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Category: Level II
Economic Growth Theories (Synopsis)
There are a number of theories that attempt to explain the growth of an economy; they fit broadly into two categories: Exogenous: economic growth is caused by factors that are external to the economy itself (the prefix exo- meaning outside) Endogenous: economic growth is caused by factors that are internal to the economy itself (the…
Triangular Arbitrage
Triangular arbitrage is nothing more than determining whether an arbitrage opportunity exists amongst three currencies with three exchange rates; the complicating factor is that the exchange rates each have a bid rate and an ask rate. (Note: the arbitrage could, in fact, involve more than three currencies. As the principles are the same, only three…
Valuing Plain Vanilla Interest Rate Swaps
Somewhat surprisingly, a plain vanilla interest rate swap is one of the easiest derivatives to value; once again, as with all derivatives, the formula for the value is: \[Value\ =\ PV(what\ you\ will\ receive)\ –\ PV(what\ you\ will\ pay)\] Because the swap is equivalent to two bonds (one long, one short, one fixed, one floating),…
Valuing Currency Forwards
The formula for computing the value to the long position of a currency forward is: \[V_t\ =\ \frac{S_t}{\left(1\ +\ r_{BC}\right)^{(T\ -\ t)}}\ -\ \frac{F_T}{\left(1\ +\ r_{PC}\right)^{(T\ -\ t)}}\] where: \(V_t\): value of the currency forward (to the PC payer / BC receiver) at time \(t\) (in \(\dfrac{PC}{BC}\)) \(T\): expiration of the forward contract \(S_t\): spot…
Pricing Currency Forwards
A currency forward contract is an agreement to exchange a given amount of one currency for a given amount of another currency at a future date. The price of a currency forward is the exchange rate for the currencies at the expiration of the contract, and is related to the spot exchange rate by covered…
Valuing FRAs
Recall that an FRA is essentially an agreement to enter into two loans (one long, one short) in the future: a fixed-rate loan and a floating-rate loan. (The difference between an FRA and an actual agreement to enter into these two loans is that the FRA will be settled at the beginning of the loan…
Valuing Forwards and Futures
The formulae for valuing all derivatives are essentially the same: \[Value\ =\ PV(what\ you\ will\ receive)\ –\ PV(what\ you\ will\ pay)\] First, the notation: \(V_t\): value of the forward (to the long) at time \(t\) \(T\): expiration of the forward contract \(S_t\): spot price at time \(t\) \(F_T\): forward price at time \(T\) \(r_f\): effective…
Investments in Financial Assets
When one company buys securities (stock or bonds) issued by another company, the accounting treatment for those investments depends on the amount of influence/control that the investing company has over the issuing company. When the investor has no influence (generally assumed when the investment represents less than 20% ownership), then the investment is treated as…
Leases III: Effect on Financial Statements and Ratios
A lease is a contract that lets one party use an asset owned by another party, in exchange for periodic payments. The owner of the asset is the lessor; the user of the asset is the lessee. For the purposes of financial reporting, leases are divided into two categories, based on the economic substance of…
Leases II: Calculations
A lease is a contract that lets one party use an asset owned by another party, in exchange for periodic payments. The owner of the asset is the lessor; the user of the asset is the lessee. For the purposes of financial reporting, leases are divided into two categories, based on the economic substance of…