Class 4 (foreign exchange markets) Flashcards
When is the foreign exchange market traded?
Traded 24/7
Name some differences between trading stock and currency
-Stock is part ownership of a company however currency has no ownership to it
-how a stock behaves is based on how the company performers however how currency behaves is very much based on the BOP, politics and much more
Why is there change in currency when stock market closes?
Because the exchange market is based off other relative currencies from other countries
Name some participants in the currency market? (6)
-Central banks
-Treasury banks
-Investor banks
-Commercial banks (FI)
-Speculative traders
-FX brokers
How do you trade currencies?
Two parties that are willing to trade currencies
What needs to happen when trading currencies and why?
There must be some sort of electronic copy since this trace helps prevent fraud, money laundering, etc
What moves the value of currency at any given time?
Supply and demand
How do you protect yourself against FX if you are selling internationally? How is the rate determined?
-You buy what is called a forward contract.
-The rate is determined based on interest rates which itself is based on the amortization of the canadian bond
What is a spot rate?
It is the exchange rate at that given moment and time
How do you determine which currency is the “local” currency? Give an example
What are forward transactions?
An agreement that takes place today for an exchange rate in the future
How far in the future can a forward rate take place?
There is forward rates for any time periods (days, months, years)
In a forward rate, when is the money paid to the other party?
Only at the pre-determined date (settlement date). Meaning if there is a settlement date in 20 years, the payment is only in 20 years
What is the idea behind the forward rate?
To protect against currency fluctuation. Therefore you don’t lose money if the currency goes down and don’t gain money if the currency goes up
What are spot against forward (forward swaps)? Give an example
You buy at today’s currency and agree on a forward rate
-Ex: You receive a payment from China now and invest it at today’s rate (spot rate) and since you know you will receive another payment in 6 months and wish to protect against currency fluctuation, you lock in a forward transaction for the date you will receive payment
What is the risk of a forward transaction?
That the FI may go bankrupt between the date of agreement and the settlement date
What are forward forward swap transactions
They are forward transactions at a later date followed by another forward contracts at an even later date
Give an example of forward forward transactions
A US based company expects to get a payment from China in 3 months and in 6 months. US will lock in a forward rate for the 3 month payment and will lock in a forward rate for the 6 month payment
What are non-deliverable forward transactions? What are their particularity?
They are currency trades that happen without any paying of currency, you are settling on the amount of difference between values
Give an example of non-deliverable forward transactions
The US expects to receive payment from India in 6 months for $1 million, so a forward rate is put in place. The forward rate agreement is 1USD = 1.75 RUP. 6 months later, the spot rate is 1USD = 1.76RUP. The US would be entitled to a payment from India for (1.76-1.75) x $1 million = $10,000. The opposite would be true if the rupee gained value, say 1USD = 1.74RUP. The US would have to pay out (1.74-1.75) x $1 million = $10,000
What impacts does the BOP have on exchange rates
The imbalance of the BOP of a country impacts them differently depending on whether the country has a fixed, floating or managed exchange rate
What impacts does the BOP have on interest rates
Lower interest rates in one country might encourage people to allocate capital where rates are higher
What impacts does the BOP have on inflation rates
Imports have the potential of lowering a country’s inflation rate but more should lead to lower GDP however.
Currency devaluation can come from what
A result of persistent and seizable trade deficits
Why would a country devalue their currency?
To make their exports more price-competitive on world markets
What is the J-curve?
It’s a concept used to describe a country’s trade balance and the effects of currency devaluation or depreciation over time. It illustrates how the trade balance might initially worsen before improving after a currency adjustment
What is a bid rate?
The price at which someone is will to buy a currency
What is an ask rate?
The price at which someone is willing to sell something
What is the spread in ask rate and bid rate?
It is the value or difference between the ask and the bid rate. It also represents the transaction cost which is key for traders
What are cross rates? Give an example
a currency that is inactively traded so the exchange rate is determined through their relationship with a widely traded third currency
Ex: wish to convert Peso to Yen and since they are both not traded, is we base the currency on the USD
What is the notional amount for for forward rates?
It is the hypothetical amount of currency that the forward contract is based on, which is used to calculate payments but is not exchanged in non-deliverable forwards
What are forward points?
Its the difference between the spot and forward rate. It should be added to the spot rate to determine the forward rate
What are interest rate differentials?
It is the difference between the interest rates of the two currencies involved in a forward contract
