Forex Markets

Question 1

What is a rate of exchange?

Answer 1

Price of one currency in terms of another where there’s the Base: Underlying

Question 2

Why do changes in exchange rates occur?

Answer 2

1) Supply and Demand (Market Forces)
Depreciation and Appreciation
2) Interest Rate (Government Forces)
Devaluation and Re-evaluation

Question 3

Conversions and Buy High, Sell Low

Answer 3

1) Converting known amount of underlying to an unknown amount of base:
UC/rate=Base
2) Converting a known amount of the base currency to an unknown amount of underlying:
Base*rate=Underlying

Forex Banks(BH/SL)
Exp to Bank: BH
Imp to Bank: SL

Question 4

What are the 3 categories of forex risks?

Answer 4

1) Transaction:
Happens to overseas traders and occurs on TP & TR due to risks of current spot rate and future spot rate moving/flunctuations to an adverse direction. Can be absorbed by large MNC
2) Translation:
Happens to overseas Assets, Liabilties, Profits and losses. Were there’s a change in terms of home currency or foreign.
3) Economic Exposure/ Competitive exposure: Based on long term changes in exchange rates affecting competitiveness of a MNC.

Question 5

What is a Forward Hedge, formula, advantages and disadvantages

Answer 5

1) Binding Contract between a co and a bank/dealer for the sale or purchase of a fixed amount of foreign currency at an agreed upon rate.

Formula: FC/SR-Prem(+Discounts)

Note: Differs from TP(SL) & TR(BH)

Advantages:
1) OTC; tailored and simple to set up.
2) Certainty of cash inflows & outflows
3) Reduces down side risk
4) Inexpensive(possible arrangement fee)

Disadvantages:
1) OTC: No secondary market
2) Removes upside potential

Question 6

Money Markets

Answer 6

Mimic a forward contract and used when FC aren’t available. Complicated and costly to set up.
Formula: PV=F(1+r/n)

When TR
1) Borrow in FC(/)
2) Convert at spot rate
3) Deposit in local(*)

When TP
1) Deposit in FC(/)
2) Convert at spot rate
3) Borrow in Local(*)