Forecasting Exchange Rate Movements Flashcards
What if an economy is importing more than exporting?
Means over time more than the domestic currency is being sold (to pay for imports) than is being bought (as export revenue is coverted into its domestic currency)
What can a balance of payments deficit cause?
Weaken the domestic currency over the long-term
What do high rates of inflation in a foreign country erode?
The purchasing power of that currency is what a unit of the currency can buy in terms of goods and services
What does the fall in purchasing power affect?
A unit of the currency can buy on the currency markets and lead to a fall in value of its currency
What does purchasing power parity predict for the exchange rate?
Value of foreign currency depends on the relative purchasing power of each currency in its own country and that spot exchange rates will vary over time according to relative price changes
If inflation is relatively high in one coutnry?
Country will over the long-term experience a fall in the value of its currecny
What should be done in the long-term for interest rates/
Two countries of similar risk should offer similar rates of return to international investors
Offering a similar rate of return to international investors effect on interest rates?
Differences in interest rates should reflect differences in inflation
What happens in the short-run for interest rates?
Banks use interest rates to calculate forward exchange rates, this is interest rate parity theory
What if interest rates are only different between two countries due to inflation?
Inflation rates can be sued to predict the future spot rate
Long-term interest rates can be used predict the future spot rate
What can be seen as an unbiased indicator of expected changes in the spot rate?
Logical to assume that if short-term interest rate differences explain the differences between forward rate and spot rate
Basis of interest rate parity theory
Forward rates are calculated by interest rate differences
Basis of interest rate parity theory?
High inflation = fall in exchange rate
What is a translation risk?
RIsk that the domestic currency value of foreign currency assets falls, or value of freign currency liabilities rise
When may difference be written off as a loss in translation risk?
If a change in exchange rate causes an adverse change in domestic currency value of foreign assets and liabilities
Is translation risk a cash flow?
No but transaction risk is
What is done to manage translation risk?
A company that has assets in a foreign currency can match these assets with liabilities in the same foreign currency
How to obtain foreign currency debt finance?
Use a currency swap
What is an economic risk?
Long-term movements in exchange rate damage’s company value as NPV of business’ cash flow is diminished by expected exchange rate trends
When can domestic companioes be affected by an economic risk?
If a sustained movement in exchange rate benefits an overseas rival
How can economic risk be difficult to manage?
Diversify its international operations so it is not overly exposed to a change in a single exchange rate
