Foreign Exchanges Flashcards
Spot rates and forward rates.
The spot rate for a currency is the exchange rate of the currency for immediate delivery. On the other hand, the forward rate is the exchange rate for a currency for future delivery. For example, a forward contract might obligate a company to purchase or sell euros at a specific exchange rate three months hence. The difference between the spot rate and the forward rate is referred to as the discount or premium. If the forward rate is less (greater) than the spot rate, the market believes that the value of the currency is going to decline (increase).
EXAMPLE: Assume that a multinational company sells products to a French company for a receivable payable in 60 days in the amount of 10,000 euros. If at the time of the sale the exchange rate is 1.25 U.S. dollars to the euro, the sale is equal to $12,500 (1.25 × 10,000). If the euro depreciates by 2% against the U.S. dollar in the 60-day period between the sale and collection, the firm has experienced a loss. The 2% depreciation would mean that the new exchange rate is 1.225 (1.25 × 98%) euros to the U.S. dollar. Therefore, the firm has lost $12,500 – $12,250 (1.225 × 10,000) = $250.
US Corporation has sold a large quantity of goods to a Japanese company on a 90-day account that is payable in Japanese yen how does it avoid fluctuation in this exchange and remain conservative? This is a US receivable from Japan payable in yen.
By selling the yen, management has locked in the purchase price. When the customer pays in 90 days, the firm can deliver the yen on the forward contract with no significant gain or loss.
Effects from opening an emerging stock market to foreign investment can include which effects?
Opening the market to foreign investment would cause an increase in investment growth rates.
Would “decrease” local firms’ cost of capital.
Would “increase” in the correlation of emerging stock markets with world markets.
Change in the volatility of emerging stock market returns.
International purchasing power effect
International purchasing power effect - When domestic price levels increase relative to foreign currencies, foreign products become less expensive causing an increase in imported goods and a decrease in exported goods. This decreases the aggregate demand of domestic products.
E.g. if the $1 of US used to buy 95 yen and then the price of US goes up or the yen goes down this depreciated the value of the dollar to the yen and Japan has greater purchasing power or Yen relative to the US dollar making it desirable for the domestic Country US to export products.
If you are paying a payable in foreign currency will you buy or sell the futures contract?
A company has a foreign-currency-dominated trade payable, due in 60 days. In order to eliminate the foreign exchange risk associated with the payable, the company could
The company can arrange today for the exchange rate at which it will purchase (BUY) the foreign currency in 60 days’ time by buying the currency in the forward market. This will eliminate the exchange risk associated with the trade payable.
Differences between
Monopolistacally competitive market and Purely Competitive Market.
both have large numbers of sellers but their product out put differs:
Monopolistically competitive market - a relatively large number of sellers “produce differentiated products”.
In a purely competitive market, the product is standardized. there are also a very large number of firms who “produce a standardized product”.
