chapter 9 Flashcards
determinants of Exchange Rates
Supply and Demand
Interest Rates
Economic indicators
Political Stability: Political events and stability affect investor confidence.
how exchange rate affects business decision
- Exchange rate fluctuations can affect import/export costs, impacting cost and revenue which will impact profitability.
- Affects decisions on where to invest or locate production.
- Companies must consider potential rate changes in their long-term plans.
what are forex risks?
Transaction Risk
Translation Risk
Economic Risk
what is transaction risk?
Arises from the effect of exchange rate changes on international trade transactions.
what is translation risk?
when a company operates in multiple countries and needs to consolidate its financial statements. The challenge comes from dealing with different currencies and their changing exchange rates.
what is an economic risk?
It involves changes in market conditions due to exchange rate movements, affecting customer behavior and market demand.
define arbitrage
purchase of foreign currency on one market for immediate resale on another market (in a different country) to profit from a price discrepancy.
what does the International Monetary Fund do
It provides financial assistance, advice, and training to its member countries to help them achieve these goals:
1. promote global monetary cooperation
2. secure financial stability
3. Facilitate international trade
4. promote high employment
5. sustainable economic growth
6. reduce poverty around the world.
what is the Quota system
when each member in the IMF contributes funds based on their economic size.
Currency classification by the IMF
Hard Peg
Soft Peg
Floating
what is a hard peg?
This means the country’s currency has a fixed exchange rate with one or more currencies. It doesn’t change or fluctuate very much. The country’s central bank actively ensures this fixed rate is maintained.
what is soft peg
when the currency is also pegged to another currency but with more flexibility. The exchange rate can fluctuate within a certain range. The central bank might adjust the value occasionally within this range based on various economic factors.
what is floating
when a country’s currency value changes freely based on market forces like supply and demand. A floating rate can go up and down with economic conditions. The currency’s value is determined by factors such as interest rates, economic performance, and investor perception.
what is the central bank’s role?
Manage reserve assets
intervene in markets
vary in intervention attitudes.
define black market
closely approximates a price based on supply and demand for a currency instead of a government-controlled price
what is fundamental forecasting?
uses trends in economic variables to predict future rates
what is Technical forecasting
uses past trends in exchange rates to spot future trends. Timing, direction, and magnitude of exchange rate movements are important to consider
what is Purchasing power parity (PPP)
define relationship between currencies based on inflation
what is big mac index
an informal way of measuring the purchasing power parity (PPP) between two currencies. It compares the price of a Big Mac burger in McDonald’s restaurants in different countries to the price in the United States. This comparison provides an understanding of whether a currency is undervalued or overvalued relative to the U.S. dollar. The idea is that the Big Mac is a product that is available in many countries and of relatively uniform quality, making it a good item for such comparisons.
what is supply and demand influenced by
international trade and capital flows.
examples of economic indicators
GDP growth
inflation
employment rates.
advantage of having high interest rates
Higher rates attract foreign investment, increasing demand for the currency.
