CH10 Flashcards
Foreign Exchange Market
Market for converting currency of one country into that of another country.
Exchange Rate
The rate at which one currency is converted into another.
- Future exchange rates cannot be accurately predicted.
Functions of Foreign Market Exchange
- Convert the currency of one country into the currency of another.
- Provide some insurance against foreign exchange risk.
Bussinesses use the Foreign Exchange Market to:
- Convert the payments received for its exports, the income received from foreign investments, or the income received from licensing agreements with foreign firms
- Make payment to a foreign company for its products or services in its country’s currency
- To invest cash for short terms in foreign money markets.
Currency Speculation
Typically involves the short-term movement of funds from one currency to another in the hopes of profiting from shifts in exchange rates.
Carry Trade
A kind of speculation that involves borrowing in one currency where interest rates are low and then using the proceeds to invest in another country where interests are high.
Insuring Against Foreign Exchange Risk
- Spot exchange rates
- Forward exchange rates
- Currency Swaps
Exchange Rate
Rate at which a foreign exchange dealer converts one currency into another currency on a particular day.
Forward Exchange
Occurs when two parties agree to exchange currency and execute the deal at some specific date in the future.
Currency Swap
The simultaneous purchase and sale of a given amount of foreign exchange for two different value dates.
- Transaction between international businesses and their banks, between banks, and between governments
Foreign Exchange Market
- Global network of banks, brokers, and foreign exchange dealers connected by electronic communications systems
- Rapidly growing
- Most important trading centers are London (largest), New York, Zurich, Tokyo, and Singapore.
- A market is open 24 hours a day
- High-speed computer linkages among trading centers around the globe have effectively created a single market.
- Arbitrage
- Most transactions involve the DOLLAR.
Arbitrage
Refers to the purchase of securities in one market for immediate resale in another to profit from a price discrepancy.
Law of One Price
States that in competitive markets free of transportation costs and barriers to trade (such as tariffs), identical products sold in different countries must sell for the same price when their price is expressed in terms of the same currency.
Purchasing Power Parity (PPP)
- Comparison of prices of identical products determine the real or PPP exchange rate
- The price of a “basket of goods” should be roughly equivalent in each country
- Big Mac Index
Efficient Market
Has no impediments to the free flow of goods and services, such as trade barriers. It is a market where prices reflect all available information.