Foreign Exchange Market Flashcards
What is the foreign exchange market?
The foreign exchange market is a global dececentralised maerket where currencies and bank deposits are traded.
What are the two types of transactions in the Forex market?
Spot transactions and forward transactions.
What is a spot transaction?
An immediate exchange of one currency for another at the spot rate, usually settled within two business days.
Spot rate would be 1 euro for every 1.10 dollar
What is a forward transaction?
A contract to exchange currencies at a future date and at a pre-agreed forward rate.
How are exchange rates determined?
By the interaction of supply and demand.
What role does the Forex market play?
It plays a crucial role in international trade, investment, and finance.
List some national currencies in the Forex market.
U.S. dollar (USD), Euro (EUR), Japanese yen (JPY), Chinese yuan (CNY), British pound (GBP), Canadian dollar (CAD).
What affects exchange rate volatility?
Supply and demand - High demand for currency = Appreciation, Supply is depreciation
Interest Rates - High rates lead to high demand for domestic currency
Inflation - High reduces currency purchasing power leading to depreciation
Economic Stability - Stability leads to attractive investments and low volatility, turmoil leads to uncertain gov policies and depreciation
Which currency is likely the most volatile?
The Japanese yen (JPY) due to economic shifts and Bank of Japan’s monetary policies.
Which currency is possibly the least volatile?
The Euro (EUR) or British Pound (GBP), though both have had fluctuations.
Why is the Forex market important?
It facilitates international business transactions and impacts inflation, interest rates, and purchasing power.
What is the estimated daily trading volume of the Forex market?
Over $7.5 trillion (as of 2022).
What influences long-term exchange rate movements?
Fundamental economic factors, primarily supply and demand.
What is the Law of One Price?
It states that an identical good should cost the same price worldwide, once exchange rates are adjusted.
What happens if price differences exist according to the Law of One Price?
Arbitrage will eventually equalize prices.
Will buy the lower 1.10 euro in NYSE and sell in LSE for 1.12 until price evens out
What is Purchasing Power Parity (PPP)?
It states that exchange rates adjust so that the same basket of goods costs the same in different countries.
Absolute PPP: Country A/ Country B = Exchange rate A/B
Relative PPP: Inflation change % A - B = %Change of Exchange Rate
What are the implications of PPP?
Higher inflation leads to currency depreciation, while high-quality competitive goods lead to currency appreciation.
What drives currency fluctuations according to key takeaways?
Price differences across countries through trade and arbitrage.
What factors affect exchange rates in the long run?
Relative price levels - High inflation in domestic goods leads to countrys currency depreciation
Tarrifs and Quotas - Higher trade barriers leads to lower imports, making domestic goods value go up, currency appreciation
Preferences for Domestic V Foreign - Preference for imports leads to currency depreciation
Productivity - Higher productivivty leads to currency appreciation
What is the exchange rate in the short run?
The price of domestic bank deposits in terms of foreign bank deposits.
What factors shift expected returns for domestic and foreign deposits?
Changes in the domestic interest rate - High rate means high demand in domestic currency appreciation
Changes in the foreign interest rate - High rate means domestic currency depreciation
Changes in the future expected exchange rate - If investors expect domestic currency to appreciate, domestic more attractive
