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Saturday, February 23, 2008, 8:13 PM
they accompany me thru the mugging period =Dokays.all the memorising of international finance stuff are killing me!
the swaps. the options.the documentary credit. the export insurance. the cap,floor and collar.
rahhh!
i'm going insane
the stuff below are STRICTLY NOT FOR READING!
Lecture 13: Other Interest Rate Derivatives
Derivative
-is a financial instrument which is based on the underlying commodity/product and is usually an off balance sheet item.
Interest rate agreement
- is an agreement between two parties whereby one party for an upfront premium agrees to compensate on a specified time period if the reference rate is different from the predetermined level.
Interest rate cap
-is to protect the company from increase in interest rate above a cap rate
-Buyer pay seller an upfront premium, and in return, seller will compensate buyer if the interest rate is above the cap rate
-it is used to manage floating rate liability
Mechanics of interest rate cap:
-Buyer and seller agrees on a rate setting day during the life of the interest rate agreement, current reference rate for a bench mark (e.g. 6 month LIBOR) will be compared against the cap rate.
If the benchmark is 6 month LIBOR, it means that rate setting day occurs on every 6 months.
When interest rate>cap rate,
Seller will compensate buyer the difference and thus reducing the amount paid by the buyer to the cap rate from the rate setting day to the next rate setting day.
When interest rate
No payment is made.
Interest rate floor
-is used to protect the company against a decrease in interest rate below the floor rate
-Buyer of a floor pay an upfront premium to the seller, and thus seller agree to compensate the buyer if the reference rate goes below the floor rate
-it is used to manage floating rate assets.
Interest rate collar
-it is a combination of floor and cap, thus containining both a limit to the amount of interest paid on a stated amount of liability and the amount of interest received on a stated amount of asset.
-by using a collar, the buyer is able to reduce the premium paid as compared to buying just a cap/floor.
Advantage of caps and floor to BUYER
-can be tailored to their own requirement
-protect against the increase in interest rate on liabilities (cap) and decrease in interest rate on assets(floor)
-sometime easier to arrange than an interest rate swap.
Disadvantage of caps and floor to BUYER
-may expire unused
-not readily tradable
-credit risk on seller
-premium may be expensive
Advantage of caps and floor to SELLER
-generate income in the form premium
-may not be used
-sometime easier to arrange than an IRS
Disadvantage of caps and floor to SELLER
-amount paid may be more than premium received
-benchmark may be > cap rate or <>
Forward rate agreement
-is a forward contract to borrow or lend money in the future on an interest rate agreed today.
Mechanics of FRA
-FRA does not involve actual lending or borrowing of money, it is merely an agreement about predetermined interest rate.
-parties are compensate when the actual rate deviates from the predetermined interest rate as agreed in the FRA
Advantage of FRA
-simple and flexible way of fixing future interest rate
-available in different currencies
-can be tailored to precise requirement
Disadvantage of FRA
-cnt enjoy favourable movement in interest rate.
-no central market place
Lecture 12: Interest Rate Swap
Interest Rate Swap:
-is a legal agreement between two parties to exchange interest rate obligation/receipt in the same currency for a period ranging from 2-10 years on an agreed notional amount.
Advantage of IRS
-reduce borrowing cost
-enable each party to obtain required interest profile.
Underlying concepts
-each party have an ability to access certain interest rate market. Thru an exchange of comparative advantage, each party is able to obtain a better interest rate than borrowing from the market.
Credit Risk
-it reflects the counter party's credit standing and it's ability to meet the obligation in the swap agreement
Market risk
-it reflects the difficulty in reversing the position due to lack of market liquidity
Lecture 11: Currency Option
Currency Options:
-it gives buyer the right to buy/sell foreign currency in exchange for another currency at a price agreed (exercise price) for a specific period of time
Difference between forward contract and currency option
Forward Contract: -Obligation
-no upfront payment required
Currency Option:- Give buyer the right not an obligation
-must pay a option premium
Lecture 9 and 10: Foreign Exchange
Foreign exchange market
- it exist to assist buyer to buy and seller to sell foreign currencies
Foreign Exchange Exposure
1) Transaction Exposure
It arises due to company's commitment to receive or pay in foreign currencies. This will affect the company's cash flow
2)Translation Exposure
It arises for a parent company with foreign subsidiaries. There are no effect on company's cash flow but it will affect the company's profit
3)Economic Exposure
It is due to the chaneges exchange rate in the market,affecting the competitiveness of the company. It has effect on the future cash flow
Indirect Quotation
-it expresses all currencies in terms of per unit USD
Direct Quotation
-it expresses how many USD per unit of another currency
*relationship btw direct and indirect quotation: they are the reciprocal of each other
Cross Quotation
-does not involve USD
-it is determined by two other exchange rates
-have a currency in common, usually USD
Spot Rate
-a price contracted today for settlement of currencies two working day after the contract
Forward Rate
-a price contracted today for settlement of currencies in a future date
Forward Contract
-is executed today to buy or sell a stated amount of foreign currency against another currency at an exchange rate agreed today with settlement at an agreed future date.
Factors affecting Foreign Exchange Rates (SIP BCC)
Speculation
Interest Rate
Price Level( increase in P, decrease in demand, exchange rate depreciates!)
Balance of payment
Country risk
Confidence
Lecture 8: Interenational Monetary System and Eurocurrency market
Free Float/Clean Float
-solely relies on market forces to determine exchange rate
-Market exchange rate is determined by the interaction of currency supply and demand
-supply and demand is affected by economic growth, interest differential and price level
- adopted by Australia, Canada and USA
Managed Float/ Dirty Float
-introduced via central bank intervention to smooth out fluctuations
*Leaning against the wind
- designed by govt to moderate/prevent abrupt short term fluctuation
-aim at delaying
*Unofficial Pegging
- designed by govt to resist fundamental upward or downward movement of exchange rate
-no official annoncement given
-adopted by korea and singapore
Fixed Rate System
-aim at maintaining the target exchange rate.
-adopted by hongkong and malaysia
Development of Eurocurrency market
it all started when USD is being deposited outside USA. Shortly after WW2, countries like soviet union and china deposited their USD in england and france instead of banks in USA.
As a communist country, they were afraid that they would not be able to withdraw their money if the leave it in the US bank. therefore they deposited it in bank outside US.
This lead to the establishment of eurocurrency market
in 1960, US levied tax on foreign borrower of US dollars and on the other hand, london relax taxation and regulatory regime. thus many bank set up branches to have easy access to euro currency market.
Eurocurrency Loans
-Not tradable
-Lender: Euro Banks
-private arrangement
Euro Bonds
-tradable
-lender: public
Lecture 7: Export Credit insurance and Factoring
Export Credit insurance
-is a specialised form of insurance to protect against non payment of trade debt
Advantage of Export credit insurance (PEE PEC)
-Provide credit evaluation on importer
-Enable exporter to obtain credit financing from bank
-Enable exporter to give better credit terms to importer
-Provide exporter with the flexibility to tailor insurance to meet their special needs
-Enable company to develop export and venture in new market
-Cover risk and provide security
* Risk: Commercial Risk and Country Risk
Commercial Risk:
-buyer become insolvent
-fails to pay
-refuses to take delivery of goods for no justifiable reason
Country risk
-war or political disturbances
-delay in receipt of payment
-imposition of impore restriction
-cancellation of valid import license
my brain is full.
yet i still got alot more to go.
shall continue memorizing tml morning.
i think studying in the morning is GREAT
please give me an easy paper on monday ):