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Financial institutions and markets > foreign exchange > Flashcards

foreign exchange Flashcards

1
Q

what is an exchange rate?

A

the value of 1 currency in the terms of another

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2
Q

when the value of an exchange rate is set by the govt or central bank it is called?

A

Fixed exchange rate

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3
Q

in relation to fixed exchange rates, what happens if demand & supply are not balanced?

A

the government has to use reserves if demand for foreign currency is greater than supply

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4
Q

what are floating exchange rates?

A

• when Exchange rates set by market forces= supply & demand

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5
Q

spot market

A

– for currency deals for immediate delivery/instruments

with maturity date within 2 business days after transaction

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6
Q

forwards & forward swaps

A

involves future delivery of currency at

specified future date (forward- any future date, more than two days)

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7
Q

What is Herstatt risk?

A

Is the risk that one party will fail to deliver terms of the contract at time of settlement, due to timing issues e.g different time zones, so banks are open at different times

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8
Q

what is SF/NZD asking?

A

the price of SF1, in terms of NZD

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9
Q

what is NZD/USD asking?

A

the price of NZD1 in terms of USD

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10
Q

the buying price is called?

A

the bid price

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11
Q

the selling price is called?

A

offer price

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12
Q

what is the commodity currency usually expressed as?

A

the one that is expressed as 1 e.g. 1 NZD, 1USD, 1 ringgit

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13
Q

what is the term currency

A

Is the currency that doesn’t have the 1 in it & varies in price

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14
Q

What is a direct quote?

A
  • local currency price of 1 unit of USD
  • USD is base currency and for example NZD is term currency
  • e.g. in NZ, direct quote is USD/ $NZ = 1.2821 for NZD/USD 0.78
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15
Q

what is a indirect quote?

A
  • Where the USD is the terms currency & the other currency (say NZD) =base currency
  • e.g. NZ$1 = USD$ 0.8207 (direct quote is 1USD = 1.2185 NZD)
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16
Q

what is a cross rate?

A

A FX rate between two currencies

derived via a third

17
Q

What direction does the demand and supply curve slope?

A

Demand- Down

Supply- Up

18
Q

If NZ & US had low inflation rates and then US had a substantial and long increase in inflation what occurs

A
  • price of US goods increases
  • NZ demand for US goods decreases
  • reduction in NZ demand for USD
    (same as reduction in supply of NZD - S1)
19
Q

What is the purchasing power parity?

A

• Asserts that if the product is the same across all countries e.g.
Big Mac, then so should be its price (once currency changed
into foreign at the prevailing rate)

20
Q

If PPP hols what happens to the currency of a country if it has high or low inflation?

A

a country with high inflation will tend to depreciate relative to
countries with low inflation.

So high inflation depreciating currency

21
Q

Relationship between interest rates between countries known

as?

A

interest rate parity

22
Q

What happens if NZ interest rates rise compered to AUS that stay the same?

A

– Australians would put some money in
accounts in NZ to earn higher interest
– Increase in demand for NZD by Australians & at same time
New Zealanders keep investments in NZ
– So reduction of supply of NZD in FX market
– Overall, increase in interest rate causes
appreciation of NZD

23
Q

The currency of the nation with _____ interest rates normally
sells at a forward _____ in terms of currency of nation with
lower interest rates.
& currency of nation with relatively _____ interest rates
normally sells at _____ forward relative to high rate country.

A
  • Higher
  • Discount
  • Lower
  • Premium
24
Q

The different effect an increase in interest rates due to inflation has on currency compered to an increase due to real rate of interest

A

– If increase in interest rates due to inflation expectations increase, then, all
else being constant, currency will depreciate

– If increase in interest rates due to increase in real rate of interest,
then, all else being constant, currency will appreciate

25
Q

Exchange rate expectations

A

• If market participants expect a depreciation of NZD, then all
else being constant, depreciation will occur (funds moved
offshore
• increase in supply of NZD on FX market as holders seek
to buy foreign currencies before value falls)

26
Q

What is a Current-account (CA) balance?

A
  • records the money from
    selling goods & services to rest of world + income earned on
    overseas investments versus payments
27
Q

What happens in CA payments are greater than CA receipts

A

CA in deficit, need to finance

by borrowing FX so foreign debt increase & interest payments increase

28
Q

Countries with accumulated CA deficit have ____ currency & countries with accumulated CA
surplus tend to have ____ currency

A
  • Weak

- Strong

29
Q

What efffect can political conditions have on currency?

A

Change in power can have a negative effect on country’s currency

30
Q

What are the 4 main types of FX risk?

A
  • Transaction exposure
  • Translation exposure
  • Operational exposure
  • Economic exposure
31
Q

What is transaction exposure?

A
  • when the value of a company’s cash inflows

received in various currencies is affected

32
Q

What is translation exposure?

A
  • when value of assets & liabilities (usually of

foreign subsidiary) is affected

33
Q

What is operational exposure?

A
  • extent to which exchange rate volatility may affect a firm’s future operating cash flows- revenue & costs
34
Q

What is economic exposure?

A
  • broad measure that tries to capture impact of
    unexpected exchange rate volatility on NPV of firm- combines
    transaction & operating FX exposures

e.g. two firms (Aus & German)
selling similar product into Europe & AUD 

35
Q

What are a firms 4 possible responses to FX risk?

A

• to hedge nothing (argument company not in FX business)
• to hedge everything (too expensive)
• to forecast
• to partially hedge
- when conditions are appropriate & select most suitable
method).

36
Q

what are the two categories of hedging?

A

(a) External or market measures
– futures/forwards

(b) Internal measures
– structural techniques
– match exposures
– leading and lagging
– diversification

Financial institutions and markets (12 decks)

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