CORE CONCEPTS IN CORPORATE FINANCE.
- Forward contracts.
This is a market for currencies that enables a MNC to lock in the exchange rate(forward rate) at which it buys or sells a currency.it specifies the amount of a particular currency that will be purchased or sold by a MNC at a specified future point in time and at a particular change rate.
- Currency future contracts.
They are similar to forward contract expect that they are sold at an exchange market (e.g. NSE) where forward contracts are offered by commercial banks. They specify a standard volume of a particular currency to be exchanged on a specific settlement date.
- Currency option contracts.
An option is an agreement between a holder (buyer) and a writer (seller) that gives the holder the right but not an obligation to buy or sell financial instrument at any time at a specified date/period.
They are classified as call or put.
- Currency call option-Provides the right to buy a specific currency at a specific price within a specified period of time. Used to hedge future payables (creditors).
- Currency put option-Provides the right to sell a specific currency at a specific price within a specified period of time. Used to hedge future receivables (debtors).
- Swaps-Parties agree to swap something, generally obligations to make specified payment stream. Most common ones are
- Foreign currency swaps –This can be illustrated by a Kenyan firm that borrowed from England and hence needs to repay the loan plus the interest in Sterling pounds though its earnings are in Kshs while a company in England has issued a bond in Kenyan securities market and hence needs to repay in Kshs.This company can swap responsibilities and avoid exchange rate risk
- Interest rate swaps-A transaction between two parties involving an exchange of one stream of interest (obligations) for another for specific maturity on a notional principal amount.
KEY TERMS
- Hedging-This is the process of covering up forex risk and involves taking of one risk to offset an equal and opposite risk.
- Speculation-Dealers in forex speculate future direction of currency movement. Appreciation of a currency will lead to high rates in the market thus more profits are earned.
- Arbitrage-Refers to simultaneous purchase and sale of a currency in order to get profit from exchange rate different in 2 countries or locations.
Risk management + Risks-Refer notes from lending.
Risks.
- Asset back
- Credit
- Foreign
- Liquidity
- Market
- Reputation
- Legal
- IT
- Interest rate
- Gearing ratio
- Political
- Commodity–Associated with commodity prices.
