Question

1. A ______contract is between a bank and its customer and requires a fixed delivery date, at a fixed exchange rate for a specified amount of a foreign currency to be delivered or purchased.

A. Currency swap

B. Currency forward

C. Currency options

D. Currency futures

2. When exchange rate are at _____, there is little to no pressure on the rates to change.

A. the world market rate

B. Parity

C. Arbitrage

D. the hedged mode

3. One important assumption when hedging foreign currency is that the hedger _______.

A. buys the forward contract from a bank

B. does not know which direction future exchange rates will change

C. knows which direction future exchange rates will change

D. buys the forward contract from a legally recognized stock markets

Answer 1

1. Currency swap

It is an contract under which two parties are obligated to exchange currencies with respect to a loan amount at a pre-specified rate and date. This is done to hedge against risks related exchange rate changes.

2. Arbitrage

When there are arbitrage opportunities available in the exchange rate market which means there is a difference in price of currency in two or more markets, this provides an opportunity of realizing gains by buying at lower price and selling at higher price. Since banks undertake huge transactions in very little time in order to capture this opportunity, prices stabilize automatically. Thus, this allows the exchange rates to remain unchanged.

3. does not know which direction future exchange rates will change

Hedging is a type of insurance for covering losses in adverse situations. It involves taking opposite position in the currency in question. For example, if a company sells its product to a foreign country, it is exposed to risk of changes in exchange rate as its revenue is dependent on foreign currency value. In such a situation, the company may hedge its risk. Since the hedger is not sure about the direction of change, it takes opposite position to offset any losses.