Exam 8: Foreign Currency Derivatives and Swaps

Your firm is faced with paying a variable rate debt obligation with the expectation that interest rates are likely to go up. Identify two strategies using interest rate futures and interest rate swaps that could reduce the risk to the firm.

The single largest interest rate risk of a firm is:

Jasper Pernik is a currency speculator who enjoys "betting" on changes in the foreign currency exchange market. Currently the spot price for the Japanese yen is ¥129.87/$ and the 6-month forward rate is ¥128.53/$. Jasper thinks the yen will move to ¥128.00/$ in the next six months. Jasper should ________ at ________ to profit from changing currency values.

Instruction 8.1: For the following problem(s), consider these debt strategies being considered by a corporate borrower. Each is intended to provide $1,000,000 in financing for a three-year period. • Strategy #1: Borrow $1,000,000 for three years at a fixed rate of interest of 7%. • Strategy #2: Borrow $1,000,000 for three years at a floating rate of LIBOR + 2%, to be reset annually. The current LIBOR rate is 3.50% • Strategy #3: Borrow $1,000,000 for one year at a fixed rate, and then renew the credit annually. The current one-year rate is 5%. -Refer to Instruction 8.1. The risk of strategy #1 is that interest rates might go down or that your credit rating might improve. The risk of strategy #3 is: (Assume your firm is borrowing money.)

A call option whose exercise price is less than the spot price is said to be:

The buyer of a long call option:

TABLE 8.1 Use the table to answer following question(s). April 19, 2009, British Pound Option Prices (cents per pound, 62,500 pound contracts). -Refer to Table 8.1. The exercise price of ________ giving the purchaser the right to sell pounds in June has a cost per pound of ________ for a total price of ________.

TABLE 8.1 Use the table to answer following question(s). April 19, 2009, British Pound Option Prices (cents per pound, 62,500 pound contracts). -Refer to Table 8.1. The May call option on pounds with a strike price of 1440 mean:

Historically, interest rate movements have shown less variability and greater stability than exchange rate movements.

Your U.S firm has an accounts payable denominated in UK pounds due in 6 months. To protect yourself against unexpected changes in the dollar/pound exchange rate you should:

Which of the following would be considered an example of a currency swap?

TABLE 8.1 Use the table to answer following question(s). April 19, 2009, British Pound Option Prices (cents per pound, 62,500 pound contracts). -Refer to Table 8.1. What was the closing price of the British pound on April 18, 2009?

Why are foreign currency futures contracts more popular with individuals and banks while foreign currency forwards are more popular with businesses?

How does counterparty risk influence a firm's decision to trade exchange-traded derivatives rather than over-the-counter derivatives?

A firm with fixed-rate debt that expects interest rates to fall may engage in a swap agreement to:

The value of a European style call option is the sum of two components:

The main advantage(s)of over-the-counter foreign currency options over exchange traded options is (are):

An agreement to swap the currencies of a debt service obligation would be termed a/an:

Jasper Pernik is a currency speculator who enjoys "betting" on changes in the foreign currency exchange market. Currently the spot price for the Japanese yen is ¥129.87/$ and the 6-month forward rate is ¥128.53/$. Jasper would earn a higher rate of return by buying yen and a forward contract than if he had invested her money in 6-month US Treasury securities at an annual rate of 2.50%.

Jack Hemmings bought a 3-month British pound futures contract for $1.4400/£ only to see the dollar appreciate to a value of $1.4250 at which time he sold the pound futures. If each pound futures contract is for an amount of £62,500, how much money did Jack gain or lose from his speculation with pound futures?