International Finance at Copenhagen Business School | Flashcards & Summaries

Lernmaterialien für International Finance an der Copenhagen Business School

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TESTE DEIN WISSEN

What is the real-world problem with the PPP?

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TESTE DEIN WISSEN
  • Frictions: transaction costs, differences in consumption bundles, lack of mobility for services, tariffs etc.
  • Empirically, the PPP does not survive econometric tests in the short run
  • in the long-run, the PPP works better because exchange rates tend to return to their long-run equilibrium
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TESTE DEIN WISSEN

How do you benefit from an arbitrage opportunity?

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TESTE DEIN WISSEN
  • buy at low ask price and sell at high bid price
  • these trades generate an excess supply of overpriced asset and excess demand of underpriced asset, moving prices toward each other


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TESTE DEIN WISSEN

What is the definition of the bid and the ask price?

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TESTE DEIN WISSEN
  • Ask price:  the price to buy the object (this is the seller’s asking price)
  • Bid price:  the price received when selling an object (this is the buyer’s bidding price)
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TESTE DEIN WISSEN

What is the definition of shopping around?

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TESTE DEIN WISSEN
  • the investor has the motivation to do a particular portfolio change and chooses the cheapest investment that achieves the portfolio change
  • thus, among assets with identical cash flows, an investor buys the cheapest (sells most expensive) one
  • again, these trades generate an excess supply of overpriced asset and excess demand for the underpriced asset, moving prices toward each other
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TESTE DEIN WISSEN

What can a forward contract be used for?

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TESTE DEIN WISSEN
  • for certain cash flows at time T in FC
  • the FC value at time T is known but the corresponding HC at T is not
  • in such a contractual exposure, a forward can be used as a perfect hedge
Lösung ausblenden
TESTE DEIN WISSEN

How is the exchange rate market organized?

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TESTE DEIN WISSEN
  1. Currency trading is over-the-counter (OTC), it does not occur on an organized exchange. 
    1. In contrast to stock markets and futures markets, trading is not limited to a particular time, there is no centralized clearing mechanism, and contracts are not standardized
  2. The currency market consists of 
    1. a wholesale tier, an informal network of about 500 banks and currency brokers that deal with each other and with large corporations (Deutsche Bank, UBS, Citi,...)
    2. a retail tier (you and me)
  3. Most interbank dealing is done electronically, but bilaterally


Some players in the wholesale market act as market makers

  1. Any interested party can ask a market maker for a two-way quote (that is, bid and ask quotes), without having to reveal whether she intends to buy or sell
  2. Such a quote is binding:  a market maker undertakes to buy or sell at the price that was indicated
  3. Of course, there are limits to the market maker’s commitment to this quote the potential customer should decide almost immediately whether to buy, sell, or no deal; she cannot invoke a quote made, say, five minutes agoIThe quote is good for only a standard amount - typically USD10 million13


Lösung ausblenden
TESTE DEIN WISSEN

What can a forward contract be used for?

Lösung anzeigen
TESTE DEIN WISSEN
  • for certain cash flows at time T in FC
  • the FC value at time T is known but the corresponding HC at T is not
  • in such a contractual exposure, a forward can be used as a perfect hedge
  • by hedging a FC asset (liability) with a forward sales contract, we lock in the HC amount that we receive (pay) at time T
Lösung ausblenden
TESTE DEIN WISSEN

What is the problem with using forwards as a hedging strategy?

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TESTE DEIN WISSEN
  • the exact magnitudes of FC cash flows might not be known
  • the precise timing of FC cash flows might not be known
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TESTE DEIN WISSEN

What are potential explanations for deviations in the CIP

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TESTE DEIN WISSEN
  • credit risk in the interest rate (they use unsecured rates between banks):  no, because the deviations are also there if they use secured repo rates
  • instead, they argue that deviations are due to two factors
    •  regulation has made financial intermediaries constrained (theydon’t have the capital to arbitrage deviations away) and therefore the supply of currency hedging is limited
    • imbalances in savings and investments across currencies andthus imbalances in the demand for currency hedging
Lösung ausblenden
TESTE DEIN WISSEN

What is different between forward and futures?

Lösung anzeigen
TESTE DEIN WISSEN
  • same economic purpose, but different institutional setup
  • futures are exchange-traded, standardised contracts
  • in futures, the counter-party risk is taken care of via a clearing house margin system, that settles the current position on a daily basis
Lösung ausblenden
TESTE DEIN WISSEN

How do you deal with counterparty default risk?

Lösung anzeigen
TESTE DEIN WISSEN
  • demand collateral
  • use short maturity contracts and roll them over
Lösung ausblenden
TESTE DEIN WISSEN

Does the CIP hold after-tax?

Lösung anzeigen
TESTE DEIN WISSEN
  • depends on the tax system...
  • CIP holds if the tax system does not differentiate taxation of interest income and capital gains
Lösung ausblenden
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  • 67 Studierende
  • 18 Lernmaterialien

Beispielhafte Karteikarten für deinen International Finance Kurs an der Copenhagen Business School - von Kommilitonen auf StudySmarter erstellt!

Q:

What is the real-world problem with the PPP?

A:
  • Frictions: transaction costs, differences in consumption bundles, lack of mobility for services, tariffs etc.
  • Empirically, the PPP does not survive econometric tests in the short run
  • in the long-run, the PPP works better because exchange rates tend to return to their long-run equilibrium
Q:

How do you benefit from an arbitrage opportunity?

A:
  • buy at low ask price and sell at high bid price
  • these trades generate an excess supply of overpriced asset and excess demand of underpriced asset, moving prices toward each other


Q:

What is the definition of the bid and the ask price?

A:
  • Ask price:  the price to buy the object (this is the seller’s asking price)
  • Bid price:  the price received when selling an object (this is the buyer’s bidding price)
Q:

What is the definition of shopping around?

A:
  • the investor has the motivation to do a particular portfolio change and chooses the cheapest investment that achieves the portfolio change
  • thus, among assets with identical cash flows, an investor buys the cheapest (sells most expensive) one
  • again, these trades generate an excess supply of overpriced asset and excess demand for the underpriced asset, moving prices toward each other
Q:

What can a forward contract be used for?

A:
  • for certain cash flows at time T in FC
  • the FC value at time T is known but the corresponding HC at T is not
  • in such a contractual exposure, a forward can be used as a perfect hedge
Mehr Karteikarten anzeigen
Q:

How is the exchange rate market organized?

A:
  1. Currency trading is over-the-counter (OTC), it does not occur on an organized exchange. 
    1. In contrast to stock markets and futures markets, trading is not limited to a particular time, there is no centralized clearing mechanism, and contracts are not standardized
  2. The currency market consists of 
    1. a wholesale tier, an informal network of about 500 banks and currency brokers that deal with each other and with large corporations (Deutsche Bank, UBS, Citi,...)
    2. a retail tier (you and me)
  3. Most interbank dealing is done electronically, but bilaterally


Some players in the wholesale market act as market makers

  1. Any interested party can ask a market maker for a two-way quote (that is, bid and ask quotes), without having to reveal whether she intends to buy or sell
  2. Such a quote is binding:  a market maker undertakes to buy or sell at the price that was indicated
  3. Of course, there are limits to the market maker’s commitment to this quote the potential customer should decide almost immediately whether to buy, sell, or no deal; she cannot invoke a quote made, say, five minutes agoIThe quote is good for only a standard amount - typically USD10 million13


Q:

What can a forward contract be used for?

A:
  • for certain cash flows at time T in FC
  • the FC value at time T is known but the corresponding HC at T is not
  • in such a contractual exposure, a forward can be used as a perfect hedge
  • by hedging a FC asset (liability) with a forward sales contract, we lock in the HC amount that we receive (pay) at time T
Q:

What is the problem with using forwards as a hedging strategy?

A:
  • the exact magnitudes of FC cash flows might not be known
  • the precise timing of FC cash flows might not be known
Q:

What are potential explanations for deviations in the CIP

A:
  • credit risk in the interest rate (they use unsecured rates between banks):  no, because the deviations are also there if they use secured repo rates
  • instead, they argue that deviations are due to two factors
    •  regulation has made financial intermediaries constrained (theydon’t have the capital to arbitrage deviations away) and therefore the supply of currency hedging is limited
    • imbalances in savings and investments across currencies andthus imbalances in the demand for currency hedging
Q:

What is different between forward and futures?

A:
  • same economic purpose, but different institutional setup
  • futures are exchange-traded, standardised contracts
  • in futures, the counter-party risk is taken care of via a clearing house margin system, that settles the current position on a daily basis
Q:

How do you deal with counterparty default risk?

A:
  • demand collateral
  • use short maturity contracts and roll them over
Q:

Does the CIP hold after-tax?

A:
  • depends on the tax system...
  • CIP holds if the tax system does not differentiate taxation of interest income and capital gains
International Finance

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