Foreign Exchange Markets Flashcards
What is the foreign exchange market
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
What is conversion for
To facilitate transaction, invest directly abroad, or repatriate profits
What is hedging
Insure against potential losses from adverse exchange-rate changes
What is arbitrage
Instantaneous purchase and sale of a currency in different markets for profits
What is speculation
Sequential purchase and sale of a currency for profit
What is the foreign exchange rate?
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
What is a direct quote of currency
The cost of one unit of foreign currency in terms of the local currency
What is indirect quote of currency
One of the local currency is expressed in terms of foreign currency
What are things to keep in mind with constantly fluctuating exchange rates
- The prices of firm charges can be quoted in the firm’s currency or in the currency of each foreign customer
- 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
- 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
What are factors influencing foreign exchange rates
Supply and demand of currency
Inflation
Interest rate
Balance of payments
Foreign investment
Economic growth
Fiscal discipline
Central bank intervention
Investor psychology
How does the supply and demand of a currency affects its exchange rate
Greater supply = lower price
Lower supply = greater price
Greater demand = higher price
Lower demand = lower price
How does inflation influence exchange rates
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
How do interest rates influence exchange rate
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
How does balance of payment influence foreign exchange rate
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
How do foreign investment influence exchange rate
^ FDI = ^ demand of country currency-> appreciation of country’s exchange rate
How does economic growth influences demand for currency
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
How does fiscal discipline influence the demand and supply of a currency
Government intervention to influence the value of their own money
How does a central bank intervention influence the supply and demand of a currency
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
How does the investor (market) psychology influences the supply and demand of a currency
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.
What is the international monetary system
The institutional framework, rules, and procedures by which national currencies are exchanged for one another
What is the global financial system
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
Who are the key participants in the global monetary and financial system and what are their roles
- The firm: international transactions require firms to deal with huge sums of foreign exchange
- National stock exchange and bond market: facilities for trading securities and bonds
- Commercial banks: LEND MONEY TO FINANCE BUSINESS ACTIVITY, PLAY A KEY ROLE IN NATIONS’ MONEY SUPPLIES, AND EXCHANGE FOREIGN CURRENCIES.
- Central banks: regulates the money supply, issue currency, manage exchange rates, control national reserves
- Bank for international settlement: supervises central bank monetary policy and other activities
How does exchange rate influence business activities
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
What are the role of foreign exchange markets in international business
Settlement of international transaction
Currency trading
Speculation
Capital source
Foreign exchange risk management
What are the foreign exchange risks
Transaction exposure
Translational exposure/accounting exposure
Economic exposures
What is translation/accounting exposure
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
What is transaction exposure
Related to accounts payable or accounts receivable in foreign currencies
Asset > liabilities = long position
Asset < liabilities = short position
What is an economic exposure
Long term cash flow can be affected by unexpected changes in exchange rates
What is hedging
Protection against potential losses as a result of changes in the exchange rate
What are the different types of hedging
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
What are two ways of protection against transaction exposure
Commercial hedging
Financial instrument
What is commercial hedging
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
What is long term hedging
Foreign exchange risks related to configuration of an international firm’s global value chain
What is a forward contract
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
What is the spot rate
The current rate at which the currency is trading in the market at that date and time
What is hedging foreign exchange risk using money markets
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
What are some international sources of capital
Euro currency market
International bond market
Global equity markets
Offshore financial centres
International joint venture partners
What is the euro currency market
Markets where investors can invest, and borrowers can borrow in currencies that are not issued by the host country
What are foreign bonds
Bonds issued by a company in a foreign country but denominated in the foreign country’s currency
What is a Eurobond
Bond issued by a company in a foreign country in a currency that is different from the host country’s legal tender
What are global equity markets
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.
