Short Term
Content
TOOLS BORROWING/ LENDING
Forward Contract
Futures Contract
Options
Interest rate swap
DESCRIPTION Borrowing or lending in different currencies to take advantage of interest rate differentials and foreign exchange appreciation/ depreciation; can be either on a certainty basis with “ up-front” costs or speculative. “tailor-made” contracts representing an obligation to buy/sell, with the amount, rate, and maturity agreed upon between the two parties; has little upfront cost Standardized contracts offered on organized exchanges; same basic tool as a forward contract but less flexible because of standardization; more flexible because of secondary-market access; has some upfront cost Tailor-made or standardized contracts providing the right to buy or sell an amount of the currency, at a particular price, during a specified time period; has up-front cost (premium) Allows the trading of one interest rate stream for another; fee to be paid in the intermediary.
IMPACT ON RISK Can be used to offset exposures in existing assets/liabilities and in expected revenues and expenses.
Can eliminate downside risk but locks out any upside potential.
Can eliminate downside risk, plus position can be nullifies, creating possible upside potential
Can eliminate downside risk and retain unlimited upside potential
Currency Swap
Two parties exchange principal amounts of two different currencies initially; they pay each other’s interest
Permits firm to change the interest rate structure of their assets/ liabilities and achieves cost savings via broader market access. Has all the features of interest rate swaps, plus allows firms to change the currency structure of their assets/liabilities
HYBRIDS
payments and then reverse principal amounts at a preagreed exchange rate at maturity; more complex than the interest rate swaps. A variety of combinations of some of the preceding tools; may be quite costly and/or speculative,
Can create, with the right combination, a perfect hedge against certain exchange rate exposures.
Forward Contract
Futures Contract
Options
Interest rate swap
DESCRIPTION Borrowing or lending in different currencies to take advantage of interest rate differentials and foreign exchange appreciation/ depreciation; can be either on a certainty basis with “ up-front” costs or speculative. “tailor-made” contracts representing an obligation to buy/sell, with the amount, rate, and maturity agreed upon between the two parties; has little upfront cost Standardized contracts offered on organized exchanges; same basic tool as a forward contract but less flexible because of standardization; more flexible because of secondary-market access; has some upfront cost Tailor-made or standardized contracts providing the right to buy or sell an amount of the currency, at a particular price, during a specified time period; has up-front cost (premium) Allows the trading of one interest rate stream for another; fee to be paid in the intermediary.
IMPACT ON RISK Can be used to offset exposures in existing assets/liabilities and in expected revenues and expenses.
Can eliminate downside risk but locks out any upside potential.
Can eliminate downside risk, plus position can be nullifies, creating possible upside potential
Can eliminate downside risk and retain unlimited upside potential
Currency Swap
Two parties exchange principal amounts of two different currencies initially; they pay each other’s interest
Permits firm to change the interest rate structure of their assets/ liabilities and achieves cost savings via broader market access. Has all the features of interest rate swaps, plus allows firms to change the currency structure of their assets/liabilities
HYBRIDS
payments and then reverse principal amounts at a preagreed exchange rate at maturity; more complex than the interest rate swaps. A variety of combinations of some of the preceding tools; may be quite costly and/or speculative,
Can create, with the right combination, a perfect hedge against certain exchange rate exposures.
