Hedging: ICAEW Financial Management flashcards

Front

What are the advantages of forwards in hedging?

Back

>Forwards offer customization to meet specific needs, no upfront costs, and are useful for hedging specific amounts and dates.
>Easy to calculate and understand
>often cheaper than other hedging techniques

Front

What are the disadvantages of forwards in hedging?

Back

>No secondary market so hard to unwind
>If supplier doesnt pay then you still have to abide by contract and may have to borrow funds to satisfy contract

Front

What are the advantages of futures in hedging?

Back

>Hedge downside risk

>Can close out anytime up to the forward maturity (flexible)

Front

What are the disadvantages of futures in hedging?

Back

>Basis risk: the futures price does not move inline with the spot price.
>Over/under hedged as can only purchase contracts
>Lose upside potential

Front

What are the advantages of OTC options in hedging?

Back

>Mitigate downside risk
>Can benefit from upside price movements

Front

What are the disadvantages of OTC options in hedging?

Back

OTC options have counterparty risk, are less liquid, and can be more expensive due to lack of standardization.

Front

What are the advantages of traded options in hedging?

Back

>Mitigate downside risk
>Can benefit from upside price movements

Front

What are the disadvantages of traded options in hedging?

Back

>can be expensive as have to pay premium regardless of whether its exercised
>Contracts so may over/under hedge
>Not available in all currencies

Front

What is a money market hedge?

Back

A money market hedge involves using the money market to lock in the value of a foreign currency transaction, reducing exchange rate risk.

Front

What are the advantages of a money market hedge?

Back

>They attempt to lock in a price, hedging downside risk
> Tailored to the investor (so won’t be under/over hedged)