Shared Flashcard Set

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test 2
test
50
Finance
Undergraduate 4
03/25/2012

Additional Finance Flashcards

 


 

Cards

Term
Locational Arbitrage
Definition
buying currency from one bank and selling it to another bank to make profit. Align Spot Rates Across the world
Term
Triangular Arbitrage
Definition
buying and selling currency in three different denominations in order to profit from a descrepancy in cross rates. Align cross rates among all currencies
Term
Covered Interest Arbitrage
Definition
borrowing one currency investing in another currency then entering into a forward contract to convert back at a future date. Align interest rate differential and forward rate
Term
Interest Rate parity
Definition
the interest rate differential should equal the forward rate differential to offset interest rate risk
Term
Interest Rate Parity
Definition
  • Covered interest arbitrage causes interest rate parity
  • focuses on a forward premium or discount to equalize interest rate
  • ensures that the return on a hedged foreign investment will equal the domestic return
  • deviations tend to be small and short lived
Term
Law of One Price
Definition
a units home currency should have the same purchasing power worldwide (more Strict than purchasing power parity)
Term
Purchasing Power Parity
Definition

exchange rates adjust to reflect inflation rate differentials so that the cost of a domestic good is similiar to the cost of a foreign good (Offset Inflation)

 

the change in the spot rate is due to inflation rate differentials

Term
International Fisher Effect
Definition

exchange rate adjust to reflect interest rate differentials.  Simple extention of purchasing power parity.

suggest that currencies with high interest rates will have high expected inflation

Term
Limitations To International Fisher Effect
Definition

Expected inflation rate derived by subtracting the each country's real interest rate from its nominal interest rate is subject to error

 

it relies on PPP theory

Term
Forecasting - Technical Analysis
Definition
focuses exclusively on past price and volume movements to forecast currency movements. best method for currency
Term
Technical Analysis - Charting
Definition
examining bar and moving average charts to determine buy and sell points
Term
Technical Analysis - Trend Analysis
Definition
use mathematical computations to follow trends
Term
Fundamental Analysis
Definition
relies on the examination of the macroeconomic variables and policies
Term
Problems/Limitations with Fundamental Analysis
Definition
  • variables must be forecasted
  • timing of the impact is uncertain and changing
  • inability to identify all factors
Term
Market-Based Forecasting
Definition
forward rate is an adequate estimate fo the future Spot rate
Term
Mixed Forecasting
Definition
some combination of the previous methods
Term
Model Evaluation
Definition
forecasting is inconsistent with the efficient market hypothesis
Term
Transaction Exposure
Definition
changes in the value of future cash flows as a result of changes in currency values
Term
Effects Transaction Exposure
Definition

First look at net cash flows

once net cash flow is determine, apply and exchange rate to determine a range of possibilities

Term
Managing Transaction Exposure
Definition

Focus is on future cash flows

identify net transaction exposure - a centralized system is optimal

Term
Eliminate Transaction Exposure
Definition

Future Hedge

Money Market Hedge

Currency Option Hedge

Forward Hedge

Term
Future Hedge
Definition

Available to small companies

  • Purchase - appropriate for a future payment
  • Sale - appropriate expects to receive foreign currency
Term
Forward Hedge
Definition
allows exact amounts on specific dates
Term
Money Market Hedge
Definition
taking a position in the money market to cover a future payable or receivable
Term
Currency Option Hedge
Definition
attractive option when foreign currency amount is uncertain
Term
Hedging long-term transaction exposure
Definition
  • Long-term forward contract - five to ten years
  • Currency Swap - contractual agreement to exchange a principle amount of two different currencies and, after a period of time return the priciple
Term
Alternative Hedging Techniques
Definition

Leading

Lagging

Term
Leading
Definition
hurrying cash payments to take advantage of favorable exchange rates
Term
Lagging
Definition
delaying cash payments to avoid unfavorable exchange rates
Term
Cross-hedging
Definition
if currency is unable to be hedged, hedge a highly correlated currency
Term
Currency diversification
Definition
reduces specific exposure
Term
Economic Exposure
Definition
change in the toal cash flows due to change in the exchange rate. some times refered to as operating exposure
Term
Effects of Economic Exposure
Definition

Encompassing view of the effects of exchange rates on a company

even purely domestic companies may have economic exposure

includes how revenues and expenses will be influences by exchange rate fluctuation

any companies whose revenues or costs are affected by curency changes has economic exposure

Term
Measuring Economic Exposure
Definition

Pro Forma income statements based on expected changes

 

regression of cash flows based on exchange rate changes

Term
Managing Economic Exposure
Definition
Requires a long-term perspective than managing other types of exposure
Term
Assesing Economic Exposure
Definition
use estimated income statements to determine how the company is affected by different exchange rates
Term
Focuses of Assesing Economic Exposure
Definition
focus is on more tan just transactions. key factors include pricing flexibility, ability to shift production, and the ability to source inputs from different countries
Term
Restructuring to Reduce Economic Exposure
Definition

Market Management

Production Management

Financial Management

Term
Market Management
Definition

Market Selection - base on currency strength

Pricing Strategy - market shar or profit margin

Product Strategy - time new products

Term
Production Management
Definition

product sourcing and plant location

input mix

Shifting Production

Term
Financial Management
Definition

Structure liabilities so they match assets

  • move debt to countries producing revenues
  • finance expansion or assets with profits
Term
Translation Exposure
Definition
arises when the parent firm translates the accounting statement of its foreign subsidiaries to its home currency also known as accounting exposure
Term
Measure Exposure
Definition

degree of foreign involvement

location of foreign subsidiaries

Accounting methods of Foreign countries

Term
Managing Translation Exposure
Definition

Funds Adjustment

Forward Contracts

Exposure Netting

Term
Funds Adjustment
Definition
altering the amounts or the currencies of the planned cash flows
Term
Forward Contracts
Definition
creates an offsetting asset or liability in foreign currency. Also creates additional transaction exposure
Term
Exposure Netting
Definition
offsetting exposure in a foreign currency so revenues and expense offset
Term
Hedging Strategies Objective
Definition
should add value to the subsidiaries
Term
Hedging Strategies
Definition

Cost and Benefits of standard hedging techniques

centralization versus Decentralizaiton- generally, centralized is more effective

Term
Managing Risk Management
Definition

derivatives expose companies to substatial potential loss

  • segregate duties
  • hedging purposes only
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