GARP 2016-FRR Exam With Confidence Using Practice Dumps

The value of an option is influenced by several factors, including the perceived volatility of the underlying asset, in this case, foreign exchange rates. As the perceived future volatility of foreign exchange rates increases, the value of all options (both calls and puts) also increases. This is because higher volatility increases the likelihood that the option will end up in-the-money, thereby increasing its potential payoff. This relationship is fundamental to option pricing models, such as the Black-Scholes model, which incorporate volatility as a key input.

The Black-Scholes model does not require discrete future stock prices as an input. Instead, it uses the current price of the underlying asset, the option’s strike price, time to maturity, risk-free interest rate, and the volatility of the underlying asset. The model assumes that the price of the underlying asset follows a continuous stochastic process and not discrete intervals.

Commercial banking can be viewed as a fixed-income carry trade because banks typically engage in maturity transformation, where they borrow short-term and lend long-term.

Short-term floating-rate deposits:

Banks often attract deposits with short-term maturities and floating interest rates.

These deposits are generally considered stable and low-cost sources of funds.

Long-term fixed-rate loans:

Banks use these short-term deposits to fund long-term loans, such as mortgages or business loans, which typically have fixed interest rates.

This creates a mismatch between the interest rates and maturities of assets and liabilities.

Carry trade analogy:

The bank earns the spread between the interest it pays on short-term deposits and the interest it earns on long-term loans.

This process is similar to a carry trade, where profits are derived from the difference between borrowing costs and investment returns.

Thus, commercial banking inherently involves aspects of a carry trade through the practice of borrowing short-term to lend long-term.

References

Source: How Finance Works​