chapter 15: Exchange Rates and Exchange Rate Systems Flashcards
Every country must choose an which types of exchange rate system?
fixed level
flexible
in between
fixed exchange rate system
no variation
flexible exchange rate system
variation determined by supply and demand for the country’s currency on a minute-by-minute basis
semi-fixed or semi- flexible exchange rates
between fixed and flexible
The exchange rate
the price of one currency stated in terms of a second currency
in which two ways can an exchange rate be given?
units of domestic currency per unit of foreign currency
vice versa
identify three reasons for holding foreign currency
trade and investment purposes
to take advantage of interest rate differentials, or interest rate arbitrage
to speculate
interest rate arbitrage
the practice of using favorable interest rate differentials to invest in a higher-yielding currency
arbitrageurs borrow money where interest rates are relatively low and lend it where rates are relatively high
arbitrage
the idea of buying something where it is relatively cheap and selling it where it is relatively expensive
Speculators
businesses that buy or sell a currency because they expect its price to rise or fall
They have no need for foreign exchange to buy goods or services or financial assets
they hope to realize profits or avoid losses through correctly anticipating changes in a currency’s market value
forex shit
they help to bring currencies into equilibrium after they have become over- or undervalued
four main participants in foreign currency markets
retail customers
commercial banks
foreign exchange brokers
central banks
the most participant in foreign currency markets
commercial banks
retail customers in currency markets include whom?
firms and individuals
why would retail customers hold foreign exchange?
to engage in purchases
to adjust their portfolios
to profit from expected future currency movements
forex broker
keeps track of buyers and sellers of currencies
acts as a deal maker by bringing together a seller and a buyer (most often banks buying for their customer)
Firms that do business in more than one country are subject to what?
exchange rate risks
how do exchange rate risks come to exist?
currencies are constantly changing in value and, as a result, expected future payments that will be made or received in a foreign currency will be a different domestic currency amount from when the contract was signed
who faces the exchange rate risks in a transaction? purchaser or the seller?
the purchaser is uncertain of the price in the currency of the seller
the seller knows the exact dollar amount it will receive
mechanisms to deal with exchange rate risks
the forward exchange rate
the forward market
the forward exchange rate
the price of a currency that will be delivered in the future
the forward market
the market in which the buying and selling of currencies for future delivery takes place
why are forward markets an everyday tool for international traders, investors, and speculators
because they are a way to eliminate the exchange rate risk associated with future payments and receipts
allow an exporter or importer to sign a currency contract on the day they sign an agreement to ship or receive goods
spot market
the market for buying and selling in the present
the transactions are denoted in spot prices
hedging
bondholders and other interest rate arbitrageurs using forward markets to protect themselves against the foreign exchange risk incurred while holding foreign bonds and other financial assets