Foreign exchange market

Question 1

Foreign exchange market

Answer 1

is the market for converting currency from one country into another country currency

Question 2

exchange rate

Answer 2

rate at which one currency is converted into another

Question 3

foreign exchange market enable

Answer 3

1. conversion of currency 2. insures against foreign exchange risk (the adverse consequences of unpredictable changes in the exchange rate)

Question 4

the spot exchange rate

Answer 4

the rate at which one foreign exchange dealer converts one currency into another currency on a particular day

Question 5

the forward exchange rate

Answer 5

the exchange rate governing a transaction in which two parties agree to exchange currency and execute a deal at some specific date in the future

Question 6

currency swap

Answer 6

the simultaneous purchase and sale of a given amount foreign exchange for two different value dates

Question 7

arbitrage

Answer 7

the process of buying a currency low and selling it high

Question 8

important factors in future exchange rates

Answer 8

1. interest rates 2. inflation 3. market psychology

Question 9

the law of one price

Answer 9

in competitive markets free of transportation costs and barriers to trade identical products sold in different countries must sell for the same price when their price is expressed in terms of the same currency

Question 10

purchasing power party

Answer 10

asks how much money would be needed to purchase the same goods and services in two countries, and uses that to calculate an implicit foreign exchange rate

Question 11

how are prices related to exchange rate movements?

Answer 11

law of one price, purchasing power party

Question 12

how do interest rates affect exchange rates

Answer 12

fischer effect, international fischer effect

Question 13

fischer effect

Answer 13

the nominal interest rate equals the real rate plus expected inflation

Question 14

how are exchange rate influenced by investor technology?

Answer 14

bandwagon effect

Question 15

international fischer effect

Answer 15

suggests that for any 2 countries the spot exchange rate should change in equal amount but move in opposite direction to the difference in nominal interest rates between the two countries.

Question 16

bandwagon effect

Answer 16

when expectations of trade turn into self full-filled prophecies and traders join the bandwagon and move exchange rates based on group expectations

Question 17

inefficient market school

Answer 17

companies should invest in forecasting services because forward rates are not the best predictor of future spot rates

Question 17

efficient market school

Answer 17

argues that forward exchange rates are best predictors of future spot rates and thus investing in forecasting services would be a waste of time

Question 18

two approaches to forecast analysis

Answer 18

1. fundamental analysis 2. technical analysis

Question 18

freely convertible

Answer 18

when both residents and nonresidents can purchase unlimited amounts of foreign currency with the domestic currency

Question 19

externally convertible

Answer 19

when nonresidents can convert their holding of domestic currency into foreign currency

Question 20

nonconvertible

Answer 20

when both nonresidents and resident are prohibited from converting their holding of domestic currency into foreign currency

Question 21

translation exposure

Answer 21

extent to which reported consolidated results and balance sheets of a corporation are effected by fluctuations in the exchange values

Question 21

exchange rate risk can be divided into:

Answer 21

1. translation exposure 2. transaction exposure 3. economic exposure

Question 22

transaction exposure

Answer 22

extend to which income from individual transactions is effective by fluctuations in foreign exchange market values

Question 23

economic exposure

Answer 23

the extent to which a firms future international earning power is effected by changes in exchange rates

Question 23

how can firms minimize or maximize translation and transaction exposure

Answer 23

Firms can buy forward exchange rates, use currency swaps, lead and lag payables and receivables (paying suppliers and collecting payments from customers early or late depending on expected exchange rate movements)

Question 24

How can a firm reduce economic exposure?

Answer 24

firms need to distribute productive assets to various locations so the firm’s long term financial well-being is not severely affected by changes in exchange rates
This requires that the firm sassets are not overly concentrated in countries where likely rises in currency values will lead to damaging increases in the foreign prices of goods and services they produce

Question 25

Are there other strategies to manage foreign risk?

Answer 25

1. establish central control to protect resources and ensure that each subunit adopts the correct mix of tactics and strategies 2. distinguish between transaction, translation, and economic exposure 3 attempt to forecast exchange rates 4. establish good reporting systems 5 produce montly foreign exchange exposure reports

Question 26

currency speculation

Answer 26

involves short term movement of funds from one currency to another in the hopes of profiting from shifts in exchange rates

Question 27

carry trade

Answer 27

borrowing in one currency where interst rates are low then using hte proceeds to invest in another currency where interest rates are high

Question 28

hedging

Answer 28

the process of insuring ones business against foriegn exhcnage risk by using forward exchanges or currency swaps

Question 29

arbitrage

Answer 29

the purchase of securities in one market for immediate resale in another to profit from a price discrepancy

Question 30

failure of PPP theory

Answer 30

assumes away transportion/trade barrier costs
-market dominated by handful of MNE that control market price and can control distribution channels and differentiate product offerings
-government intervention

Question 31

capital flight

Answer 31

residents convert domestic currency into foreign currency (usually ocurs when domestic currency is depreciating rapidly)

Question 32

counter trade

Answer 32

the trade of g/s for other g/s (barter)
-can deal with nonconvertibility with countertrade

Question 33

lead strategy

Answer 33

Attempting to collect foreign currency receivables early when a foreign currency is expected to depreciate and paying a foreign currency payables before they are due when a currency is expected to appreciate.

Question 34

lag strategy

Answer 34

Delaying collection of foreign currency receivables if that currency is expected to appreciate and delaying payables if the currency is expected to depreciate