### Simplified Notes on Foreign Exchange Risks and Quotes
#### Types of Foreign Exchange Risks
1. **Transaction Risk**:
- Risk from actual transactions (payables/receivables) in foreign currencies.
- Example: A UK company needs to pay CAD 100 million in six months. The GBP may depreciate against CAD, increasing costs.
2. **Translation Risk**:
- Risk when consolidating financial statements of foreign subsidiaries to the parent company's currency.
- Example: A US company with a European subsidiary may see its assets' value fluctuate due to changes in the EUR/USD rate.
3. **Economic Risk**:
- Risk to a firm's market value from changes in exchange rates affecting future cash flows.
- Example: A US firm exporting goods to Europe may become less competitive if the USD appreciates against the EUR.
#### Types of FX Quotes
1. **Spot Quotes**:
- Immediate exchange of currencies.
- Example: CADUSD 0.7535 (Bid), 0.7541 (Ask).
2. **Forward Quotes**:
- Agreement to exchange currencies at a future date.
- Example: CADUSD forward bid at 90.11 points means 0.7535 + 0.009011 = 0.762511.
3. **Futures Quotes**:
- Standardized contracts traded on exchanges (e.g., CME Group).
- Example: If USDEUR is 0.8700, the futures quote is 1.1494 (1/0.8700).
#### Key Concepts
1. **Bid-Ask Spread**:
- Difference between the buying price (bid) and selling price (ask).
- Example: Spot spread for CADUSD is 0.0006.
2. **Outright (Forward) Transactions**:
- Simple forward contracts for future currency exchange.
3. **FX Swap Transactions**:
- Involves two transactions: buying/selling in spot and selling/buying in forward markets.
#### Hedging Strategies
1. **Hedging Transaction Risk**:
- **Importers**: Hedge by buying forward contracts if paying foreign currency.
- **Exporters**: Hedge by selling forward contracts if receiving foreign currency.
2. **Hedging Translation Risk**:
- Use forward contracts or options to protect against unfavorable exchange rate movements when consolidating financials.
3. **Hedging Economic Risk**:
- Adjust operational strategies, such as shifting production or sales to different regions, to mitigate long-term currency exposure.
### Multiple Choice Questions (MCQs)
1. **What is transaction risk?**
- A) Risk from translating foreign financial statements
- B) Risk from changes in the market value of a firm due to currency fluctuations
- C) Risk from exchange rate changes affecting specific transactions
- **Answer**: C
2. **In a spot FX quote of CADUSD 0.7535/0.7541, what is the bid price?**
- A) 0.7535
- B) 0.7541
- C) 0.0006
- **Answer**: A
3. **Which of the following describes an outright (forward) FX transaction?**
- A) A currency exchange agreement occurring immediately
- B) A currency exchange agreement for a future date
- C) A currency exchange agreement involving two simultaneous transactions
- **Answer**: B
4. **If a US exporter sells goods to Europe and expects payment in EUR in three months, what risk are they exposed to?**
- A) Translation risk
- B) Economic risk
- C) Transaction risk
- **Answer**: C
5. **How can an importer hedge transaction risk when they have a payable in foreign currency?**
- A) By selling the foreign currency forward
- B) By buying the foreign currency forward
- C) By doing nothing
- **Answer**: B
These simplified notes and MCQs can help you grasp the fundamental concepts of foreign exchange risks and quotes. Make sure to review the concepts regularly and practice with more questions to reinforce your understanding.
No comments:
Post a Comment