Posted on 09 August 2009
Tags: Black-Scholes formula, Currency Rates, economic theory, EUR investments, Euribor rates, finance, financial instruments, German government bills, government debt, governments defaulting, hyperinflation, interest rate, interest-rate risk, liquidity risk, long-term bonds, market risk, owners of government debt, risk, Risk-Free Assets, Risk-Free Interest Rate, short-dated government bonds, US treasury bills, USD investments
The interest rate that can be obtained by investing in financial instruments with no default risk is referred to as the risk-free interest rate. However, other types of risk could be carried by the financial instrument, e.g. market risk (market is the risk of changes in market interest rates), liquidity risk (liquid risk is the risk of being unable to sell the instrument for cash at short notice without significant costs), etc.
Risk-Free Assets
Though it is true that a truly risk-free asset exists only in theory, while in practice short-dated government bonds of the currency in demand is used by most professionals and academics. Usually US Treasury bills are used for USD investments, while German government bills or Euribor rates are a common choice for EUR investments. During the 20th century the mean real interest rate of US treasury bills was 0.9% p.a. (Due to hyperinflation during the 1920s corresponding figures for Germany are inapplicable.)
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Posted on 03 August 2009
Tags: cash flow, Cross-Currency swaps, currency swap, Danmarks Nationalbank, Europe, foreign exchange, foreign exchange market, forex, Forex trading, FX market, global financial crisis of 2008, interest rate, interest rate swaps, maturities, over-the-counter derivatives, Reserve Bank of Australia, Salomon Brothers, Structure of currency swap, the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, the Norges Bank, the Reserve Bank of New Zealand, the Sveriges Riksbank, the Swiss National Bank, United States Federal Reserve System, Uses of Currency swaps, World Bank
A currency swap also called cross currency swap is a name given to a foreign exchange agreement between two parties. This agreement is done to exchange principal and fixed rate interest payments on a loan in one currency for principal and fixed rate interest payments on an equal (regarding net present value) loan in another currency. comparative advantage motivate the Currency swaps.
Structure
For a variety of maturities Cross-Currency swaps can be negotiated occassionaly in excess of 10 years.
Unlike interest rate swaps, the exchange of the principal amount is involved in currency swaps. Interest payments are not netted (as they are in interest rate swaps) because these interest payments are denominated in different currencies. Cross-Currency swaps are identical to interest rate swaps, they are over-the-counter derivatives.
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Posted on 02 August 2009
Tags: cost of carry, Covered Interest Arbitrage, Currency Rates, currency trading, dollar rate, euro-denominated bonds, financial instrument, financial models, foreign currency, foreign currency bonds, foreign exchange risk, foreign stock, forward contract, hedges, interest rate, interest rate parity, investing in any currency, investors, risk-free instruments, transactions
Covered interest arbitrage is the name given to an investment strategy. In this strategy an investor buys a financial instrument that is denominated in a foreign currency, and by selling a forward contract in the amount of the proceeds of the investment back into his base currency, he hedges his foreign exchange risk. If the financial instrument is risk-free and only pays interest once, on the date of the forward sale of foreign currency, then only the proceeds of the investment are known exactly. Otherwise, some foreign exchange risk still remains there.
Traders can also make similar trades using risky foreign currency bonds or even foreign stock, but the risk may be added to the transaction by hedging trades, for instance, in case if the bond defaults then the investor may lose on both the bond and the forward contract.
Example
In this example the investor is based in the United States and following prices and rates are assumed by him: spot USD/EUR = $1.2000, forward USD/EUR for 1 year delivery = $1.2300, dollar interest rate = 4.0%, euro interest rate = 2.5%.
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