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75 terms

Chapter 9: The Foreign Exchange Market

STUDY
PLAY
What are the two ways to quote currency?
spot rates and forward rates
What is a spot rate?
the exchange rate between 2 currencies; delivery within two days (conversion on a particular day)
What is a forward rate?
the exchange rate between 2 currencies;future delievery in 30/60/90/180 days
What are the three ways of insuring against a Forex risk?
spot rates, forward rates, and swaps
What is hedging?
the process of insuring one's business against foreign exchange risk by using forward exchanges or currency swaps
What is a currency swamp?
simultaneous purchase and sale of a given amount of foreign exchange for two different value dates
What are some characteristics of swaps?
- these transactions are used when need to move out of one currency into another
- they are for a limited period
- there is no foreign exchange rate risk
No single theory can explain explain the causes the value of currencies to change. True or False?
True
What are some factors that influence exchange rates?
-Supply & demand of the currency
-Interest rates
-Inflation
-Investor expectations
What are the types of Exchange Rate Fluctuations?
- monetary and fiscal policies
What do monetary policies do?
-control the amount of money in circulation
-enforced by government policies
- focus on growth rate
What are the purposes of fiscal policies?
collecting & spending of money by the government
What is the law of one price?
in competitive markets free of transportation costs and barriers to trade identical products sold in different countries must sell for the same price is expressed in terms of the same currency
What is arbitrage?
the purchase of securities in one market for immediate resale in another to profit from a price discrepancy (no risk)
What is the nature of the forex market?
high-speed computer linkages between trading centers around the globe
-have created 1 market
-resulted in no significant difference between exchange rate quotes
-different exchange quoted result in arbitrage opportunities
True or False. Most Transaction inovolve u.s. dollar
True
What are the important trading centers?
London, New York, Tokyo, and Singapore
Ture or false. Marekts are open 24/7
True
According to economic theories of exchage rate determination?
exchange rates are determined by the demand and supply for different currencies
What are three factors that impact a country's future exchange rate movements?
inflation, interest rate, and market psychology
What is the nominal exchange rate?
currency of one country can be exchanged for the currency of another country
What is the real exchange rate?
goods and services of one country can be exchanged for the goods and services of another country
What holds true to Purchase Power Parity Theory?
-there is absence of trade barriers
-each country price in commodity basket are at an equal ration
- not accurate in predicting exchange rates in the short run
In the long run empirical testing has of the PPP Theory has proven to be accurate in the long run. True or False
True
Burger economics!!! Why do we use it?
It is used to measure how far the nominal exchange rate deviate from the one that would create PPP
What causes big mac prices to vary?
transportation costs, trade barriers, and not trade inputs such as rents or wages
When do countries use the foreign exchange market?
1. receive payments for exports
2. receive income from FDI
3. Receive income from licensing agreements with foreign firms are in foreign currencies.
When do countries use foreign exchange market?
1. pay a foreign co for its products or services in a countries currency
2. spare cash for short term money market investments
3. involved in currency speculation
What is free convertible currency?
government allows both residents and non residents to purchase unlimited amounts of foreign currency with domestic currency
What is non convertible currency?
both residents and on residents are prohibited from converting their holdings of domestic currency into a foreign currency
What is externally convertible currency
1. non residents can convert their holdings of domestic currency
2. residents are limited in some way to convert currency
What are the first two things that determine Forex rates?
relative price differences and ppp
What is the second thing that determines the Forex rates?
interest rates and money supply
What is the third thing that determines the forex rates?
productivity and balance payments
What is the fourth thing that determines the forex rates?
exchange rate policies
What is the fifth thing that determines the forex rates?
investor psychology
What is the first roels of the U.S. dollar outside the U.S.?
a common reference
What is the second role of the U.S. dollar outside the U.S. ?
intervention currency (peg country currency)
What is the third role of the U.S. dollar outside the U.S.?
reserve currency
What is the fourth roles of the U.S. dollar outside the U.S.?
vehicle currency(transaction between 2 less commonly used currencies)
What is the bandwagon effect when looking at form investor psychology ?
group of investors movement in the same direction and same time
or government intervention
What is capital fight when looking at it form investor psychology?
large number of individuals and cos exchange of domestic currencies for a foreign currency
What implications does understanding foreign exchange rates have on managers?
it helps them understand the influence of exchange rates on profitability of trade investment deals
What are the three different types of foreign exchange rate risks?
transaction, translation and economic exposure
How can transaction exposure be described?
the income form individual transacations
What is the first characteristic of transaction exposure ?
affected by fluctuation in foreign exchange values
what is the second characteristic of transaction exposure?
obligations for the purchase or sale of goods and services at previously agreed prices
what is the third characteristic of transaction exposure?
borrowing of funds in foreign currency
what is the fourth characteristic of transaction exposure?
lending of funds in foreign currencies
How can translation exposure be described?
impact of currency exchange rate changes on reported financial statements
What is the characteristic of translation expose?
measurement of past events
What is economic exposure?
firms future international earning power
what are the characteristics of economic exposure?
affected by changes in exchange rates aslo long term effect of changes in exchange rates on future prices, sales, and costs
What are two methods of reducing translation and transaction exposure?
lead and lag strategies
What is the first characteristic of lead strategy?
an attempt to collect currency receivables early as result of expected depreciation
What is the second characteristic of lead strategy?
paying foreign currency payable before dues as a result expected currency appreciation
What is the first characteristic of lag strategy?
delay collection of foreign currency receivables if currency is exception to appreciate
What is the second characteristic of lag strategy?
delay payables if currency is expected to depreciate
What are the two ways to reduce economic exposure?
1. distribute productive assets
2. ensure assets are not concentrated in countries
How and what is the purpose of distributing assets?
distribute to various locatoij so firms long term financial well being is not severly affected by changes in exchange rates
What is the purpose of not concentrating assets in countries?
increase currency values and protect against increases in foreign prices of goods and services
How do you insure or hedge against a Forex risk?
forward exchange or spot exchange
What are some strategies for managing forex risk?
establish central control and attempts to forecast future exchange rates
HOw do you establish central control?
1. protect resources efficiently
2. ensure correct mix of tactics and strategies
What are other strategies for managing forex risk?
estb. good reporting systems, check monthly foreign exchange reports and distinguish between transaction , economic and translation exposure
True or False. It is important to stay up to date with yo current events
True
The euro faces risks fo recapitalization?
banks stability was measure at a 5% capital adequacy ratio
Currently margins require more cash reserves, what is the best method of doing this **** in the Euro Zone?
Issue mo good loans so that profits from new business can eat away the losses form the bad
Because of the recessionary environment euro banks have failed to do what?
increase their exposure to banking europe's banking center
Because many banks (2/3) are below the capital adequacy ratio of 9% many can not recapitalize on their own as a result
state driven recapitalization are now needed
Bailout Fund of EFSF, What is this shiz nitz?
manages the Greeks, the Irish, and Portuguese bailouts and has passed recent amendments to legally assit euro banks and govs
What is the first issue with EFSF?
1. no process
2. no agreement as to who should hold the process
3. Germans want eco reforms following bailout
4. remediation and supervisory structures must be built
What is the second issue with EFSF?
1. not that many staffing
2. months away form being implemented
3. esfs new power to restructured banks goes against EU treaties that guarantee all banking authority to the member state level
Greece has not defaulted because it has not been able to fully implement it agreed upon austerity. True or False
True
Defaulting on debt has a domino effect that intertwines all countries in Europe.
True