Foreign Exchange Markets

Question 1

What is the foreign exchange market

Answer 1

Market in which currencies are bought and sold and their prices are determined

International system through which money of one country is exchange for that of another country

It includes individual foreign currency dealers, commercial banks, brokers, central banks, and non-commercial institutions who exchange currencies through a connected global network of electronic communication system

Question 2

What is conversion for

Answer 2

To facilitate transaction, invest directly abroad, or repatriate profits

Question 3

What is hedging

Answer 3

Insure against potential losses from adverse exchange-rate changes

Question 4

What is arbitrage

Answer 4

Instantaneous purchase and sale of a currency in different markets for profits

Question 5

What is speculation

Answer 5

Sequential purchase and sale of a currency for profit

Question 6

What is the foreign exchange rate?

Answer 6

Price of one currency in terms of another

Affects fortunes of the firm in various ways— costs of inputs, sales, performance, which market entry strategy to use

Most currencies are not very convertible. The dollar, yen, pound, and euro are hard currencies. Universally accepted and preferred in international transactions

Question 7

What is a direct quote of currency

Answer 7

The cost of one unit of foreign currency in terms of the local currency

Question 8

What is indirect quote of currency

Answer 8

One of the local currency is expressed in terms of foreign currency

Question 9

What are things to keep in mind with constantly fluctuating exchange rates

Answer 9

1. The prices of firm charges can be quoted in the firm’s currency or in the currency of each foreign customer
2. Because several months can pass between placement and delivery of an order, fluctuations in the exchange rate during that time can cost or earn the firm money
3. The firm and its customer can use the exchange rate as it stands on the date of each transaction, or they can agree to use a specific exchange rate

Question 10

What are factors influencing foreign exchange rates

Answer 10

Supply and demand of currency
Inflation
Interest rate
Balance of payments
Foreign investment
Economic growth
Fiscal discipline
Central bank intervention
Investor psychology

Question 11

How does the supply and demand of a currency affects its exchange rate

Answer 11

Greater supply = lower price
Lower supply = greater price
Greater demand = higher price
Lower demand = lower price

Question 12

How does inflation influence exchange rates

Answer 12

High inflation erodes currency purchasing power
Interest rates and inflation are positively related, high inflation = banks pay high interest rates
Investors expect to be compensated for inflation induced decline of value of their money

Question 13

How do interest rates influence exchange rate

Answer 13

When country’s interest rise it will see an increase in the demand of its currency and therefore an appreciation of its currency, while countries with falling interest rates will see a fall in their exchange rate

Nominal interest rate: the one usually reported
Real interest rate: rate adjusted to inflation

Question 14

How does balance of payment influence foreign exchange rate

Answer 14

The national balance sheet of trade, investment, and transfer payments with the rest of the world. It reflects the difference between the total amount of money coming in and going out

Question 15

How do foreign investment influence exchange rate

Answer 15

^ FDI = ^ demand of country currency-> appreciation of country’s exchange rate

Question 16

How does economic growth influences demand for currency

Answer 16

Increase in value of the goods and services produced by an economy

Driven by entrepreneurship innovation

Nation central bank regulates the money supply, issues currency and manages the exchange rate to accommodate economic growth

Question 17

How does fiscal discipline influence the demand and supply of a currency

Answer 17

Government intervention to influence the value of their own money

Question 18

How does a central bank intervention influence the supply and demand of a currency

Answer 18

Central bank tend to fix their exchange rates at a specific rate and would constantly intervienne by selling and buying their currencies to maintain the desired exchange rate

Question 19

How does the investor (market) psychology influences the supply and demand of a currency

Answer 19

Refers to a foreign exchange market behaviour that may be a result of pure speculation rather than macroeconomic fundamentals, but a tendency to investors to copy each other, also known as the herding mentality. When groups of large well known investors purchase or sell of a currency.

Question 20

What is the international monetary system

Answer 20

The institutional framework, rules, and procedures by which national currencies are exchanged for one another

Question 21

What is the global financial system

Answer 21

The collection of financial institutions that facilitate and regulate the flow of investment and capital funds worldwide. it includes the national and international banking systems, the international bond market, and national stock market

Question 22

Who are the key participants in the global monetary and financial system and what are their roles

Answer 22

1. The firm: international transactions require firms to deal with huge sums of foreign exchange
2. National stock exchange and bond market: facilities for trading securities and bonds
3. Commercial banks: LEND MONEY TO FINANCE BUSINESS ACTIVITY, PLAY A KEY ROLE IN NATIONS’ MONEY SUPPLIES, AND EXCHANGE FOREIGN CURRENCIES.
4. Central banks: regulates the money supply, issue currency, manage exchange rates, control national reserves
5. Bank for international settlement: supervises central bank monetary policy and other activities

Question 23

How does exchange rate influence business activities

Answer 23

A country with a currency that is weak will see a decline in the price of their exports and increase in price of imports.lower prices on exports can give companies the opportunity to take market share away from companies whose products are priced high. Company improves profits by selling to a country with a strong currency and source from a country with a weak currency

Question 24

What are the role of foreign exchange markets in international business

Answer 24

Settlement of international transaction
Currency trading
Speculation
Capital source
Foreign exchange risk management

Question 25

What are the foreign exchange risks

Answer 25

Transaction exposure
Translational exposure/accounting exposure
Economic exposures

Question 26

What is translation/accounting exposure

Answer 26

Result of converting consolidated balance sheet and income statements of an international company’s worldwide operation into home currency

Foreign assets and liabilities have different values based on exchange rate

Has potential to hurt the book value of multinational entreprise

Question 27

What is transaction exposure

Answer 27

Related to accounts payable or accounts receivable in foreign currencies
Asset > liabilities = long position
Asset < liabilities = short position

Question 28

What is an economic exposure

Answer 28

Long term cash flow can be affected by unexpected changes in exchange rates

Question 29

What is hedging

Answer 29

Protection against potential losses as a result of changes in the exchange rate

Question 30

What are the different types of hedging

Answer 30

Commercial hedging
- home currency invoicing
- mixed currency invoicing

Long term hedging
- outsourcing
- offshoring
- matching liabilities with assets in the same currency

Short term hedging
- forward contracts
- options
- money market hedge
- forex swaps
- futures

Question 31

What are two ways of protection against transaction exposure

Answer 31

Commercial hedging
Financial instrument

Question 32

What is commercial hedging

Answer 32

Incorporating measures to limit transaction exposure in the terms of the commercial contract during contract negotiations

By having the contract in home currency, they avoid exchange rate fluctuation

Question 33

What is long term hedging

Answer 33

Foreign exchange risks related to configuration of an international firm’s global value chain

Question 34

What is a forward contract

Answer 34

Hedging tool

International firm arrange with a financial institution for an agreement to buy or sell a foreign currency at specified exchange rate on a specified future date

Exchange rate may not be the same as the ongoing spot rate on that specified date

Question 35

What is the spot rate

Answer 35

The current rate at which the currency is trading in the market at that date and time

Question 36

What is hedging foreign exchange risk using money markets

Answer 36

The aim is to avoid future foreign exchange risk by converting foreign exchange using today’s spot rate so that future transaction will not involve the use of the conversion of foreign exchange

Uses interest rates differentials by borrowing in one currency and investing in another currency with the aim of covering foreign exchange receivable or payables

Question 37

What are some international sources of capital

Answer 37

Euro currency market
International bond market
Global equity markets
Offshore financial centres
International joint venture partners

Question 38

What is the euro currency market

Answer 38

Markets where investors can invest, and borrowers can borrow in currencies that are not issued by the host country

Question 39

What are foreign bonds

Answer 39

Bonds issued by a company in a foreign country but denominated in the foreign country’s currency

Question 40

What is a Eurobond

Answer 40

Bond issued by a company in a foreign country in a currency that is different from the host country’s legal tender

Question 41

What are global equity markets

Answer 41

COMPANIES CAN SOURCE CAPITAL IN FOREIGN MARKETS BY LISTING THEIR COMPANIES IN THE HOST COUNTRY’S STOCK EXCHANGE OR IN FOREIGN EXCHANGES IN OTHER COUNTRIES.
LISTING IN THE HOST COUNTRY MARKET SAVES THE FOREIGN COMPANY THE RISKS INHERIT IN
FLUCTUATIONS OF EXCHANGE RATES.
ISSUING SHARES IN INTERNATIONAL MARKETS IMPROVES THE LIQUIDITY OF ITS EXISTING SHARES, IT INCREASES SHARE PRICES BY OVERCOMING MISS-PRICING IN A SEGMENTED AND ILLIQUID HOME MARKET.