Strategic cost issues

CFA Level III Derivatives
#1

Dear all,

I have the following open question from SS14, LOS 28b, pg 101 under strategic cost issues, 3rd bullet point

Statement:

It reads ’ forward currency contracts are often short term than the hedging period, requiring contracts be rolled over as they mature (an FX swap)

Q1. Why does it refer to ‘fx swap’ and not another forward currency contract’?

Continuing int he same bullet point.

‘Financial cash outflows when interest rates are high can be costly as the interest that would have been earned on the fund is lost’

Q2. How does the cash outflow situation arise?

Q3. How do we know if the interest rates are high and that is what creates a cash outflow situation.

Where I am struggling is to visualise this situation.

If anyone can kindly help.

Thank you

#2

The term FX swap means rolling an expiring currency forward into a new currency forward.

When you roll an expiring currency forward (or any forward, for that matter), you pay or receive the difference between the forward rate to which you agreed and the spot rate at expiration. If that difference is negative, you have a cash outflow.

You phone your bank and ask them if interest rates are high. You could also check Yahoo! Finance.

The level of interest rates doesn’t create the cash flow situation. The level of interest rate determines whether you lose a lot of interest or only a little interest _ when you have a cash outflow _.

You’re welcome. I hope I helped a bit.