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International Corporate Finance > Exchange Rates > Flashcards

Exchange Rates Flashcards

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1
Q

What is an exchange rate?

A

Exchange rate is simply, the price of one nation’s currency in terms of another currency. Exchange rates can be for spot or forward delivery.

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2
Q

What is a spot rate?

A

Spot rate is the price at which currencies are traded for immediate delivery (actual delivery takes place two days later).

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3
Q

What is a forward rate?

A

Forward rate is the price at which foreign exchange is quoted for delivery at a specific future date.

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4
Q

What is the exchange rates market?

A

The exchange rates market is an electronically linked network of banks, foreign exchange brokers, and dealers whose function is to bring together buyers and sellers of foreign exchange.

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5
Q

EUR/USD is a direct quote of what currency?

A

EUR

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6
Q

EUR/USD is a indirect quote of what currency?

A

USD

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7
Q

If €1=$0.93 and it changes to €1=$1,09, has euro appreciated or depreciated in its dollar value?

A

Appreciated

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8
Q

What is the formula to find the amount of appreciation/depreciation?

A

(New dollar value - Old dollar value) / Old dollar value

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9
Q

What is the formula to find the change in foreign currency?

A

(New dollar value - Old dollar value) / Old dollar value

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10
Q

What is the formula to find the change in domestic currency?

A

(Old dollar value - New dollar value) / New dollar value

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11
Q

What is the EUR/USD BID?

A

The price at which the investor buys USD and sells EUR. Also the price at which the bank sells USD and buys EUR.

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12
Q

What is the EUR/USD ASK?

A

The price at which the investor buys EUR and sells USD. Also the price at which the bank sells EUR and buys USD.

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13
Q

Which one is bigger: BID or ASK prices?

A

ASK

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14
Q

What is the formula for the BID/ASK Spread?

A

(Ask rate - Bid rate) / Ask rate

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15
Q

What is the bid/ask spread intended to cover?

A

The bid/ask spread is intended to cover the costs involved to exchange currencies.

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16
Q

In which countries is the bid/ask spread usually greater?

A

Less traded countries

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17
Q

When is the bid/ask rate smaller?

A

“Wholesale” transactions (not “retail” transactions)

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18
Q

Is the bid/ask spread constant over time?

A

No, volume traded and implied volatility can alter the spread.

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19
Q

When given the spot rates GBP/AUDbid and GBP/AUDask, if you want to buy AUD which one should you use?

A

GBP/AUDbid

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20
Q

When given the spot rates GBP/AUDbid and GBP/AUDask, if you want to buy GBP which one should you use?

A

1/GBPAUDask

21
Q

Who participates in the exchange market?

A

1) MNCs and individuals
2) Banks and dealers
3) Brokers
4) Central banks

22
Q

Why do firms and individuals trade currency?

A

Usually for economic reasons

23
Q

How do banks and dealers intervene in the exchange market?

A

On their own accords and risk, they can buy/sell currency for themselves or for clients

24
Q

What do brokers do in the exchange market?

A

Brokers buy/sell currency in representation of their clients (who remain anonymous) for a commission.

25
Q

How do central banks intervene in the exchange market?

A

Central banks intervene directly or indirectly as a means of monetary policy conduct.

26
Q

What is the standard delivery time of currency?

A

t + 2 days

27
Q

Why is the standard delivery time of currency t + 2 days?

A

1) Different time zones
2) Administrative procedures between banks and intermediaries
3) Minimize no payment risk
4) “Clearing House”

28
Q

What are the reasons to participate in the exchange markets?

A

1) Hedging
2) Speculation
3) Arbitrage
4) Monetary Policy

29
Q

How can a MNC hedge in the exchange market?

A

Engaging in forward contracts to protect the home currency value of various foreign-denominated assets and liabilities.

30
Q

What is speculating in the exchange market context?

A

Active exposure to currency risk by buying or selling currencies forward in order to profit from exchange rate fluctuations.

31
Q

What is arbitrage in the exchange market context?

A

Seeking to earn risk-free profits by taking advantage of differences in interest rates among countries.

32
Q

What does a forward contract allow us to do?

A

A forward contract allows us to lock in today the rate at which we can buy/sell a given currency at some point in the future.

33
Q

Can the forward contract be tailored made?

A

Yes, the forward contract can be tailored made between the firm and its bank in order to accommodate the firm’s needs.

34
Q

What is the outright rate?

A

The outright rate is the actual price commercial customers are usually quoted.

35
Q

What is the swap rate?

A

The swap rate is the forward differential, since dealers quote the forward discount/premium on the spot rate.

36
Q

How do we compute the forward premium/discount as annual percentage deviation from the spot rate?

A

Forward Premium/Discount =[(Forward rate - Spot rate) / Spot rate] * 360 / Contract number of days

37
Q

When is a foreign currency at a forward discount?

A

A foreign currency is at a forward discount if the forward rate expressed in dollars is below the spot rate.

38
Q

What is the rule to know if the forward rate is at a premium?

A

When the forward bid in points is smaller than the ask rate in points. The points should be added to the spot price to compute the outright price.

39
Q

What are spreads in the forward market?

A

In the forward market, spreads are a function of the volume of transactions in a given currency and the risks associated with forward contracts.

40
Q

In the context of equilibrium, what are exchange rates?

A

Exchange rates are market-clearing prices that equalize demand and supply in the foreign exchange markets.

41
Q

In terms of demand for euro, what happens when there is an increase in EUR/USD?

A

An increase in EUR/USD is equivalent to an increase in the dollar price of Eurozone products, so it will reduce demand.

42
Q

In terms of demand for euro, what happens when there is a decrease in EUR/USD?

A

A decrease in EUR/USD is equivalent to a decrease in prices of Eurozone products, so demand will increase.

43
Q

The supply of euros is based on what?

A

The supply of euros is based on the Eurozone demand for US products.

44
Q

In terms of supply of euro, what happens when there is an increase in EUR/USD?

A

An increase in EUR/USD is equivalent to lowering the cost of US products, leading to an increase in the Eurozone demand, which leads to an increase of euros supplied.

45
Q

What are the main factors affecting the equilibrium exchange rate?

A

1) Relative Inflation Rates
2) Relative Interest Rates
3) Relative Economic Growth Rates
4) Political and Economic Risk

46
Q

What happens when there is an inflation in the US compared to the Eurozone products?

A

Americans substitute US products for Eurozone products, leading to an increase in the demand for euros. Eurozone consumers consume less US products, which leads to a decrease in demand, which leads to a decease in the supply of euros. The result is that the euro is appreciated and the equilibrium exchange rate increases.

47
Q

What happens when there is a rise in the real US interest rates?

A

Eurozone consumers will buy less Eurozone financial assets and more US financial assets, which increases the supply of euros. Americans will also buy more US financial assets, which decreases the demand for euros. The result is a depreciation of euro and a decrease in the equilibrium exchange rate.

48
Q

How can higher growth rates affect exchange rates?

A

A nation with strong economic growth will be able to attract investment capital seeking to acquire domestic assets. The increase demand in domestic assets leads to an increase in the domestic currency’s demand.

49
Q

How can political and economic risk affect exchange rates?

A

Investors prefer to hold lesser amounts of riskier assets; thus, low-risk currencies– those associated with more politically and economically stable nations– are more highly valued than high-risk currencies.

International Corporate Finance (10 decks)

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