Exchange rates

Question 1

Why is the USD strong?

Answer 1

• safe haven amidst trade war
• boosted when trade talks progress
• relative outperformance
• money market pressures
• rate expectations

Question 2

what is the foreign exchange market?

Answer 2

the set of markets where foreign currencies and other assets are exchanged for domestic ones

Question 3

who participates in the foreign exchange market?

Answer 3

• commercial banks and other depository institutions: buy/sell deposits in different currencies for investment
• non-bank financial institutions: mutual funds, hedge funds, security firms, insurance companies, pension funds: buy/sell foreign assets for investment
• non-financial businesses: conduct foreign currency transactions to buy/sell goods, services and assets
• central banks: conduct official reserve transactions

Question 4

what are spot rates?

Answer 4

exchange rates for currency exchanges on the spot or when trading is executed in the present

Question 5

what are forward rates?

Answer 5

exchange rates for currency exchanges that will occur at a future date

Question 6

what are foreign exchange swaps?

Answer 6

a combination of spot sale with forward repurchase

Question 7

what are future contracts?

Answer 7

contract designed by a third party for a standard amount of foreign currency delivered/received on a standard date

Question 8

what are options contracts?

Answer 8

contract designed by a third party for a standard amount of foreign currency delivered/received on or before a standard date

contracts can be bought or sod in markets. A contract gives the owner the option but not the obligation of buying/selling currency if the need arises

Question 9

what types of rate of returns exist?

Answer 9

nominal rate of return: the percentage change in value that an asset offers during a time period

real rate of return: inflation adjusted rate of return

Question 10

what do you need to consider when comparing rate of return of a deposit between two currencies?

Answer 10

• interest rate of foreign currency

- expected rate of appreciation/depreciation of foreign currency relative to domestic currency

Question 11

What does the interest parity imply?

Answer 11

that deposits in all currencies are equally desirable assets and that arbitrage in foreign exchange markets is impossible

Question 12

What is the law of one price?

Answer 12

that the same good in different markets must sell for the same price.

This does not hold in real life because of imperfect information.