Which of the following statements regarding currency forward contracts is least accurate? A) If the domestic currency appreciates over the term of the contract, the party that is long the foreign currency will have losses on the contract.
Why is this the correct answer? Isnt the statement true which makes it not least accurate?
If the underlying of the contract gains in value then the party which is long the contract should gain (assuming the spot price exceeds the strike price at maturity, i.e. the basis is positive).
This is a tricky question, but that statement is not always true. Specifically, the statement is false when the foreign currency depreciates less than the original spot-forward spread.
For instance, let’s say domestic currency = USD, foreign currency = EUR, spot is 1.0 USD/EUR, and the 1-year forward price is 0.9 USD/EUR. You enter a forward contract to buy EUR in 1-year at 0.9.
Now, in 1-year, USD has appreciated relative to EUR. The new spot price is 0.95. Yet, your contract says you buy EUR at 0.9. So you profit even though you were long the EUR forward and EUR has depreciated.
Anyone know why Eurodollar futures are different from interest rate options or FRAs when the interest rate increases?
Eurodollar futures are quoted (100 - interest rate) which means you lose on long position if IR rise in contrast to FRAs where you gain if IR rise.
Moreover, futures are marked to market daily which makes them (in certain exposures) more valuable than forwards. For example, if you are short in a Eurodollar futures and short term interest rates rise you realize the gains almost immediately and you can invest the proceeds at higher interest rates. It can make a slight difference especially if you roll your position for longer periods of time.