Chapter 17

Question 1

When JPY has a higher interest rate than USD,

will JPY sell at a ___, against USD, in the fwd market?

Answer 1

The interest rate differential between 2 countries determines if respective currencies will trade at par, discount, or premium in the fwd. mkt

• CCY1 is @ discount when:
  
  • CCY1 is worth less in fwd. mkt vs. the spot market.
  • CCY1’s interest rate > CCY2’s interest rate

fwd. rate = spot +/- fwd pts”

*fwd. pts: reflect the diff. between 2 ccy’s/countries’ ST mmkt interest rates (e.g., rates on ST. govt. borrowing or interbank rates) @ trade execution

Question 2

American option vs. European option:

what’s the difference?

Answer 2

American option:

• can exercise anytime on/before expiration date
• sells for LARGER PREMIUM vs. European options

European option:

• exercise only on maturity/expiry date

Question 3

Speculation

Answer 3

• involves taking a “position” on the direction of the market, in the attempt to make a profit
  
  • LONG POSITION in a fwd. contract
    
    • GAIN = underlying asset’s price RISES
    • (loss = underlying’s price decreases)
  • short position gains value when underlying asset’s price FALLS
• goes beyond hedging
• (not usually a treasury objective)