Chat with AIExam 14: Global Financial Management
Losses that are incurred and that cause the participant's balance to fall below the maintenance margin at the end of the trading day is called a _____.
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Differentiate between futures contract and forward contract. Provide an example of each.
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Answered by Examlex AI CopilotFutures contracts and forward contracts are both types of financial derivatives that allow parties to buy or sell an asset at a predetermined price at a specific time in the future. However, there are several key differences between the two:
1. Standardization:
- Futures Contracts: These are standardized contracts that are traded on an exchange. They have standardized terms, including quantity, delivery time, and increments of price movement.
- Forward Contracts: These are private agreements between two parties and are not traded on an exchange. The terms of a forward contract, including the quantity of the asset and the delivery date, can be customized to fit the needs of the parties involved.
2. Counterparty Risk:
- Futures Contracts: Because they are traded on an exchange, the risk of one party defaulting is mitigated by the clearinghouse associated with the exchange, which acts as the counterparty to all trades and guarantees the performance of the contract.
- Forward Contracts: There is a higher counterparty risk because the contract is private, and there is no intermediary to guarantee performance. If one party defaults, the other party may have no recourse other than legal action.
3. Margin Requirements:
- Futures Contracts: Participants are required to post margin, which is a performance bond to cover potential losses. Margin requirements can change daily as the value of the underlying asset changes.
- Forward Contracts: Typically, there are no margin requirements, although counterparties can negotiate any terms they wish, including possible collateral to mitigate credit risk.
4. Settlement:
- Futures Contracts: These contracts are usually settled daily, with the daily gains or losses reflected in the participants' accounts. At expiration, the contract can be settled by physical delivery of the asset or cash settlement.
- Forward Contracts: Settlement occurs at the end of the contract term, and the contract is usually settled by physical delivery of the asset, although cash settlement can also be arranged.
5. Liquidity:
- Futures Contracts: They are highly liquid due to their standardization and the presence of an exchange, which facilitates easy entry and exit from positions.
- Forward Contracts: They are generally less liquid because they are custom contracts and finding a party to take the opposite position can be difficult.
Example of a Futures Contract:
An agricultural producer wants to lock in the price of wheat for the next harvest. They could enter into a futures contract by agreeing to sell 5,000 bushels of wheat at a price of $5.00 per bushel six months from now. This contract would be traded on a commodities exchange like the Chicago Board of Trade (CBOT).
Example of a Forward Contract:
A manufacturing company that requires a specific type of steel not commonly traded on futures exchanges might enter into a forward contract with a steel supplier. They could agree to purchase 10,000 tons of steel at a price of $700 per ton, to be delivered in one year. This contract is a private agreement between the company and the supplier, tailored to their specific needs.
In summary, futures contracts are standardized and traded on exchanges with lower counterparty risk and daily settlement, while forward contracts are private, customizable agreements with higher counterparty risk and settlement at the end of the contract term.
How short-term changes in exchange rates can affect operating costs and revenues of firms engaged in international business activities is referred to as ________ risks.
(80) VerifiedTransactions
______ refers to an investor's right to buy an asset at a pre-determined price.
(84) Attempts in currencies and currency derivatives to earn profits from trading them and help to make prices efficient are referred to as _______.
(82) The sensitivity of a stock to market risk affected by currency movements is known as the _____.
(65) An interest rate swap, often combined with a currency swap when the interest being swapped is in different currencies, is called a syndicate swap.
(63) ______ is a Japanese bank that supports exporters around the world that have at least 30 percent Japanese content.
(67) __________ refers to a basket of currencies consisting of dollars, euros, pounds, and yen created by the International Monetary Fund (IMF).
(84) The _____ is the difference between present value of futures profits on an investment project minus the initial investment cost.
(77) Scenario - The Gayla Corporation
The Gayla Corporation is a multinational business that conducts operations in twelve foreign markets. This multi-million dollar organization is very familiar with currency exchanges and has considerable understanding when it comes to the risks associated with operating in the global market arena. The Gayla Corporation claims it would not be as successful without the expertise of the financial wizards that work for it. The company has not lost money so far and plans to stay that way.
-The Gayla Corporation must fully understand and effectively handle the short-term changes in exchange rates and how this can affect operating costs and revenues derived from its international business operations. Which of the following best identifies what this organization is facing in this situation?
(78) Two kinds of short-term effects of currency movements are _____ risk and _____ risk.
(69) ______ refers to an interest rate swap, often combined with a currency swap, if the interest being swapped is in different currencies.
(73) The _____ risk refers to the impact of random change in the value of one currency with respect to other currencies.
(85) ______ refers to an investor's right to sell an asset at a pre-determined price.
(70) Whether a firm has growth or value and how this firm characteristic affects an estimate of the cost of equity is called the _____.
(88) _____ refers to a group of banks that collectively make a loan to a firm.
(69) A basket of currencies consisting of dollars, euros, pounds, and yen created by the International Monetary Fund is known as the _____.
(70) The two types of short-term effects on currency movements are transactions risk and transformational risk.
(68) Clearing House Interbank Payment System (CHIPS)is an organization that provides secure communication for contracts, invoices, and other trade documents that normally accompany cash payments.
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