Chapter 9 Flashcards
Markets in which cash flows from the sale of products or assets denominated in a foreign currency are transacted
- may use own currency
- may use shared currency (euro, east caribbean)
- may use multiple currencies
foreign exchange markets
Risk that cash flows will vary as the actual amount of U.S. dollars received on a foreign investment changes due to a change in foreign exchange rates.
foreign exchange risk
When a country’s currency falls in value relative to other currencies, meaning the country’s goods become cheaper for foreign buyers and foreign goods become more expensive for foreign sellers.
currency depreciation
When a country’s currency rises in value relative to other currencies, meaning that the country’s goods are more expensive for foreign buyers and foreign goods are cheaper for foreign sellers.
currency appreciation
- required to pay in legal currency of seller’s country
- $78 billion dollars in good per day cross boarders
- $6.6 trillion in FOREX daily volume globally
international trade
dollar backed by gold, other currencies tightly ‘pegged’ to dollar
bretton wood agreement (1944)
the bretton woods agreement led to what situation
some currencies (such as US dollar) became overvalued and others (like the german mark) became undervalued
- smithsonian agreement of 1971 sought to address this situation
1973: US ___ gold backing, world drops ___ ___
drops; dollar peg
most currencies were backed by
gold/silver
1944 gold redemption rates:
the rate of exchange was fixed by governments
- ___ pounds per ounce of gold
- ___ dollars per ounce of gold
- pound had to be worth = 7.96 dollars
4.25; 33.85
simplify trade among european union member countries:
1999: exchanges rates ____
2002: national currencies phased out for ___
fixed; euro
secondary benefit/curse: non-EU trade
- economic health drives the value of a fiat currency
2000s: ____ value
2010s: ____ value
increasing; decreasing
The use of a foreign currency in parallel to, or instead of, the local currency.
dollarization
major countries allowed the dollar to be devalued and the boundaries between which exchange rates could fluctuate were increased from 1% to 2 1/4%
- exchange rate boundaries were eliminated altogether
Smithsonian Agreement II
trade tomorrow
- when matched to future transaction, zero volatility
- trade 1-6 months in the future
forward rates
- leggett and platt (furniture)
- manufacture in china, sell in US –> Exchange risk (inputs)
- sell in china
—> sell furniture to receive yuan
–> generate sufficient yuan cash flow to cover inputs/manufacturing costs
–> profit from sales in dollars independent of $/yuan exchange rate
hedging without forwards
- first decade of 2000s the US experienced an increasing national debt that led to the ___ increasing value by 35% against the US dollar
euro
in 2019 88% of all foreign exchange transactions were dominated in ___
32% were denominated in ___
-because 2 currencies are involved in each transaction the sum of % shares of individual currencies totals 200%
dollars; euros
theorizes that nominal IR observed in financial markets must
(1) compensate investors for any reduced purchasing power due to inflationary price changes
(2) provide an additional premium above the expected rate of inflation for forgoing present consumption due to the time value of money (which reflect the real risk-free rate)
the fisher effect
the country with the higher nominal interest rate will see its currency ____
depreciate
The theory explaining the change in foreign currency exchange rates as inflation rates in the countries change.
purchasing power parity (PPP)
according to PPP the most important factor determining exchange rates is in open economies, differences in ___ (and by implication, price level changes with inflation) drive ___ ___ and thus demand for and supplies of ____
prices; trade flows; currencies
The theory that the domestic interest rate should equal the foreign interest rate minus the expected appreciation of the domestic currency.
interest rate parity theorem (IRPT)
the IRPT a change in US interest rates, foreign interest rates, and expected exchange rates affect the __ __ __
current exchange rate
hedge by taking a position in the forward or other derivative markets for foreign currencies
-ex: the one-year forward market for selling pounds for dollars
any forward position taken would not appear on the balance sheet
- instead it would appear as a contingent off-balance-sheet claim
hedging with forwards
Foreign exchange transactions involving the immediate exchange of currencies at the current exchange rate.
spot foreign exchange transactions
the role of the forward FX contract is to ___ the uncertainty regarding future spot rate on pounds at the end of the one-year investment horizon
offset
The exchange of currencies at a specified exchange rate at some specified date in the future.
forward foreign exchange transaction
foreign contracts are normally written in
one- ,three- , or six-month periods
Summary of all transactions between citizens of two countries
balance of payment (international transactions) accounts
the balance of payments is divided into 3 accounts:
(1) current account
(2) capital accounts
(3) financial accounts
The section of the balance of payment table that summarizes foreign trade in goods and services, net investment income, and gifts, grants, or aid given to other countries.
current account
The section of the balance of payment table that summarizes capital flows into and out of a country.
capital accounts
The section of the balance of payments table that records transactions between U.S. residents and nonresidents for direct investment, portfolio investment, other investment, reserves, and financial derivatives other than reserves.
financial accounts
result from the import of more foreign goods relative to the export of domestic goods
trade deficit (in goods)
