Futures VS options
1. Futures have unlimited risk while options have limited risk.
2. establishing a fixed price and requiring a margin on long or short positions. establishing floor or ceiling price protection, and not always requiring a margin on long or short positions.
3. gains on futures are decided by the price of the future at the end of the trading day. a gain can be obtained by exercising the option, by taking the opposite position in market, or by allowing the option to expire without taking action
4. A futures contract gives the buyer the obligation to purchase a specific asset, and the seller to sell and deliver that asset at a specific future date, unless the holder's position is closed prior to expiration. Whereas An option gives the buyer the right, but not the obligation to buy (or sell) a certain asset at a specific price at any time during the life of the contract
Interest rate swap vs currency swap
a popular form of swap is the interest rate swap, in which one party exchanges a stream of interest for another party's stream. Interest rate swaps are normally 'fixed against floating', but can also be 'floating against floating' rate. A 'fixed against fixed' rate swap would be theoretically possible, but since the entire cash-flow stream can be predicted at the outset there would be no reason to maintain a swap contract as the two parties would just settle for the difference between the present value of the two fixed streams. Because one party would be definitely at a disadvantage in such an exchange, that party would decide not to enter into the deal. Hence, there are no single-currency 'fixed versus fixed' swaps in existence.
A currency swap is a foreign-exchange agreement between two parties to exchange aspects (namely the principal and/or interest payments) of a loan in one currency for equivalent aspects of an equal in net present value loan in another currency.
suppose a U.S.-based company needs to acquire Swiss francs and a Swiss-based company needs to acquire U.S. dollars. These two companies could arrange to swap currencies by establishing an interest rate, an agreed upon amount and a common maturity date for the exchange. Currency swap maturities are negotiable for at least 10 years, making them a very flexible method of foreign exchange. Currency swaps were originally done to get around exchange controls
FDI vs FII
Both FDI and FII is related to investment in a foreign country. FDI or Foreign Direct Investment is an investment that a parent company makes in a foreign country. On the contrary, FII or Foreign Institutional Investor is an investment made by an investor in the markets of a foreign nation.
In FII, the companies only need to get registered in the stock exchange to make investments. But FDI is quite different from it as they invest in a foreign nation.
The Foreign Institutional Investor is also known as hot money as the investors have the liberty to sell it and take it back. But in Foreign Direct Investment, this is not possible. In simple words, FII can enter the stock market easily and also withdraw from it easily. But FDI cannot enter and exit that easily. This difference is what makes nations to choose FDI’s more than then FIIs.
FDI is more preferred to the FII as they are considered to be the most beneficial kind of foreign investment for the whole economy.
Foreign Direct Investment only targets a specific enterprise. It aims to increase the enterprises capacity or productivity or change its management control. In an FDI, the capital inflow is translated into additional production. The FII investment flows only into the secondary market. It helps in increasing capital availability in general rather than enhancing the capital of a specific enterprise.
The Foreign Direct Investment is considered to be more stable than Foreign Institutional Investor. FDI not only brings in capital but also helps in good governance practises and better management skills and even technology transfer. Though the Foreign Institutional Investor helps in promoting good governance and improving accounting, it does not come out with any other benefits of the FDI.
While the FDI flows into the primary market, the FII flows into secondary market. While FIIs are short-term investments, the FDI’s are long term.
Summary
1. FDI is an investment that a parent company makes in a foreign country. On the contrary, FII is an investment made by an investor in the markets of a foreign nation.
2. FII can enter the stock market easily and also withdraw from it easily. But FDI cannot enter and exit that easily.
3. Foreign Direct Investment targets a specific enterprise. The FII increasing capital availability in general.
4. The Foreign Direct Investment is considered to be more stable than Foreign Institutional Investor
Foreign direct investment (FDI) flows into the primary market whereas foreign institutional investment (FII) flows into the secondary market, that is, into the stock market.
All other differences flow from this primary difference. FDI is perceived to be more beneficial because it increases production, brings in more and better products and services besides increasing the employment opportunities and revenue for the Government by way of taxes. FII, on the other hand, is perceived to be inferior to FDI because it only widens and deepens the stock exchanges and provides a better price discovery process for the scrips.
Besides, FII is a fair-weather friend and can desert the nation which is what is happening in India right now, thereby puling down not only our share prices but also wrecking havoc with the Indian rupee because when FIIs sell in a big way and leave India they take back the dollars they had brought in.
ADR VS GDR
American Depository Receipt (ADR)
An American Depository Receipt (ADR) is a stock which trades in the United States (US) but represents a specified number of shares in a non-US corporation (like Infosys, etc). ADRs are bought and sold on American stock markets just like regular stocks, and are issued/sponsored in the U.S. by a bank or brokerage.
ADRs were introduced because of the difficulty in buying shares from other non-US countries which trade at different prices and currency values. U.S. banks simply purchase a large lot of shares from a foreign company, bundle the shares into groups and reissue them on either the NYSE, AMEX, or Nasdaq. The depository bank sets the ratio of U.S. ADRs per home country share. This ratio can be anything less than or greater than 1. For example, a ratio of 4:1 means that 1 each ADR share represents 4 shares in the foreign company.
The main objective of ADRs is to save individual investors money by reducing administration costs and avoiding duty on each transaction. For individuals, ADRs are an excellent way to buy shares in a non-US company and capitalize on growth potential outside North America. ADRs offer a good opportunity for capital appreciation as well as income if the company pays dividends.
Global Depository Receipt - GDR
GDR's are similiar to ADR's except that they are issued and can be traded in more than one country (globally).
When the depository bank is in the USA, the instruments are known as American Depository Receipts (ADR). European banks issue European depository receipts, and other banks issue global depository receipts (GDR)
Forward Rates vs Spot Rates
spot rate for maturity t is the interest rate on the zero coupon bond maturing at time t.
Forward rate from time s to time t, with s < t, is the interest rate I such that if you invested a dollar in a zero coupon maturing at time s, and investet at the rate I until time t, you would end up with the same amount as if invested in a zero coupon bond maturing at time t.
THE RELATIONSHIP BETWEEN SHORT-TERM FORWARD RATES AND SPOT RATES
Let's say an investor buys a two-year zero-coupon bond. The proceeds will equal:
X (1 + z4)4.
The investor could also buy a six-month Treasury bill and reinvest the proceeds every six months for two years. In this case, the value would be:
X (1 + z1)(1+ future rate at time 1)(1 + future rate at time 2)(1+ future rate at time 3) (1 + future rate at time 4)
Because these two investments must be equal this tells us that:
X (1 + z4)4 = X (1 + z1)(1+ future rate at time 1)(1 + future rate at time 2)(1+ future rate at time 3)
So Z4 = [(1 + z1)(1+ future rate at time 1)(1 + future rate at time 2)(1+ future rate at time 3)]¼ – 1
This equation states that the two-year spot rate depends on the current six-month rate and the following three six-month spot rates.
As we can see, short-term forward rates must equal spot rates or else an arbitrage opportunity can exist in the market place.
Compute Spot Rates if Given Forward Rates, and Forward Rates if Given Spot Rates
Computing a forward rate by using spot rates is covered above. Using spot rates, an investor can develop any forward rate.
There are two elements to the forward rate. The first is when the future rate begins. The second is the length of time for that rate. The notation is length of time of the forward rate f when the forward rate began. For example, a 2 f 8 would be the 1-year (two six-month periods) forward rate beginning four years (eight six-month periods) from now.
Nostro Vs Vostro Account
International accounting procedures between Local banks and overseas banks often involve the use of nostro and vostro accounts. A nostro (means "ours" in Latin) account is an account maintained by a Local bank with a foreign bank that allows the Local bank to buy foreign currency. A vostro (means "yours" in Latin) account is an account maintained by an overseas bank with a Local bank that allows the overseas bank to purchase Local currency. The system of nostro and vostro accounts facilitates foreign exchange dealings and settlements and allows the settlement of currency transactions between the Country's (Local)Bank and foreign banks.
Example : When X (Buyer) a trader in Base Country wants to purchase $5000 worth of goods by paying cash. Mr.X deposits the cash in his local bank in the country's currency for the corresponding amount ($5000) then a swift message is sent to the corresponding bank in the foreign country where the local bank holds a NOSTRO account requesting the bank to make the payment to Y (Seller) in his local currency i.e. US Dollars. Thus facilitating the trade between X & Y. IF Y wanted to buy something from X then the foreign bank would complete the deal using their VOSTRO account in X's country.
Author is management student with Somaya Institute of management.
She can be reached at apeksha40@gmail.com
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