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Hello Mr. Moffat
The most difficult area for me in AFM is Risk management – derivatives especially the point in time when we have to decide whether to sell or buy futures in case of currency and interest rate futures and to go for a call or put options in case of options.
Can you kindly clear my concept as to how I should determine the decision to select a call or put option in a question and how to determine whether to sell or buy the future?
In the previous two attempts, I had this area crammed and compromised on the concept. However, this time I want to sit in the exam with a crystal clear concept.
Kindly help me out with this.
Have you watched my free lectures on foreign exchange risk management and on interest rate risk management?
I do explain all of this in detail, with examples, in my free lectures.
For both options and futures, it depends on what currency the contract sizes are quoted.
Do if, for example, the contract size is quote in $’s, then if the transaction involves buying $’s then you would buy a call option or you would buy futures. If the transaction involves selling %’s then you would buy a put option or you would sell futures.
Hello Sir. I would like to get something clear on how to determine the “unhedged amount”. Let me show you my understanding of it using the simple example below. This is just a very simple scenario so no need for detailed math.
Let’s assume the following:
Company A uses £ and expect to receive $10000 from company B based in the US (so $ is its currency).
My understanding is that there’s an unhedged amount because company A’s currency is different from company B’s. Am I correct?
Assuming that the money will be received on a date in the future, and nothing has been done to remove the risk, then yes, it is all unhedged.
However in the exam the unhedged amount refers to the situation where futures or options have been used to hedge most of the amount, but some is left unhedged because of the fact that futures and options are in fixed sized contracts and therefore do not match the exact amount of the transaction.
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