Foreign Currency Issues

Question 1

Hard Currencies

Answer 1

“safe haven” currency, strong currency
- stable
- globally traded
- can be transferred across borders easily
–> serve as the reserve assets for many governments
–> full convertibility, free floating rate
Hard currencies: USD, JPY, EUR and GBP

Question 2

Influencing Currency value

Answer 2

1. Short term
   - news
2. long term
   - economic factors: Interst rates, inflation, monetary reserves etc
   - political factors
   - Expectation Factors

Question 3

Why is Hedging Important?

Answer 3

Risks:
Translation Risk:
- Variances (gain/losses) between value of assets hold in foreign exchange market (past earnings) and the value of these assets reported on the financial statements of a company
Transaction Risk:
- Variation of currency exchange rate on the day of settlement and the day of exchange in domestic currency (when you get paid or you have to pay)
-Economic Risk
long run effect in exchange rates on future revenue and cost

Question 4

Hedging method

Answer 4

• natural hedging: spend money in the same currency you earned it (building production sides)
• forward foreign exchange contract

Question 5

What is a spot rate

Answer 5

current real time relationship between two currencies;

Question 6

what is a forward rate

Answer 6

exchange rate a bank agrees on to warrant on a specific future date

Question 7

trading at premium

Answer 7

forward rate is stronger than current spot rate

Question 8

trading at discount

Answer 8

forward rate is weaker than current spot rate

Question 9

Forward foreign excange contract

Answer 9

• often for 3,6,9 months
• -> why not longer? If you sell something you do not want to get paid later than 6,9 months
• the cost of forward exchange contract is the premium/discount to the spot rate

Question 10

Fisher Effect

Answer 10

i = r +I 
i= nominal interest rate
r= real market interest rate
I = Expectations on Inflation
The difference of nominal interest rates can be traced down to the differences of the expectations of INflation of two currencies (real rate of interest is fixed globally--> free float of money)

Question 11

Fisher effect example

Answer 11

US dollar 10% , Japanes Yeng 6 %

Excpected depreciation of US dollar against the Yeng of 4 % in one year