Currency Risk Definitions Flashcards
A foreign exchange transaction:
An agreement between a buyer and a seller that a fixed amount of one currency will be delivered for some other currency at a specified rate
The FOREX markets provide the physical and institutional structure through which
The money of one country (currency) is exchanged for that of another country
The rate of exchange between currencies is determined
Foreign exchange transactions are ‘physically’ completed
6 Main characteristics of FOREX markets.
The geographic extent
The daily transaction volume
The functions of FOREX markets
The market’s participants
Types of transactions including spot, forward and swaps
Methods of stating exchange rates, quotations, and changes in exchange rates
1.The geographic extent
Worldwide 24 hours on business days.
2.The daily transaction volume
Size of the FOREX markets, with USD, JPY and the Euro in the top 3 currencies. 4. Pound sterling 5. Australian dollar. total also add up to 200%
3.Function of the FOREX markets.
provide the mechanism by which participants:
Transfer purchasing power between countries
Obtain or provides credit for international trade transactions
Minimize exposure to exchange rate risk
- Market Participantsoperating in the wholesale and/or retail markets
- Central banks and treasuries
- FOREX
- Foreign exchange brokers
- Banks and non banks exchange dealers
- speculators & arbitragers
- individuals and firms
Central banks and treasuries operate to do what?
Influence exchange rates of own currency for the benefit of citizens of their own country
FOREX markets operate to do what?
To facilitate trading between dealers. They stay anonymous. No positions
Banks and non-banks exchange dealers operate to do what?
Trading for customers or for themselves. ‘‘Market makers/ inventory position. Exchange dealers as they earn money by spreading bid/ask and the changes in exchange rates.
Speculators & Arbitragers operate to do what?
Trading for themselves to make profit. They earn money by: exchange rate changes as speculators. exchange rate differences in different markets are arbitragers.
The authors identify two tiers of foreign exchange markets, what are they?
Interbank and client markets.
While trading in foreign exchange takes place worldwide, where are the major currency trading centers located?
London, New York, and Tokyo.
In the foreign exchange market which participants seek all of their profit from exchange rate changes?
Speculators
- Types of transactions in the Interbank Market
Transactions within this market can be executed on a spot, forward, or swap basis:
Transactions within this market can be executed on a spot, forward, or swap basis:
- A spot transaction requires almost immediate delivery of foreign exchange
- A forward transaction requires delivery of foreign exchange at some future date
- A swap transaction is the simultaneous exchange of one foreign currency for another for two different value dates (a temporarily exchange)
5b. (Outright) Forward Transactions
This transaction requires delivery at a future value date of a specified amount of one currency for another
The exchange rate is established at the time of the agreement, but payment and delivery are not required until maturity.
Forward rates are contracts quoted for value dates of one, two, three, six, nine and twelve months
Example: Suppose one company purchases products from another foreign company. The payment terms: 3 months. Is forward contact beneficial?
Floating, Fixed, Managed Exchange rates
Free floating currencies
Fixed exchange rates
Managed Floating exchange rates
Free floating currencies
No state intervention on FOREX markets: exchange rates reflect supply and demand conditions
Examples $, ¥ (yen), £, €
Fixed exchange rates
Central Bank buys or sells its currency at a fixed price in order to stabilize the value to another currency
Examples: gold standard; Bretton Woods ($ key role), EU currencies before start of the €
Managed Floating exchange rates
Examples ¥ (Chinese Yuan)
- Stating Foreign Exchange Rates & Quotations
A foreign exchange quote is a statement of willingness to buy or sell at an announced rate Currency Traditional Symbol ISO 4217 Code U.S. dollar $ USD European euro € EUR Great Britain pound £ GBP Japanese yen ¥ JPY Mexican peso Ps MXN Renminbi (Yuan) ¥ CNY
In the retail market (newspapers and exchange-‘shops’), quotes are often given as the home currency price of the foreign currency: £(GBP)1.770/$
The foreign currency price of the unit one dollarSfr1.6000/$, read as ‘I have to pay 1.600 Swiss francs for one dollar’
SFR1.6000/$
Swiss franc is foreign currency
($ is HOME currency)
The dollar price of a unit of foreign currency$0.6250/Sfr, read as ‘I have to pay 0.625 dollars per Swiss franc’
$0.6250/Sfr
$ is home currency and swiss franc is foreign currency.
