List what is right and what is wrong The old lady was absolutely afraid of the e
ID: 2802943 • Letter: L
Question
List what is right and what is wrong The old lady was absolutely afraid of the economic situation, she wanted to make sure that her money would be safe, so, she went to speak with a broker. The broker expressed understanding and explained the following: We will invest part of your money in futures contracts for Euros, it is an absolutely safe instrument where you pick the settlement price and you know how much you will get for the Euro and you do not lose a penny. You have to post margin but do not worry, you can always walk out of the contract if you want. Now, we can also enter into a Foreign Exchange swap, where the constant stream of cash you will receive over the years will keep your money safe. Furthermore, we can calculate the value of the swap in such a way that you always receive more than you pay. The old lady looked at the broker, did not say a word, and went away muttering curses against the ignorance of some brokers. Was she right?Explanation / Answer
The old lady seems to be an intelligent one.
The broker was right for the following:
1. The margin is required in a future contract which is paid to enter into the contract.
2. He is right regarding walking out of the contract but that can only be done when the person enters into an equivalent position that is opposite to the contract she already owns.
The broker was wrong for the following reasons:
1. There is no way that the broker can calculate the value of the swap as it is depended on the movement of the currencies.
2. There is no guarantee that the person will always receive more money than they are actually paying.
3. There is no constant stream of cash available to the person in a foreign exchange swap as the currency is exchanged only at the beginning and expiration of the contracts.
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