# Automobile Buy and Sell Contract

Document Sample

```					                           Chapter 5
Currency Derivatives

Source: http://www.mcdonalds.com/corp/invest/pub/2006_Annual_Report.html
McDonald’s Corporation 2006, Annual Report, p 46            1
Source: http://www.mcdonalds.com/corp/invest/pub/2006_Annual_Report.html
McDonald’s Corporation 2006, Annual Report, p 36
2
Forward Contracts
Agree today on a price to be paid in the
future for a specified amount of foreign
currency at a specified delivery date

When you enter into a Forward Contract,
four important things must be agreed upon:
• Whether you will buy or sell the foreign currency
• How much of the foreign currency is involved
• The exchange rate
• When the exchange will take place

3
Suppose an American tourist plans to
go to England six months (180 days)
from today and he plans to spend
\$1,000 while he is there.
What choices does he have for getting
the £’s he will need?
1. Buy £’s today at the current
spot rate of S0 = \$1.48/ £
How many £’s will he get?

1,000
 £676
1.48

4
2. Buy £’s with a Forward Contract today at
the current forward rate of F180 = \$1.44/£

\$1,000
 £694
\$1.44 / £
3. Wait six months and buy £’s at the then
current spot rate

Which of the three is the best course of action?
He will not know until six months from today
but he must make a decision today.

5
Today’s Spot Rate (S) and Today’s Forward Rate (F)
F = S(1 + p)
p is the forward premium as a percentage
F     FS
p   1
S       S
In the previous example:
\$1.44  \$1.48  \$0.04
        2.7%
\$1.48       \$1.48
A negative number indicates a Forward Discount
A positive number indicates a Forward Premium

Frequently calculated as an annual rate,
but we won’t in this class
6
Forward Discount
The Forward Rate is better for buying the
foreign currency than the current Spot Rate
(in direct quotations, the Forward
Rate is less than the Spot Rate)

The Forward Rate is worse for buying the foreign
currency than the current Spot Rate
(in direct quotations, the Forward Rate is more
than the Spot Rate)
7
What influences today’s Forward Rate (F180)?
A major influence is what people today expect
the Spot Rate (S180 ) to be 180 days from now
Suppose today
F180 = \$1.50/£ > \$1.40/£ = E[S180]
What will happen in the market for
£ Forward Contracts under these conditions?
More people will want to sell £’s at \$1.50/£
than will want to buy them at that price 
A surplus will exist 
The 180-day Forward Rate of \$1.50/£ will
decrease until it is equal to E[S180 ]
Later in the semester we will investigate other
factors which influence today’s Forward Rates
8
Wall Street Journal
Tuesday, July 10, 2007
Currencies                                              Monday, July 9, 2007
U.S.- dollar foreign-exchange rates in late New York trading
US\$ vs
----- Mon -----            YTD chg
Country/currency         In US\$       per US\$            (%)
Europe
Spot Rate
UK pound                 2.0150          0.4963        - 2.8
1-mos forward            2.0140          0.4965        - 2.8
3-mos forward            2.0121          0.4970        - 2.7
6-mos forward            2.0083          0.4979         -2.5

On Monday, what was the market expecting the
value of the \$ to do over the next 180 days?
The \$ will appreciate against the £ over the
next 6 months (180 days)                                      9
Source: http://www.bmonesbittburns.com/economics/fxrates/?region=us   10
¥ vs \$
On Tuesday, October 6, 1998, the spot rate
for the yen was ¥130.18/\$. The next day the
spot rate dropped to ¥120.55/\$.
Wednesday’s Wall Street Journal reported that
some analysts were predicting “the U.S. currency
could rally to ¥140/\$ in six months”.
Wednesday’s 6-month forward rate was
¥117.45/\$. Assume you believed the analysts’
prediction and you had \$500. How could you
have used a forward contract to make a profit?
Should you “buy” or “sell” yen at the forward
rate of ¥117.45/\$?                11
CAUTION
To apply the rule “buy low and sell high”,
think in terms of \$/¥ rather than ¥/\$ 

Spot market in 6 months: ¥140/\$ = \$0.007143/¥
6-months forward rate: ¥117.45/\$ = \$0.008514/¥

Sell yen forward at \$0.008514/¥ anticipating being
able to buy yen in six months at \$0.007143/¥

12
Wednesday Oct 7
Enter into a forward contract

Sell ¥ forward 6 months at a rate of ¥117.45/\$

How many ¥?

You anticipate buying ¥ in the spot market in
6 months at a rate of ¥140/\$

\$500(¥140/\$) = ¥70,000
13
Six Months Later

Deliver the ¥70,000 on the

70,000
 \$596
117.45

Dollar profit = \$96

14
Non-Deliverable Forward Contracts
Frequently used for currencies in
emerging markets

Similar to Forward Contract: specified currency,
specified amount, specified future settlement
date, specified rate (reference index)

Different from Forward Contract: no actual
exchange of currencies in future, instead a \$
payment is made based on reference index at
the settlement date
15
Source: http://www.cme.com/files/renminbi_factcard.pdf   16
Futures Contracts
Specifies a standard amount of a currency to be delivered at
a specified settlement date in the future at a specific price

Wall Street Journal
Tuesday, July 10, 2007
CURRENCY FUTURES
Monday, July 9, 2007
Japan Yen (CME) 12.5 million; \$ per 100¥
CME = Chicago Mercantile Exchange
Open
Open     High      Low     Settle     Chg    Interest
Sept      .8179    .8189    .8158    .8180     .0001   310,150
June ’08 .8445    .8453    .8440    .8448      .0001     15,360

Sept contracts opened at \$0.008179/¥
At the end of the trading day Monday, there
were 310,150 Sept contracts outstanding
18
Comparison of Forward
and Futures Contracts

Size of contract
Forward: Tailored to individual needs
Futures: Standardized

Delivery date
Forward: Tailored to individual needs
(30, 60, 90 or 180 days)
Futures: Standardized (third Wednesday in
March, June, September, December)
19
Participants
Forward: Banks, brokers, MNC’s
(public speculation not encouraged)
Futures: Banks, brokers, MNC’s
(Qualified public speculation is
encouraged)

Marketplace
Forward: Over the telephone, worldwide
Futures: Central exchange floor with
worldwide communications
20
Security deposit
(collateral)
Forward: Usually none (relationship with
bank) but compensating balance or
line of credit sometimes required
Futures: Small security deposit required
(buy on margin, subject to daily
margin calls)

21
Liquidation
Forward: Most settled by actual delivery
(Some by offset, at a cost)
Futures: Most by offset (very few by delivery)

Transactions costs
Forward: Set by “spread” between bank’s
Futures: Negotiated brokerage fees

22
Regulation
Forward: Self-regulating
Commission, National Futures
Association

Terminology
Forward: you enter into a forward contract
Futures: you buy or sell futures contracts

23
Futures Contract
January 5
125,000 Swiss Francs per contract
\$0.76/SF on a March contract
The buyer of this contract agrees to
purchase 125,000 Swiss Francs on the third
Wednesday in March for
\$0.76(125,000) = \$95,000
The seller of this contract agrees to
deliver 125,000 Swiss Francs on the third
Wednesday in March and will receive
\$95,000
24
the contract you decide you do not
want Swiss Francs in March
Sell a March SF contract at the current
price of \$0.74/SF  you would receive
0.74(125,000) = \$92,500
On this investment you lost
\$95,000 - \$92,500 = \$2,500

Approximately 44% annual rate
25
Why is the CME in business?
To make money by “making a market”.
What concern does the buyer of a futures
contract have about the seller of the contract?
That the seller won’t deliver the foreign currency.
What concern does the seller of a futures
That the buyer won’t deliver the home currency.
What can the CME do to make sure both
parties honor the contract?
The CME guarantees delivery on contracts by
requiring a margin when the contract is sold.
26
Suppose the buyer and seller put up a margin
of \$1,500 on January 5 when they bought/sold
the \$0.76/SF March futures contract

If the price of SF’s falls the next day to \$0.755,
the contract is worth only \$94,375. Who might
not show up, the buyer or the seller?

CME may choose to increase the buyer’s
margin by \$95,000 - \$94,375 = \$625

If the buyer refuses, CME will sell an offsetting
futures contract for \$94,375 and close out
\$1,500 - \$625 = \$875
27
Source: http://www.mcdonalds.com/corp/invest/pub/2006_Annual_Report.html
McDonald’s Corporation 2006, Annual Report, p 36          28
Source: http://www.mcdonalds.com/corp/invest/pub/2006_Annual_Report.html
McDonald’s Corporation 2006, Annual Report, p 36            29
Currency Options

Call Option
Grants the right to buy a specific
amount of a specific currency
At a specific price (strike price or exercise price)
Within a specific period of time (expires on Saturday
before third Wednesday of contract month)
The “premium” is what it costs to
“European style” can be exercised
only on the expiration date
Sold on exchanges and offered by
commercial banks and brokerage firms            30
Why do people buy automobile insurance?

31
So that if their car is in an accident, the
insurance will pay for repairing the car.

32
Insurance provides protection for the
car’s owner in the event something

Currency options are similar to insurance
in that they provide protection against
something “bad” happening to the value
of a foreign currency.

The cost of automobile insurance (the
premium) depends on the total amount of
coverage and the size of the deductible.
33
Source: http://www.cme.com/

Source: http://www.phlx.com/products/currency/cug.pdf
34
British Pound (£) Options
£62,000 per contract
cents per pound
for these options
Strike                  January 5
Price           Calls                   Puts
Jan    Feb     March   Jan     Feb    March
1500     6.06   6.23     6.50    ----   0.16    0.44
1525     3.71   3.94     4.42   0.04    0.40    0.90
1550     1.26   2.12     2.80   0.20    1.06    1.74
1575     0.16   0.92     1.62   1.60    2.36    3.04
1600     0.14   0.34     0.86   4.01    4.26    4.76
1625     0.10   0.16     0.42   6.54    6.62    6.80

Current spot rate \$1.56/£                     35
How much did it cost on January 5 to buy a
March Call with a strike price of \$1.50?
6.5¢/£  0.065(62,000) = \$4,030
Suppose on January 5 the
with a strike price of \$1.50 is
spot rate on January 5 is
how you could make money
under these circumstances?

36
Step 1:
Buy a Call option for (2¢)(62,000) = \$1,240
Step 2:
Exercise it immediately, receive £’s at \$1.50/£
\$1.50(62,000) = \$93,000 
total cost of \$1,240 + \$93,000 = \$94,240
Step 3:
Sell £’s in spot market at \$1.56 and collect
\$1.56(62,000) = \$96,720 
profit of \$96,720 - \$94,240 = \$2,480
with no risk

37
If markets are efficient then
The lower the strike price is
relative to the spot rate
The longer until Call expires
The greater the variability in a currency
38
If the purchaser of the March Call
exercises it, what is the cost of each £?

\$1.50 + \$0.065 = \$1.565 per £

39
How is buying the March Call option
like buying insurance for an MNC?
It guarantees the MNC that it can buy
the £’s it needs in March for no more
than \$1.565 per £

40
In deciding whether or not to exercise the
March Call, should the owner of the Call
compare the current spot rate to

\$1.50            Strike price

or
\$1.565                 Cost of £’s by
exercising Call

41
?
Spot
Market

January 5

\$4,030
Exercise
Call

42
\$1.50            Strike price

Since the premium is a sunk cost, it
should be ignored in this decision.
The owner of the Call wants to buy £’s
where they are the cheapest.

 If spot < \$1.50  do not exercise March call

 If spot > \$1.50    exercise March call

43
On January 5 an MNC bought a March call
option because it must pay £’s in March to
one of its British suppliers. The Call’s
strike price was \$1.50/£. It is now the
Saturday before the third Wednesday in
March and the spot rate is \$1.53.

Should the Call be exercised ?

44
?
Spot
Market
\$1.53

Saturday
January 5     before

Exercise
\$4,030     Wednesday
Call
in March
strike price
\$1.50

45
Calculate the total cost of the £’s if the
MNC exercises the Call
( \$1.50 + 6.5¢ )(62,000) = \$93,000 + \$4,030 =
\$97,030
Compare this to the total cost of the £’s if the MNC
does not exercise the Call
Buying £’s in the spot market will cost
(\$1.53)(62,000) = \$94,860
Remember that the MNC had to pay the \$4,030
even if it does not exercise the option 
Total cost of not exercising the Call is
\$94,860 + \$4,030 = \$98,890
46
?
Spot
Market
\$98,890

Saturday
January 5     before

\$4,030     Wednesday
Exercise
in March
Call
\$97,030

47
Exercising the Call is less expensive
than not exercising it by
\$98,890 - \$97,030 = \$1,860

Or, ignoring the premium (sunk cost)
\$94,860 - \$93,000 = \$1,860

48
Suppose it is January 5 when the MNC is
considering whether or not to purchase the
March Call with a strike price of \$1.50, and it
forecasts the March spot rate to be \$1.53

Should the MNC
purchase the March
Call or go uncovered ?
49
?
Uncovered
forecast
spot rate
\$1.53

January
5

Exercise
Call    strike price
6.5 ¢
50
Cost of the £’s if MNC purchases
and exercises the Call

(\$1.50 + 6.5¢)(62,000) = \$93,000 + \$4,030 =
\$97,030

Cost of the £’s if the MNC goes
uncovered and forecast is correct
(\$1.53)(62,000) = \$94,860

51
?
Uncovered
\$94,860

January
5

Exercise
By going uncovered, MNC anticipates         Call
buying £’s at a lower cost, thus saving   \$97,030
\$97,030 - \$94,860 = \$2,170 RISK
52
Under what circumstances would an MNC be
interested in buying a Call option?
1. MNC must deliver the foreign
currency in the future
2. MNC feels spot will rise above
Under what circumstances would an MNC be
interested in selling a Call option?
1. MNC has the foreign currency on hand and
wants to make an additional return on it
2. MNC feels spot will go below the strike price
(so the owner of the Call will not exercise it)
53
Speculators
A speculator hopes to profit from changes in
the exchange rate. He does not currently
have the foreign currency, does not need to
pay foreign currency in the future and will
not receive foreign currency in the future
Suppose a speculator thinks £’s will depreciate.

Would the speculator want to
Sell a Call, receive \$4,030 and hope Call
is never exercised so he gets to keep
the entire \$4,030 as profit
54
What happens if the spot rate is \$1.53 and
the Call is exercised?

Speculator must buy £’s in spot market at \$1.53
for \$1.53(62,000) = \$94,860

\$1.50(62,000) = \$93,000 for a profit of
\$93,000 + \$4,030 - \$94,860 = \$2,170

55
Under what circumstances would
a speculator be interested in
1. He feels spot will rise above strike + premium

Under what circumstances would
a speculator be interested in
selling a Call option?
1. He feels spot will fall below the strike
price and the Call will never be
exercised so the entire premium is profit
56
General Conclusions
Suppose the strike price of a Call Option
is \$1.40/£ and the premium is 5¢
If spot < strike
spot < \$1.40
 Buyer does not exercise the Call
 Seller keeps entire premium as profit

If \$1.35 < spot < \$1.40 the buyer recoups part
foreign currency in the spot market
If spot < \$1.35 the buyer recoups more
foreign currency in spot market
57
If strike < spot < strike + premium
\$1.40 < spot < \$1.45
 Buyer exercises Call and recoups some of
 Seller’s profit is only part of the premium
If strike + premium < spot
\$1.45 < spot
 Buyer exercises Call and recoups more
 Seller loses all of the premium and more
if the foreign currency must be
purchased in the spot market               58
Contingency Graph
This is a picture of the “profit/loss” position
of a speculator buying or selling a Call
Option or a Put Option. The magnitude of the
profit or loss depends on what the strike
price is and can be shown “per unit” of the
foreign currency or for the entire size of the
contract.

Consider a Call Option with a strike
price of \$1.40/ £ and a premium of 5¢

59
Net Profit
per Unit
at the           in the money
money            spot > strike

0¢
\$1.40       \$1.45       Spot Rate
- 5¢
out of the
money
spot < strike
60
Seller of Call
Net Profit
per Unit
+ 5¢

0¢
\$1.40   \$1.45   Spot Rate

61
Put Option
Grants the right to sell a specific
amount of a specific currency

At a specific price (strike price or exercise price)

Within a specific period of time (expires on Saturday
before third Wednesday of contract month)

Put Option
62
British Pound (£) Options
£62,000 per contract
cents per pound

Strike                  January 5
Price           Calls                  Puts
Jan    Feb     March   Jan    Feb    March
1500     6.06   6.23     6.50     -    0.16    0.44
1525     3.71   3.94     4.42   0.04   0.40    0.90
1550     1.26   2.12     2.80   0.20   1.06    1.74
1575     0.16   0.92     1.62   1.60   2.36    3.04
1600     0.14   0.34     0.86   4.01   4.26    4.76
1625     0.10   0.16     0.42   6.54   6.62    7.00

Current spot rate \$1.56/£
63
How much would it cost to buy a
March Put with a strike price of \$1.625?
The premium is 7¢/£  \$0.07(62,000) = \$4,340
Suppose on January 5 the
premium on a March Put with a
strike price of \$1.625 was 4¢/£
instead of 7¢/£. The spot rate at
that time was \$1.56/£. Any
make money under these
circumstances?

64
Step 1:
Buy Put option for (4¢)(62,000) = \$2,480
Step 2:
Buy £’s in spot market at \$1.56 for
\$1.56(62,000) = \$96,720 
total cost is \$96,720 + \$2,480 = \$99,200
Step 3:
Exercise Put  deliver £’s and receive
\$1.625(62,000) = \$100,750 
profit = \$100,750 - \$99,200 = \$1,550
Or \$1.625 - (\$1.56 + \$0.04) = \$0.025/£
With NO RISK

65
General Observations
If Markets are efficient then
The lower the spot price is relative to
the strike price  higher premium
The longer until put expires 
The greater the variability in a currency
66
If the purchaser of the March Put with
a strike price of \$1.625 exercises it,
how much will he actually receive for
each £ he sells?

\$1.625 - \$0.07 = \$1.555 per £

67
How is buying the March Put option
like buying insurance for an MNC?
It guarantees the MNC that it can sell
the £’s it receives in March for a
minimum of \$1.555 per £

68
In deciding whether or not to exercise the
March Put, should the owner of the Put
compare the current spot rate to

\$1.625               Strike price

or
by exercising Put

69
?
Spot
Market

January 5

\$4,340
Exercise
Put

70
\$1.625             Strike price

The owner wants to sell £’s where he receives
the most for each £. Since the premium is a
sunk cost, it should be ignored when making
this decision.

 If spot < \$1.625  exercise March Put

 If spot > \$1.625  do not exercise March Put

71
On January 5 an MNC bought a March Put option
because it will receive £’s in March from one
of its British customers. The Put’s strike price
is \$1.625/£. It is the Saturday before the third
Wednesday in March and the spot rate is \$1.58.

Should the Put be exercised ?

72
?
Spot
Market
\$1.58

Saturday
January 5     before

\$4,340     Wednesday        Put
in March   strike price
\$1.625

73
Calculate the total revenue the MNC receives
from selling £’s if it exercises the Put
( \$1.625 - 7¢ )(62,000) = \$100,750 - \$4,340 =
\$96,410
Compare this to the total revenue from the sale of
the £’s if the NMC does not exercise the Put
and sells them in the spot market
\$1.58(62,000) = \$97,960
from selling £’s in the spot market
Remember that the NMC had to pay the \$4,340
premium even if it does not exercise the option 
Total revenue if MNC sells £’s in spot market
\$97,960 - \$4,340 = \$93,620          74
?
Spot
Market
\$93,620

Saturday
January 5     before

\$4,340     Wednesday   Exercise
in March     Put
\$96,410

75
Exercising the Put generated more revenue
than selling the £’s in the spot market by
\$96,410 - \$93,620 = \$2,790

Or, ignoring the premium (sunk cost)
\$100,750 - \$97,960 = \$2,790

76
Suppose it is January 5 when the MNC is
considering whether or not to purchase the
March Put with a strike price of \$1.625/£, and it
forecasts the March spot rate to be \$1.58/£

Should the MNC purchase the
March Put or go uncovered ?

77
?
Uncovered
forecast
spot rate
\$1.58

January
5

Exercise
Put
Put
strike price
\$1.625
7¢
78
Revenue from selling the £’s if MNC
purchases a Put and exercises it.

(\$1.625 - 7¢ )(62,000) = \$100,750 - \$4,340 =
\$96,410

Revenue from selling the £’s if the MNC goes
uncovered and its forecast is correct
(\$1.58)(62,000) = \$97,960

79
?
Uncovered
\$97,960

January
5

The MNC anticipates receiving
Exercise
more revenue by going uncovered
Put
than from selling £’s by exercising
\$96,410
the Put
\$97,960 - \$96,410 = \$1,550        RISK              80
Under what circumstances
would an MNC be interested
1. It will receive foreign currency in the future
2. It feels spot will fall below strike - premium
Under what circumstances
would an MNC be interested
in selling a Put option?
1. It will deliver foreign currency in the future
2. It feels (strike - premium) < spot < strike

NOTE: If MNC feels spot will rise above strike,
buying a Call option is a better hedge
81
RECALL: A speculator hopes to profit from
changes in the exchange rate. He does not
currently have the foreign currency, does not
need to pay foreign currency in the future and
will not receive foreign currency in the future

Under what circumstances would a speculator be
interested in buying a Put option?

1. He feels spot will fall below strike - premium

Under what circumstances would a speculator be
interested in selling a Put option?
1. He feels spot will rise above strike and the
Put will never be exercised so
the entire premium is profit             82
General Conclusions
Suppose the strike price is \$1.60/£
If strike < spot
\$1.60 < spot
 Buyer does not exercise Put
 Seller keeps entire premium as profit
If \$1.60 < spot < \$1.66 the buyer recoups
part of the 6¢ premium by selling foreign
currency in spot market
If \$1.66 < spot the buyer recoups more
than the 6¢ premium by selling foreign
currency in spot market
83
If strike - premium < spot < strike
\$1.54 < spot < \$1.60
 Buyer exercises Put and recoups some of the
 Seller’s profit is only part of the 6¢ premium

If spot < strike - premium
spot < \$1.54
 Buyer exercises Put and recoups more
 Seller loses all of the 6¢ premium and
more if the foreign currency must be
sold in the spot market
84
Contingency Graph
for Put Options

strike price is \$1.60/£ and the premium is 6¢
Net Profit
at the    out of the money
money
spot > strike
0¢
\$1.54     \$1.60       Spot Rate
in the money
- 6¢   spot < strike

85
Seller of Put
Net Profit
per Unit
+ 6¢

0¢
\$1.54   \$1.60   Spot Rate

86
¥ vs \$
On Tuesday, October 6, 1998, the spot rate
for the yen was ¥130.18/\$ . The next day the
spot rate dropped to ¥120.55/\$.
On Tuesday, the yen options prices as
reported in the Wall Street Journal were as
follows:

87
Japanese Yen (CME) Tuesday, Oct 6, 1998
12,500,000 yen; cents per 100 yen
Strike         Calls - Settle            Puts - Settle
Price     Oct       Nov       Dec    Oct     Nov         Dec
7600      1.49      2.39      2.87  0.28     1.19        1.67
7650      1.12      2.11      2.59  0.42     1.40        1.89
7700      0.83      1.85      2.35  0.62     1.64        2.14
7750      0.60      1.60      2.12   ….       ….          ….
7800      0.42      1.40      1.91  1.21      ….         2.69
7850      0.28       ….       1.71   ….       ….          ….

Strike price 7600 means \$0.007600/¥

What should you have done on Tuesday
in order to benefit from what happened
on Wednesday?
88
Tuesday
Should you use a Call or a Put?
HINT: ¥120.55/\$ = \$0.008295/¥ tomorrow

CALL
Should you buy a call or sell a call?

Tuesday a strike price
Buy an October Call Option with
of \$0.0076/¥ for a premium of 1.49¢ per 100¥
cost: \$0.0149(125,000) = \$1,862.50

Wednesday
Step 1: Exercise the Oct Call Option
cost: \$0.007600(12,500,000) = \$95,000
Step 2: Sell ¥12,500,000 in the spot market at
the current spot rate of \$0.008295/¥
Profit: \$103,687.50 - \$95,000 - \$1,862.50 = \$6,825
90
Conditional Currency
Option
Currency Option with a conditional premium:
Payment of the premium is conditioned on
the actual movement of the spot rate
EXAMPLE:
£ Put Option with a strike price of \$1.60 and a
conditional premium of 4¢ with a trigger of
\$1.66. If the future spot rate is \$1.66 or lower,
91
Net Amount

\$102,920

\$100,440
\$99,200

\$97,960

Normal Put Option

\$1.60 \$1.66
Spot Rate
92

If a currency is highly volatile, a speculator may
buy both a Call (anticipating appreciation) and a
Put (anticipating depreciation)

Spot rate may fluctuate enough to
exercise both and profit on both

Spot may move strongly in one
direction and profit on that option
may exceed premium on the other option

93
Building Blocks
for FINC 445
Skills:
Communication
Problem Solving
Forward Contracts:           Futures Contracts             Arbitrage              Put            Call             Contingency
Forward Premium                  margin                                         Options        Options             Graph

MNC’s and consumers         Exchange Rate Determination:                Adjustment of Market Equilibrium:                   Speculating on
Investors                    Exports and imports                  Inflation, interest rates, income levels,          anticipated exchange
Central Banks                pair of currency markets              expectations about future exchange rates               rate movement
Speculators               supply, demand, equilibrium

Motives:             Familiar Setting:             Currency Conversion:                    Spot Market:                Bank participation in
Involved in foreign       U.S. grocery store          The basics, value, appreciate,      Bid & ask rates, direct &          foreign exchange
financial markets         Buyer vs seller            depreciate, purchasing power          indirect, cross rates,                markets
arbitrage

Trade Agreements:             FX Systems:            Balance of Payments:           Trade Issues:             Economic Factors:                  Intl
U.S.-Canada, NAFTA,         Euro, Dollarization,         Current Account            Japan & China,          Inflation, national income,        Agencies:
Mercosur, FTAA, CAFTA,       Floating Exchange            Capital Account           deficits, surpluses,   interest rates, trade barriers,      World Bank
Mexico, EU, GATT, WTO           Rate System             Official Reserve Acct        trading partners               capital controls               IMF

Problem of Scarcity:         Economic              Goal of Corp:        Ethical              Perfect      MNC vs           Risk of doing         PV of
Interdependence            Capitalism,           shareholders                                labor        firm           internationally
Socialism
cashflows
interest
Communism
94

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