Question

a) Explain TWO (2) disadvantages using forward contract to hedge the exchange rate risk. (150 words)

b) Why it is not suitable to use ROA and ROE to measure the performances of financial institutions? (250 words)

Answer 1

A. Two disadvantages using forward contract to hedge the exchange rate risk would be as follows-

1. These are not standardized contracts and these are highly customised contract, so this will not be tradable on the stock exchanges.

2. These forward contracts are not liquid in nature because they are not continuously traded on the stock exchanges and there are no sellers and buyers which are continuously discovering it's price, so it will have to be executed on the specified date in the over-the-counter exchange market.

B.it is not suitable to use return on asset and return on equity to measure the performance of the Financial institutions because various Financial institutions are not able to generate the profit continuously and hence this financial companies are mostly judged by the nature of the cash flows which are generated by them.

cash flows are the most important factor in determination of the performance of the company in the long run because the cash flows which are generated by the company reflect the ability of the company in order to repay its payment obligation as well as it also reflects the company's liquidity status as well as the company is solvent in nature so it can be said that the the return on equity and return on assets are not the appropriate measurement standards for performance of the company in the long run.