Lecture 10

Question 1

Where do Fx market occur?

Answer 1

Whenever transactions occur in foreign money
Financial flows associated with international trade in goods
and services.

Capital flows involving investment and borrowing of funds.

Speculative transactions to profit from changing exchange
rates.

Central bank intervention within the FX markets.

Question 2

What was the fixed rates system?

Answer 2

Governments were required to keep the value of their currency within a certain amount but the system collapsed and the money floated

Question 3

What are floating exchange rates?

Answer 3

Determined by supply and demand

Question 4

What are three types of floating Fx rates?

Answer 4

Managed Float

An exchange rate that is allowed to float or move
within a defined or set band relative to another currency.

Crawling Peg

A managed float where an exchange rate is allowed to
appreciate in controlled steps over time.

Pegged Exchange Rate

The value of the pegged currency is tied to the value of
another currency or a basket of currencies.

Question 5

Who participates in Fx Market?

Answer 5

Dealers and brokers who are authorised. They are price makers and profit from the difference between their buy and sell price.
Central Banks pay for imports purchased by the government or alter the exchange rate
Exporting firms who use foreign currency
Investors and borrowers
Financial institutions who borrow from overseas
Foreign currency speculators

Question 6

How do these participants use the market (same as derivatives)?

Answer 6

1. hedgers
2. speculators
3. Arbitrageurs

Question 7

What are the operations of the Fx market?

Answer 7

Most done over the counter but futures markets do exist.
Spot is just buying
Forward market is Agree to exchange fixed amount for fixed price some time in the future

Question 8

What is the first factor affecting Fx?

Answer 8

Relative inflation rates. Inflation increases overseas relative to us then our goods become more attractive and our dollar appreciates with demand.

Question 9

What is the second factor affecting Fx?

Answer 9

Relative national income growth rates

Demands for our currency are affected by demands for our imports and exports.

Question 10

What is the third factor affecting Fx?

Answer 10

Relative interest rates

A relative increase in foreign interest rates would result in a depreciation of the local currency.

Question 11

What is the fourth factor affecting Fx?

Answer 11

Exchange Rate expectations

Investors will speculate where to place their funds

Question 12

What is the fifth factor affecting Fx?

Answer 12

Central bank/government intervention
Any government policy that alters the relative rate of
inflation, relative income, or relative interest rates will
have an impact on the exchange rate.

Question 13

What are the componants of the Fx calc?

Answer 13

1. Interest Rate Parity
   1 + if = F
   1 + id S

        2. Uncovered Interest Rate Parity
       			1 + if  =   E(S) 
        1 + id         S
   
        3. Unbiased Forward Rates
        		F  =  E(S)  
        S         S 
   
        4. Purchasing Power Parity
        E(S)  = 1 + inff
      		S          1 + infd

Question 14

What are Eurocurrency markets?

Answer 14

They allowed individuals to hold US dollars - now can hold any countries dollars outside its boarders

Question 15

What functions does the Eurocurrency market perform?

Answer 15

Source of working capital for firms
Storehouses for excess liquidity at competitive rates
Facilitates international trade
Used by banks around the world as source of overnight borrowing - Uses LIBOR

Question 16

What is the Eurobond Market?

Answer 16

Market for lending or long term borrowing large amounts of capital in the form of bonds
Disclosure costs and registration costs are much lower than domestic markets