FINAL EXAM Flashcards
is the conversion of one currency into another at a specific rate known as the foreign exchange rate. The conversion rates for almost all currencies are constantly floating as they are driven by the market forces of supply and demand.
Foreign exchange (Forex or FX)
Many factors can potentially influence the market forces behind foreign exchange rates. The factors include various economic, political, and even psychological conditions. The economic factors include a government’s economic policies, trade balances, inflation, and economic growth outlook.
FACTORS THAT AFFECT FOREIGN EXCHANGE RATES
Many factors can potentially influence the market forces behind foreign exchange rates. The factors include various economic, political, and even psychological conditions. The economic factors include a government’s economic policies, trade balances, inflation, and economic growth outlook.
FACTORS THAT AFFECT FOREIGN EXCHANGE RATES
• is a decentralized and over-the-counter market where all currency exchange trades occur. It is the largest (in terms of trading volume) and the most liquid market in the world.
• The forex market’s major trading centers are located in major financial hubs around the world, including New York, London, Frankfurt, Tokyo, Hong Kong, and Sydney.
The foreign exchange market
It is a theory regarding the relationship between the spot exchange rate and the expected spot rate or forward exchange rate of two currencies, based on interest rates.
The theory holds that the forward exchange rate should be equal to the spot currency exchange rate times the interest rate of the home country, divided by the interest rate of the foreign country.
The interest rate parity (IRP)
refers to the state in which no-arbitrage is satisfied without the use of a forward contract.
UNCOVERED INTEREST RATE PARITY
refers to the state in which no-arbitrage is satisfied with the use of a forward contract.
covered interest rate parity
is also often shown in the form that isolates the interest rate of the home country.
Interest rate parity
o This theory states that the exchange rate between currencies of two countries should be equal to the ratio of the countries’ price levels.
o The concept of this is a tool used to make multilateral comparisons between the national incomes and living standards of different countries.
PURCHASING POWER PARITY
the ORIGIN OF PURCHASING POWER PARITY is originated in the ________ and was developed by _____________
16th century
Swedish economist Gustav Cassel in 1918.
The concept of purchasing power parity is based on the ______which states that similar goods will cost the same in different markets when the prices are expressed in the same currency (assuming the absence of transaction costs or trade barriers)
“law of one price,”
• Absolute PPP states that similar products in different countries should be priced equally when measured in common currency.
• Relative PPP that accounts for imperfections like transportation costs, tariffs, and quotas. It states that the rate of price changes should be similar
There are two popular techniques of PPP
Although it is widely used, PPP ratios may not always portray the real standard of living in countries for the following reasons:
1. The underlying expenditure and price levels that represent consumption patterns may not be reported correctly.
2. It is difficult to construct identical baskets of goods and services while comparing dissimilar countries, as people show different tastes and preferences, and the quality of the items varies.
3. The prices of traded goods are rarely seen to be equal, as there are trade restrictions and other barriers to trade that result in deviation from PPP.
RELIABILITY OF PURCHASING POWER
is the risk incurred due to the fluctuations in exchange rates before the contract is settled
Transaction exposure management
When transaction exposure exists, the firm faces three major tasks:
- Identify its degree of transaction exposure.
- Decide whether to hedge this exposure.
- Choose a hedging technique if it decides to hedge part or all of the exposure.
THE INTERNATIONAL MONETARY FUND or IMF was conceived in 1._________________. The 2.________ countries in attendance sought to build a framework for international economic cooperation and avoid repeating the competitive currency devaluations that contributed to the Great Depression of the 1930s.
- July 1944 at the United Nations Bretton Woods Conference in New Hampshire, United States
- 44 countries
The IMF’s primary mission?
The IMF’s primary mission is to ensure the stability of the international monetary system—the system of exchange rates and international payments that enables countries and their citizens to transact with each other.
:
In order to maintain stability and prevent crises in the international monetary system, the IMF monitors member country policies as well as national, regional, and global economic and financial developments through a formal system known as surveillance.
The IMF provides advice to member countries and promotes policies designed to foster economic stability, reduce vulnerability to economic and financial crises, and raise living standards.
Surveillance
:
In order to maintain stability and prevent crises in the international monetary system, the IMF monitors member country policies as well as national, regional, and global economic and financial developments through a formal system known as surveillance.
The IMF provides advice to member countries and promotes policies designed to foster economic stability, reduce vulnerability to economic and financial crises, and raise living standards.
Surveillance
Financial assistance of the IMF
Providing loans to member countries that are experiencing actual or potential balance-of- payments problems is a core responsibility of the IMF.
