5.8. TEST YOUR UNDERSTANDING 215
4.8 Test Your Understanding
4.8.1 Quiz Questions
- Which of the following are risks that arise when you hedge by buying a forward
contract in imperfect financial markets?
(a) Credit risk: the risk that the counterpart to a forward contract defaults.
(b) Hedging risk: the risk that you are not able to find a counterpart for your
forward contract if you want to close out early.
(c) Reverse risk: the risk that results from a sudden unhedged position be-
cause the counterpart to your forward contract defaults.
(d) Spot rate risk: the risk that the spot rate has changed once you have
signed a forward contract.- Which of the following statements are true?
(a) Margin is a payment to the bank to compensate it for taking on credit
risk.
(b) If you hold a forward purchase contract forjpythat you wish to reverse,
and thejpyhas increased in value, you owe the bank the discounted
difference between the current forward rate and the historic forward rate,
that is, the market value.
(c) If the balance in your margin account is not sufficient to cover the losses
on your forward contract and you fail to post additional margin, the bank
must speculate in order to recover the losses.- Which of the following statements are correct?
(a) A forward purchase contract can be replicated by: borrowing foreign
currency, converting it to domestic currency, and investing the domestic
currency.
(b) A forward purchase contract can be replicated by: borrowing domes-
tic currency, converting it to foreign currency, and investing the foreign
currency.
(c) A forward sale contract can be replicated by: borrowing foreign currency,
converting it to domestic currency, and investing the domestic currency.
(d) A forward sale contract can be replicated by: borrowing domestic cur-
rency, converting it to foreign currency, and investing the foreign cur-
rency.- The following spot and forward rates are in units ofthb/fc. The forward
spread is quoted in centimes.