Chapter 7 Terms - Foreign Exchange

Question 1

Foreign exchange rate:

Answer 1

The price of one currency in terms of another

Question 2

Appreciation:

Answer 2

An increase in the value of the currency

Question 3

Depreciation:

Answer 3

A loss in the value of the currency

Question 4

What Determines Foreign Exchange Rates?

Answer 4

The supply and demand of foreign exchange which is all determined by the following 5 factors:

1. Relative price differences & PPP
2. Interest rates & Money Supply
3. Productivity & Balance of Payments
4. Exchange Rate policies
5. Investor Psychology

Question 5

Balance of payments (BOP):

Answer 5

A country’s international transaction statement, which includes merchandise trade, service trade, and capital movement

Question 6

Floating (flexible) exchange rate policy:

Answer 6

A government policy to let supply-and-demand conditions determine exchange rates

Question 7

Fixed exchange rate policy:

Answer 7

A government policy to set the exchange rate of a currency relative to other currencies

Question 8

Target exchange rate (crawling band):

Answer 8

Specified upper or lower bounds within which an exchange rate is allowed to fluctuate

Question 9

Bandwagon effect:

Answer 9

The effect of investors moving in the same direction at the same time, like a herd

Question 10

Capital flight:

Answer 10

A phenomenon in which a large number of individuals and companies exchange domestic currency for a foreign currency

Question 11

Currency risk:

Answer 11

The potential for loss associated with fluctuations in the foreign exchange market

Question 12

Strategies for Financial Companies:

Answer 12

Spot transactions
Forward transactions
Swaps

Question 13

Strategies for Nonfinancial Companies:

Answer 13

Invoicing in your own currency
Currency hedging
Strategic hedging

Question 14

Foreign exchange market:

Answer 14

The market where individuals, firms, governments, and banks buy and sell foreign currencies

• Services the needs of trade and FDI
• Trades in its own commodity—namely, foreign exchange

Question 15

Spot transaction:

Answer 15

The classic single-shot exchange of one currency for another

Question 16

Forward transaction:

Answer 16

A foreign exchange transaction in which participants buy and sell currencies now for future delivery

Question 17

Currency hedging:

Answer 17

A transaction that protects traders and investors from exposure to the fluctuations of the spot rate

Question 18

Currency swap:

Answer 18

A foreign exchange transaction between two firms in which one currency is converted into another at Time 1, with an agreement to revert it to the original currency at a specified Time 2 in the future

Question 19

Offer rate:

Answer 19

The price to sell a currency

Question 20

Bid rate:

Answer 20

The price to buy a currency

Question 21

Spread:

Answer 21

The difference between the offer rate and the bid

Question 22

Nonfinancial companies cope with currency risk using three primary strategies:

Answer 22

Invoicing in their own currencies
Currency hedging

Strategic hedging: Spreading out activities in a number of countries in different currency zones to offset any currency losses in one region through gains in other regions

Question 23

Implications for Action - MGMT Savy

Answer 23

1. Fostering foreign exchange literacy is a must
2. Risk analysis of any country must include an analysis of its currency risk
3. A currency risk management strategy is necessary - via currency hedging, strategic hedging, or both.