Saint Cloud State University Foreign Exchange Markets and Rates Answers

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1. What is a derivative security? (LG 10-1, LG 10-4, LG 10-7)
2. What are the differences between a spot contract, a forward contract, and a futures contract? (LG 10-1)
3. What are the functions of floor brokers and professional traders on the futures exchanges? (LG 10-2)
4. What is the purpose of requiring a margin on a futures or option transaction? What is the difference between an initial margin and a maintenance margin? (LG 10-2)
5. When is a futures or option trader in a long versus a short position in the derivative contract? (LG 10-2)
6. What is the meaning of a Treasury bond futures price quote of 103-13? (LG 10-3)
7. Refer to Table 10-4. (LG 10-3) a. If you think 15-year Treasury note prices will fall between August 7, 2013, and March 2014, what type of futures position would you take? b. If you think inflation in Japan will increase by more than that in the United States between August 2013 and December 2013, what type of futures position would you take? c. If you think stock prices will fall between August 2013 and December 2013, what type of position would you take in the December S&P 500 Index futures contract? What happens if stock prices actually rise?
8. What is an option? How does an option differ from a for ward or futures contract? (LG 10-4)
9. What is the difference between a call option and a put option (/G /01)
10. What must happen to the price o the underlying T bond lutures contrct for the purchaser of a call optien on T-bond
11. What must happen to the price of the underlying stock for the purchaser of a put option How does the writer of the put option make money'? (LG 10-4) on the stock to make money?
12. What are the three ways an option holder can er her position? (LG 104) liquidate his

Ch 19
13. What are foreign exchange markets and foreign exchange rates? Why is an understanding of foreign exchange markets important to financial managers and individual investors? (LG 9-1)

14.If the Swiss franc is expected to depreciate in the near future, would a U.S.-based FI in Bern City prefer to be net long or net short in its asset positions? Discuss. (LG 9-1)

15. How did the Bretton Woods and the Smithsonian Agreements allocate the ability of foreign exchange rutes to float freely How did the elimination of exchange bundariestn 1973 acetic the ability of foreign exchange rates to float freely?
16.what motivates FIs to hedge foreign currency exposures? what are the limitations to hedging foreign currency exposure ?
17.What are the two primary methods of hedging FX risk for an FI? What two conditions are necessary to achieve a per- fact hedge through on-balance-sheet hedging? What are the advantages and disadvantages of off-balance-sheet hedging in comparison to on-balance-sheet hedging? (LG 9-5)
18.If international capital markets are well integrated and oper- ate efficiently, will Fls be exposed to foreign exchange risk? What are the sources of foreign exchange risk for FIs? (LG 9-5)
19.Explain the concept of interest rate parity. What does this concept imply about the long-run profit opportunities from investing in international markets? What market conditions must prevail for the concept to be valid?
20.One forms of the interest rate parity equation appears as 1 +se d/s)x+r)xt where both the spot and forward rates are expressed in terms of dollars for pounds or diret eachange rates How would the equation be what ten if the exchange rates were indirect-that is pounds for dollars?

21. In 1992 hedge fund manager George Soros sold short more than 10 billion British Pounds, a bet which eventually earned him a $1 billion profit. How did he accomplish this feat?
22. In 2008 Credit Default Swaps were traded OTC in a dark and nearly unregulated market. How does this differ from Put Options listed on the CBOE in terms of regulations and transparency?
23. Both the capital asset pricing model and the arbitrage pricing theory rely on the proposition that a no-risk, no-wealth investment should, on average, no return. Explain why this should be the case, being sure to describe briefly the similarities and differences between the CAPM and the APT. Also, using either of these theories, explain how superior investment performance can be established.
24. How might a jewelry store and a grocery store differ in terms of asset turnover and profit margin? Would you expect their return on assets to differ assuming equal business risk? Discuss.

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Explanation & Answer

Attached.

1. What is a derivative security? (LG 10-1, LG 10-4, LG 10-7)
Derivative securities are types of securities whose values worth is dependent on the worth of
another asset. The main types of derivative securities include swaps, futures, options and
forwards. Convertible bonds is an example of derivative security whose worth is dependable on
worth of underlying stock.

2. What are the differences between a spot contract, a forward contract, and a futures
contract? (LG 10-1)
Despite Forward contract and future contracts both involving agreement of future buying and
selling of assets, the settlement of forward contracts is done at the end of the contract while
future contracts happens on a daily basis. The settlement of Spot contracts on the other hand, is
done immediately/ instant delivery.

3. What are the functions of floor brokers and professional traders on the futures
exchanges? (LG 10-2)
Floor brokers are independent exchange members authorized in executing trades on behalf of
clients on the exchange floor. The public task the floor brokers to trade for them with other floor
brokers or professional traders who are skilled and trade on their own account.

4. What is the purpose of requiring a margin on a futures or option transaction? What is
the difference between an initial margin and a maintenance margin? (LG 10-2)
A margin on a futures or option transaction determines the terms of futures contract traded.
Initial margin is an upfront payment required on futures trades for ensuring terms of any future
position is taken while maintenance margin is a margin that must be maintained.

5. When is a futures or option trader in a long versus a short position in the derivative
contract? (LG 10-2)
When a futures holder wants to purchase a futures contract, then he takes a long position in the
futures contract while when a futures holder wants to sell a futures contract, he takes a short
position of the futures contract.

6. What is the meaning of a Treasury bond futures price quote of 103-13? (LG 10-3)

A bid asked quote of 103 + 13/32 = 103.40625/10 = 1.0340625 * 100,000 = $103,406.25 quoted
price. The face value was $100,000.

7. Refer to Table 10-4. (LG 10-3) a. If you think 15-year Treasury note prices will fall between
August 7, 2013, and March 2014, what type of futures position w...


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