FINA 470 Lecture Notes - Lecture 5: Downside Risk, Spot Contract, Forward Rate
5 Mar 2016
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Document Summary
They are well-known customers with a credit agreement. Restricted use: with a agreed credit line, speculative forward positions are not liked unless large margin posted. Short lives: most forward contracts are for less than one year, longer term contracts go up to 10 years only for good credit rated customers. For long-term hedging, need to roll-over contracts: benefit of roll-over is loss does not accumulate so worst loss is greater for three year than one year. Probability of default increases with greater time horizon, and thus size of loss: uncertainty of spot rate three years from now greater than one year. Rolling over is imperfect substitute for three-year forward contract. Can be quoted outright or as swap rate. Show numbers that are to be added or subtracted from spot bid and ask rates. In case of premium we add the smallest swap rate to the smallest bid rate and larger swap to larger ask rate.
