Corporate Finance

NAME: XUECHAOYI XIAO    SUID: 452547250

Ways to use derivatives: hedge risk, speculate, arbitrage, change nature of a liability and investment[pic 1][pic 2]

Forward: work in Over-the-Counter (OTC) Markets (telephone and computer-linked)+ the contract’s initial market value is zero+ popular on currencies and interest rates

Difference: forwards (Private contract between 2 parties; Not standardized; Usually 1 specified delivery date; Settled at maturity; Delivery or final cash settlement usually occurs;

Some credit risk vs futures(Exchange traded; Standard contract; Range of delivery dates; Settled daily; Contract usually closed out prior to maturity; Virtually no credit risk)

Moneyness: In-the-money: a positive payoff is obtained; At-the-money: this is a break-even point; Out-of-the-money: a zero or negative payoff occurs

Future+ Forwards(obligation)    Options(right) –types of traders: hedgers, speculators, arbitrageurs   American option≥ European option [pic 3] [pic 4] Put-Call Parity:[pic 5]

non-dividend-paying stock, a = erΔt  rf is the foreign risk-free interest rate, a = e(r – rf)Δt  q is the dividend yield on the index, a = e(r – q)Δt

An American call on a non-dividend-paying stock should never be exercised early + only ever be exercised immediately prior to an ex-dividend date

Floating exchange rate system: Currencies float freely, and exchange rates (prices) are set by supply and demand. US dollar, Japanese yen, British pound, Swiss franc. Fixed exchange rate system: Currency value is fixed (pegged) in terms of another currency. Demand for currency increases, government sells currency to maintain fixed rate. Managed floating rate system: Currency is loosely pegged to another currency, but the government does not expend the effort and resources needed to maintain a truly fixed rate.

European Monetary System: 16 European countries maintain exchange rates among their currencies within narrow bands, and jointly float against outside currencies. Objectives: Establish a zone of monetary stability in Europe; Coordinate exchange rate policies vis-à-vis non-European currencies; Pave the way for the European Monetary Union; The euro is the single currency of the European Monetary Union

Determinants of Exchange Rate Choice: Country’s size; Degree of openness (dependency on international trade); Degree to which trade is concentrated; Inflation differential between country and main trading partner; Nature of disturbance to the economy; Other considerations