Foreign Exchange Markets and the Exchange Rate

Question 1

Exchange Rate

Answer 1

Sets the amount of currency required to buy one unit of another

Question 2

Floating Exchange Rates

Answer 2

A system where exchange rates are allowed to fluctuate

Question 3

Activities Affecting Currency Demand

Answer 3

Importing
Investing
Inflation
Speculation
Gov spending (buying & selling its currency)
Interest rates
Internationally recognised currencies ($)

Question 4

Dirty Floating

Answer 4

Where governments manipulate exchange rates by buying and selling large amounts of currencies, or altering interest rates so the exchange rate is not allowed to freely react to market conditions

Question 5

Hot Money

Answer 5

Funds from investors which move as quickly as possible to take advantage of the highest short term interest rates

Question 6

Factors Affecting Currency Supply

Answer 6

Trade - in order to buy imports, supply of domestic currency will be high as currency is sold in order to buy from overseas

Gov Policy - govs may sell their own currency to lower the exchange rate to make their goods seem more competitive (dirty floating)

Question 7

International Capital Market

Answer 7

A market through which funds are provided for a variety of business and investors needs, e.g. to borrow funds for new machinery

Question 8

International Foreign Exchange

Answer 8

Central banks, banks, companies, investment companies etc can buy and sell currencies

Question 9

Central Bank

Answer 9

The bank responsible for keeping inflation under control and printing money

Question 10

Int Capital Market: Eurocurrency

Answer 10

Any currency held outside the country where it is legal tender, which is borrowed and lent. Short term.

Question 11

Int Capital Market: Eurocredit Market

Answer 11

Made up of the same banks in the Eurocurrency market, but offering longer term loans. Medium term.

Question 12

Int Capital Market: Eurobond Market

Answer 12

A group of financial institutions, large companies, government and supranational institutions that issue Eurobonds. Long term.

Question 13

Eurobond

Answer 13

Long term finance that typically covers a duration of 5-30 years (not necessarily based in Europe or issued in Euros)

Question 14

Uses of the Forex Market

Answer 14

To facilitate international trade

Investment for which another currency is required due to location or nature of it

Speculation

Financial institutions making investments on behalf of their clients in foreign currencies

Managing FX rate risk i.e. buying currency in advance of when it’s needed as the rate is good

Question 15

Gov Controlling of BoP

Answer 15

Do nothing
Devaluation
Import controls
Deflation
Supply-side policy

Question 16

Types of FX Risk

Answer 16

Economic risk - FX movements may increase or decrease long term competitiveness

Translation - accounting concept relating to an assets value changing over time because of FX rates

Transaction Risk - Risk an FX rate will change unfavourably over time

Question 17

Hedging

Answer 17

An investment which reduces or manages FX risk

Question 18

Internal Hedging

Answer 18

An investment which reduces or manages FX risk which can be done within a company

Question 19

Internal Hedging Techniques

Answer 19

Matching - receipts in a foreign currency are matched against payments made in that currency

Lagging - paying amounts due later to match against receivables in the same currency

Leading - paying amounts early in funds already received in that currency

Invoicing/paying in home currency - avoiding all currency risk by avoiding need for FX

Counter-trading - where customers are also suppliers, payment can be made in goods/services

Netting inter-co transactions - central treasury department can offset payments made

Question 20

External Hedging

Answer 20

An investment which reduces or manages FX risk using a rage of financial products from outside an organisation

Question 21

External Hedging Techniques: Forward Exchange Contracts

Answer 21

Non-standardised contract between two parties to buy or sell a fixed amount of foreign currency at a specified time at a price agreed on today.

Legally binding, any date can be set but can’t be changed.

Question 22

External Hedging Techniques: Currency Futures

Answer 22

A futures contract to exchange one currency for another at a specified date in the future at a price/rate that is fixed on the purchase date.

Question 23

PESTEL

Answer 23

Model which helps businesses consider risks and opportunities:
Political
Economic
Social
Technological
Environmental
Legal