Buy and Sell Agreement for a Car - PowerPoint by kur83138

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									Currency forwards




11/30/2010   Currency forwards - Kevin
Background
 Foreign exchange rates fluctuate constantly
 Fluctuations expose parties dealing in foreign
  exchange to risk
 Risk is the possibility of incurring loss
 Examples:
        Exporter expecting to receive foreign currency in
         the future
        Importer obliged to make payment in a foreign
         currency
   Parties would like to hedge the risk

11/30/2010             Currency forwards - Kevin
Financial derivatives
 Instruments for hedging risk
 Has an underlying asset – foreign
  currency, share




11/30/2010      Currency forwards - Kevin
Types of derivatives
 Forwards
 Futures
 Options
 Swaps




11/30/2010   Currency forwards - Kevin
Currency forwards: meaning
 Forward contracts are part of everyday life
 Examples: luxury car, real estate
 Definition:
        An agreement
        To buy or sell
        An asset ( commodity or financial asset)
        At a predetermined price
        Within a specified future date
 Contract for forward delivery, not ready (spot)
  delivery
 The buyer has a long position; the seller has
  a short position
11/30/2010             Currency forwards - Kevin
Forward dealings in foreign
currency: exporter
 An exporter exports goods worth USD
  1,00,000 to USA
 Receipt of USD expected after 3 months
 Current exchange rate: 1 USD = Rs.46
 Decline in the value of USD is anticipated
 Exporter enters into a forward contract to sell
  USD after 3 months at Rs.45.70 /USD
 After 3 months:
        If USD 1= Rs.45 – gain of Rs.70,000
        If USD 1= Rs.45.70 – no profit, no loss
        If USD 1= Rs.46.50 – opportunity loss (loses
         opportunity to gain Rs.80,000)
11/30/2010             Currency forwards - Kevin
Forward dealings in foreign
currency: importer
 An importer has imported goods worth Euro
  1,00,000 from Europe
 Payment to be made after 3 months
 Current exchange rate: 1 Euro= Rs.58
 Increase in the value of Euro is anticipated
 Importer enters into a forward contract to buy
  Euro after 3 months at Rs.58.40 /Euro
 After 3 months:
       If Euro 1= Rs.60 – gain of Rs.1,60,000
       If Euro 1= Rs.58.40 – no profit, no loss
       If Euro 1= Rs.57.40 - opportunity loss (loses
        opportunity to gain Rs.1,00,000)
11/30/2010             Currency forwards - Kevin
Currency forwards: merits and
demerits
 Merit:
      Helps   in hedging risk
 Demerits:
      Does    not provide opportunity for making
       profit
      There is illiquidity (forwards have to be
       executed being bilateral private contracts)
      There is default risk (credit risk) (the party
       at disadvantage may default)

11/30/2010           Currency forwards - Kevin
Operation of financial
derivates
 Facilitates exchange of financial assets in the
  future at prices determined in the present
 Enables participants to “lock in” a price for the
  future transaction
 Uncertainty arising out of future fluctuations in
  asset prices is eliminated
 Example: an exporter can convert foreign
  currency into Indian rupees in future at a
  predetermined price


11/30/2010        Currency forwards - Kevin

								
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