcome with some probability distribution Forward contract A contract between two parties to exchange a specific amount of one currency for a specific amount of another currency (i.e. at a specific ER) at a specific future date Futures contract A contract between two parties to buy or sell specific amount of one currency for a specific amount of another currency (or at a specific ER) at a specific future date à same definition as forward Swaps An exchange between two parties over time; an exchange in general over two time streams Currency Swap A contract or agreement to do the following: 1. At the beginning of the contract, exchange the principal amounts in different currencies 2. Periodically, exchange interest payments in the currency received in step one 3. At the end of the contract, reverse the exchange in step one (i.e. exchange principals in different currencies in opposite directions) Distributing prohibited | Downloaded by K C ([email protected]) lOMoARcPSD|2330446
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Interest Rate Swap A swap of interest payment streams between two parties where the interst rates are calculated on the same notional principal (i.e. don’t exchange the principal), one at fixed rate and one at a variable rate. Cross-currency interest rate swap Beginning: Exchange principal amounts in different currencies Periodically: exchange interest payment streams paying in the currency received at the beginning (in this case, one in a fixed and other in a variable rate) End: reverse exchange of principal amounts Currency Options A contract between two parties, one party has the right but not the obligation to buy (sell) a specific amount of foreign currency at a specific exchange rate/exercise price on (or before) a specific future date Option writer Sells the right … to buy/sell FX in the future Option Holder Buys the right … to buy/sell FX in the future Option premium The price of the option contract itself Exercise/strike price The price the contract gives you the right but not the obligation to buy/sell the underlying asset Call options The right to buy the underlying asset Put options The right to sell the underlying asset American Options Exercise on or before European Options Exercise on (usually worth less/ cheaper than American option) Risk averse If you prefer 1.00 (mean) with certainty to the uncertain prospect Risk-neutral Indifferent between 1.00 (mean) with certainty and the uncertain prospects Risk-loving Prefer the uncertain prospects to the 1.00 (mean) with certainty Variance The probability weighted average of the deviation average from its mean Long exposure Have foreign currency assets and we want to convert these into domestic
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