Description
Book SynopsisManaging Foreign Exchange Risk explains how treasurers can better manage their foreign exchange risk through the use of financial derivative instruments and how to manage their various exposures.
Table of ContentsPreface xv
Chapter 1 Global Markets: Transactions and Risks 1
Savings and Loans Problems 2
Agency Problems 3
Types of Markets 5
Types of Transactions 7
Types of Risks 10
Chapter 2 Balance of Payments Exposure Management 15
Balance of Payments as a Source and Use of Funds 17
Components of Balance of Payments 17
Current Account and Economic Fundamentals 19
Capital Account, Expectation, and Interest Rate 21
U.S. Balance of Payments: Recent Evidence 21
Exposure Related to Capital Account 23
Exchange Rate Arrangements, Dollarization, and Peg 28
Managing Balance of Payment Exposure in the Emerging Market Economies 32
Case Study: Kairos Capital 33
Chapter 3 Foreign Exchange Rate Dynamics: Managing Exposure 39
Foreign Exchange Markets 39
Foreign Exchange Transactions 39
Foreign Exchange Market Functions 45
Foreign Exchange Quotations 45
Cross-Exchange Rate 46
Bid and Offer Quotations in the Interbank Market 47
Arbitrage in the Foreign Exchange Market 47
Major Players in the Foreign Exchange Market 47
Speculative Transactions 50
Foreign Exchange Loss 50
Settlement Risk 51
Spot Rate and the Law of One Price 51
Big Mac Index 52
Central Bank Intervention 54
Relative Version of Purchasing Power Parity 56
Exchange Rate Pass-Through 59
Spot Exchange Rate and Nominal Interest Rate 61
Forward Exchange Rate and Covered Interest Parity 62
Forward Premium or Discount for Selected Currencies 65
International Parity Relationship 66
Real Exchange Rate 66
Real Exchange Rate and East Asian Currency Crisis 68
Case Study: Real-World Furniture, Inc. 69
Chapter 4 Application of Options and Futures for Managing Exposure 75
Determinants of the Option Price (Premium) 75
Options Traded in Organized Exchanges 77
Sensitivity of Put and Call Price to Underlying Factors 79
Functions of Options and Futures 82
Hedging Receivables Denominated in Foreign Currency 86
Speculation on the Futures Premium or Discount 91
Hedge Ratio 93
Price Discovery of Options and Futures 95
Regulatory Arbitrage 96
Binomial Option Pricing 96
Hedged Portfolio 99
Derivatives Application in Practice 100
Synthetic Forward Contract 101
Case Study: Applications of Futures Contracts in Portfolio Hedging 102
Chapter 5 Principles of Futures: Pricing and Applications 107
Cost of Carry 107
Stock Index Futures 108
Index Arbitrage 109
Portfolio Insurance 113
Hedging with Stock Index Futures Options 115
Basis Risk 119
Changing the Beta of the Portfolio with Futures 120
Anticipatory Hedge with Stock Index Futures 122
Case Study: Competition for Safeway, PLC 123
Managing Exposure of an Individual Stock 124
Currency Futures 124
Hedging with Currency Futures 126
Anticipatory Hedging of Weakening Currency 128
Rolling Over the Futures Hedge 129
Marking to Market and Margin 131
Commodity Futures 132
Spread Position 133
Hedging with Commodities Futures 134
Empirical Evidence: Forward and Future Prices 138
Case Study: Chockletto International Hedging 140
Chapter 6 Interest Rate Futures: Pricing and Applications 143
Treasury Bills Futures 144
Spot Rate 144
Forward Rate 146
Determinants of the Shape of the Term Structure of Interest Rates 148
Approximate Duration 154
Pricing Treasury Bill Futures 155
Eurodollar Futures 156
Treasury Notes Futures 158
Treasury Bond Futures 160
Conversion Factor 162
Arbitrage in the Interest Rates Futures Market 165
Pricing Synthetic Futures or Forward 165
Hedging with Futures: Duration-Based Approach 168
Chapter 7 Swaps 177
Interest Rate Swaps 178
Forward Rate Agreement 178
Interest Rate Conventions 181
Stripes of Forward Rate Agreements 181
Motivations for Swaps 183
Swaps Due to Comparative Advantage 185
Swap Valuation 188
Interest Rate Caps, Floors, Collars, and Corridors 190
Volatility of Interest Rates 198
Swaptions 200
Callable Swap 201
Putable Swap 202
Warehousing Swap 203
Swaps Risks 203
Exotic Swaps 206
Currency Swaps 207
Break-Even Analysis of Swap and Refinancing 211
Options Embedded in Currency Swaps 212
Three-Way Swaps 213
Chapter 8 Translation, Transaction, and Operating Exposure 217
Translation Exposure 217
Case Study: Accounting Exposure 220
Functional Currency 222
Managing Translation Exposure 223
Balance Sheet Hedging 223
Transaction Exposure 224
Operating Exposure 224
Hedging in Practice: Nike and DuPont 225
Exposure Netting 226
Forward Hedging: Example 226
Money Market Hedge 228
Hedging with Futures 231
Option Hedging 233
Value at Risk 235
Two Assets Portfolio 237
Lufthansa Buys Aircraft from Boeing 238
Managing Operating Exposure 243
Fixed for Fixed Currency and Interest
Rate Swaps 249
Chapter 9 Debt, Equity, and Other Synthetic Structures 253
Inverse Floater 253
Creating a Synthetic Fixed Rate 256
Synthetic Structures 258
Mortgage- and Asset-backed Derivatives 259
Prepayment Risks 259
Sequential-Pay Collateralized Mortgage Obligations 261
Interest Only and Principal Only 261
Equity-Linked Debt 263
Zero Coupon Bond Linked to Goldman Sachs Commodity Index 264
Global Diversification with Swaps 265
Catastrophe Bonds 266
Liability Management with Derivatives 266
Spread on Treasury Yield Curve 275
Chapter 10 Options on Futures 279
Spreads 281
Bull Spreads 281
Bear Spreads 283
Butterfly Spreads 284
Box Spreads 285
Long Straddle 288
Short Straddle 289
Calendar Spread 290
Strips 292
Straps 294
Price and Yield Volatility 296
Spread Trades on Treasury Curves 297
Exotic Options 301
Chapter 11 Credit Derivatives: Pricing and Applications 307
Credit Derivatives Products 308
Credit Event/Default Swap 309
Pricing Credit Default Swap 312
Unwinding and Assignability of Credit Default Swaps 315
Default Probability 318
Break-Even High-Yield Bonds 320
Default Risk/Return 321
Creating Synthetic Assets 321
Synthetic Credit Default Swaps 323
Credit Default Swap Applications 323
Restructuring 324
Credit-Linked Notes 326
Synthetic Collateralized Loan Obligations 327
Objectives of Structuring Collateralized Loan Obligations 329
Synthetic Collateralized Loan Obligations 329
Synthetic Arbitrage Collateralized Loan Obligations 331
Synthetic Balance Sheet Collateralized Loan Obligations 332
Capital Adequacy Requirements 333
Credit Exposure Method 334
Total Return Swaps 335
Chapter 12 Credit and Other Exotic Derivatives 341
Credit Spread Forward 342
Credit Spread Option 342
Asset Swap Switch 344
Callable Step-ups 347
Transfer and Convertibility Protection 348
Pricing Transfer and Convertibility Protection 353
Speculative Capital 354
Emerging Market Debts and Brady Bonds 354
International Swaps and Derivatives Association Master Agreement 356
Weather Derivatives 357
Weather Derivatives Market 358
Exchange-Traded Weather Derivatives 359
CME Futures 360
CME Options 362
Swaps 363
References 365
Index 373
