Chapter 1 Flashcards
An exchange rate system in which a currency’s value
is allowed to fluctuate in response to market forces.
Floating Exchange rate
An exchange rate system in which the price of one currency’s
is fixed relative to another country by government authorities.
Fixed exchange rate
A hybrid currency system in which a government loosely fixes the value of the national currency relative to one or more other countries.
Manage Floating Rate system
An exchange rate system in which each unit of the domestic currency is backed by a unit of some foreign currency.
Currency Board Arrangement
An exchange rate quoted in terms of units in domestic currency per unit of foreign currency.
Direct Quote
An exchange rate quoted in terms of foreign currency per unit of domestic currency.
Indirect quoted
A currency ?? when it buys less of another currency than it did previously.
Depreciate
A currency ??? when it buys more of another currency than it did previously.
Appreciate
The exchange rate that applies to immediate currency transactions.
Spot Exchange Rate
The exchange rate quoted for a transactions
that will occur on a future date.
Forward Exchange Rate
When one currency buys more of another on the on the forward market that it buys on the spot market.
Forward Premium
When one currency buys less of another on the on the forward market that it buys on the spot market
Forward Discount
An exchange rate between two currencies calculated by taking the ratio of the exchange rate of each currency.
Cross Exchange Rate
A trading strategy in which traders buy a currency in a country where the value of that currency is too low and immediately sell the currency in another country where the currency value is too high.
Triangular Arbitrage
The world’s largest financial market
Foreign Exchange Market
Market Participants of Foreign Exchange
Exporters & importers
Investors
Hedgers
Speculators
Dealers
Governments
To pay bills denominated in foreign currency or to convert foreign currency revenues back into the domestic currency
Importers & Exporters
When they seek to buy and sell financial assets in foreign Countries
Investors
influence currency values when they take position to offset the risks of their existing exposures to certain currencies
Hedgers
Sell a currency if they expect it to depreciate and buy if they expect it to appreciate.
Speculators
To put upward or downward pressure on currencies as circumstances dictate.
Government
Types of Parity Conditions
❖Forward-Spot Parity
❖Purchasing Power Parity
❖Interest Rate Parity
❖Real Interest Rate Parity
refer to the economic theories that link exchange rates, price levels (inflation), and interest rates.
International Parity
term used to describe when two things are equivalent to one another
Parity
is any equation expressing the relation between arbitrage-free prices for spot and forward delivery
Spot-forward Parity
the current exchange rate
Spot rate
the rate at which a bank agrees to exchange one currency for another in the future
Forward rate
are simply price relatives that show the ratio of the prices in national currencies of the same goods or services in different countries.
Purchasing Power Parity
A theory that says that identical good trading in different markets must sell at the same price.
Law of one price
An equilibrium relationship that predicts that differences in risk-free interest rates in two countries must be tied to differences in currency values on the spot and forward markets.
Interest Rate Parity
simply means that risk free investments should offer the same return after converting currencies everywhere.
Interest Rate Parity
designed to exploit deviations from interest rate parity to earn an arbitrage profit.
Covered Interest Arbitrage
is a strategy in which an investor uses a forward contract to hedge against exchange rate risk.
Covered Interest arbitrage
An equilibrium relationship that predicts that the real interest rate will be the same in every country. This means that investors should earn the same real rate of return on risk-free investments no matter the country in which they choose to invest.
Real Interest Rate Parity
The risk that movements in exchange rates will adversely affect the value of a particular transaction.
Transaction Risk
The risk that exchange rate movements will adversely impact reported financial results on a firms financial statements.
Translation Exposure
The risk that a firm’s value will fluctuate due to exchange rate movements.
Economic Exposure
An equilibrium relationship that predicts that differences in risk-free interest rates in two countries must be tied to differences in currency values on the spot and forward markets.
Interest Rate Parity
An equilibrium relation- ship that predicts that the real interest rate will be the same in every country
Real Interest Rate Parity
The process by which investors determine the value of a potential investment project.
Capital Budgeting
is the price at which the currency dealer is willing to sell foreign currency
Ask price
is the price at which the dealer is willing to buy currency.
Bid Price
To put upward or downward pressure on currencies as circumstances dictate.
Government
