Class 4 (foreign exchange markets)

Question 1

When is the foreign exchange market traded?

Answer 1

Traded 24/7

Question 1

Name some differences between trading stock and currency

Answer 1

-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

Question 2

Why is there change in currency when stock market closes?

Answer 2

Because the exchange market is based off other relative currencies from other countries

Question 3

Name some participants in the currency market? (6)

Answer 3

-Central banks
-Treasury banks
-Investor banks
-Commercial banks (FI)
-Speculative traders
-FX brokers

Question 4

How do you trade currencies?

Answer 4

Two parties that are willing to trade currencies

Question 5

What needs to happen when trading currencies and why?

Answer 5

There must be some sort of electronic copy since this trace helps prevent fraud, money laundering, etc

Question 6

What moves the value of currency at any given time?

Answer 6

Supply and demand

Question 7

How do you protect yourself against FX if you are selling internationally? How is the rate determined?

Answer 7

-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

Question 8

What is a spot rate?

Answer 8

It is the exchange rate at that given moment and time

Question 9

How do you determine which currency is the “local” currency? Give an example

Question 10

What are forward transactions?

Answer 10

An agreement that takes place today for an exchange rate in the future

Question 11

How far in the future can a forward rate take place?

Answer 11

There is forward rates for any time periods (days, months, years)

Question 12

In a forward rate, when is the money paid to the other party?

Answer 12

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

Question 13

What is the idea behind the forward rate?

Answer 13

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

Question 14

What are spot against forward (forward swaps)? Give an example

Answer 14

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

Question 15

What is the risk of a forward transaction?

Answer 15

That the FI may go bankrupt between the date of agreement and the settlement date

Question 16

What are forward forward swap transactions

Answer 16

They are forward transactions at a later date followed by another forward contracts at an even later date

Question 17

Give an example of forward forward transactions

Answer 17

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

Question 18

What are non-deliverable forward transactions? What are their particularity?

Answer 18

They are currency trades that happen without any paying of currency, you are settling on the amount of difference between values

Question 19

Give an example of non-deliverable forward transactions

Answer 19

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

Question 20

What impacts does the BOP have on exchange rates

Answer 20

The imbalance of the BOP of a country impacts them differently depending on whether the country has a fixed, floating or managed exchange rate

Question 21

What impacts does the BOP have on interest rates

Answer 21

Lower interest rates in one country might encourage people to allocate capital where rates are higher

Question 22

What impacts does the BOP have on inflation rates

Answer 22

Imports have the potential of lowering a country’s inflation rate but more should lead to lower GDP however.

Question 23

Currency devaluation can come from what

Answer 23

A result of persistent and seizable trade deficits

Question 24

Why would a country devalue their currency?

Answer 24

To make their exports more price-competitive on world markets

Question 25

What is the J-curve?

Answer 25

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

Question 26

What is a bid rate?

Answer 26

The price at which someone is will to buy a currency

Question 27

What is an ask rate?

Answer 27

The price at which someone is willing to sell something

Question 28

What is the spread in ask rate and bid rate?

Answer 28

It is the value or difference between the ask and the bid rate. It also represents the transaction cost which is key for traders

Question 29

What are cross rates? Give an example

Answer 29

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

Question 30

What is the notional amount for for forward rates?

Answer 30

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

Question 31

What are forward points?

Answer 31

Its the difference between the spot and forward rate. It should be added to the spot rate to determine the forward rate

Question 32

What are interest rate differentials?

Answer 32

It is the difference between the interest rates of the two currencies involved in a forward contract