P2B.6 International Finance

Question 1

Foreign Exchange Definition

Answer 1

Financial instruments such as paper currency, notes and checks used to make payments between countries.

Question 2

Fixed Exchange Rate Definition

Answer 2

A monetary system in which a country’s currency is set at a fixed rate relative to other currencies or commodity.

Question 3

Flexible (Floating) Exchange Rate Definition

Answer 3

1. An exchange rate for a country’s currency that is determined by the market forces of supply and demand.
2. This exchange rate works through an open market system, which allows investors to speculate on currency exchange rates.

Question 4

Direct Quote

Answer 4

With a direct quote, the first currency is the domestic currency.
The exchange rate is the comparative value of one currency to another, in this case US dollars and the Euro.
1 USD = 3 Euro.

Question 5

Indirect Quote

Answer 5

With an indirect quote, the second currency is the domestic currency.
The exchange rate is the comparative value of one currency to another, in this case US dollars and the Euro.

Ex: .33 USD = 1 Euro

Question 6

Factors Affecting Exchange Rate

Answer 6

1. Inflation rates
2. Interest rates
3. Trade Deficit or Surplus
4. Level of Public Debt
5. Current Account Deficit
6. Political & Economic Stability

Question 7

Currency Futures

Answer 7

1. Represent an obligation to buy or sell at a predetermined price at the end of the contract.
2. Difference between predetermined and spot price is premium or discount.

Question 8

Currency Options

Answer 8

1. Gives the holder the right but not obligation to buy or sell currency on or before a specified date at a particular price (exercise or strike price).
2. Option to buy = call
3. Right to sell = put

Question 9

Currency Swaps

Answer 9

1. Agreements where parties agree to swap loan amounts and interest in one currency against another currency.
2. At end of agreement, the original amounts are swapped back at an exchange rate agreed upon at the beginning.
3. Used for trading flexibility in the international market by partnering with foreign companies.

Question 10

Letter of Credit

Answer 10

A letter of credit is a guarantee from the importer’s bank that they will act on the order of the importer and pay the exporter for the merchandise if all specified documents are presented according to its terms. Often used in international trade to eliminate perceived risks.

Question 11

Demand/Sight Draft

Answer 11

A draft payable on demand.

Question 12

Time Drafts

Answer 12

A financial instrument that is payable at a specified point in the future.

A written order instructing the importer or his agent, the importer’s bank, to pay the amount specified on its face on a certain date is the definition of a time draft.

Question 13

Consignment

Answer 13

An arrangement under which items are delivered by a cosignor (seller) to a cosignee (buyer) and paid for by the cosignee upon reselling.

Question 14

Open Account

Answer 14

A procedure in export trading where an overseas buyer is instructed to make payment to the exporters bank thereby providing the exporter immediate cash and reducing risk.

Question 15

Prepayment

Answer 15

Payment before the delivery date.

Question 16

Banker’s Acceptances

Answer 16

1. Financial instrument of an entity stating that payment is guaranteed by a bank, commonly used in foreign trade.
2. A banker’s acceptance is created when the importer’s bank accepts a time draft. The banker’s acceptance is a negotiable money market instrument for which there is a secondary market.
3. An instrument created after the importer’s bank takes title to the goods via the bill of lading is the definition of a banker’s acceptance.

Question 17

Countertrade

Answer 17

Trade financing method of exchanging goods and services of the buying country and paying with goods from the selling entity. (bartering)

Question 18

Cross Border Factoring

Answer 18

Factoring is the sale of accounts receivables to a lender.

Question 19

Forfaiting

Answer 19

A form of finance where a third party purchases trade receivables from an exporter at a discount, and then collects from the importer the payment using the shipped goods as collateral.

The sale of a promissory note signed by the importer in favor of the exporter that is purchased by a bank at a discount without recourse is a general definition of forfaiting.

Question 20

Foreign Currency Loans

Answer 20

Seller borrows buyer’s currency and then repays with settlement.

Question 21

Benefits of International Diversification

Answer 21

1. Risk Management
2. Expansion & learning opportunities
3. Cost Control
4. Capitalize on emerging markets
5. Avoid turbulence at home
6. Gain on currency boost
7. Grow market share

Question 22

Risk of International Diversification

Answer 22

1. Transaction risk: exchange rate between transaction date & settlement date could cause gain or loss.
2. Translation risk: company’s financials being affected by exchange rate
3. Economic risk: volatility in exchange rates.

Question 23

Trade-related factors that affect exchange rates

Answer 23

1. Relative inflation
2. Relative income rates
3. Government intervention

Question 24

Inflation Rates and Foreign Currency

Answer 24

Low inflation = strong purchasing power

High inflation = weak purchasing power

Question 25

Interest rates

Answer 25

High interest rates = high demand for currency

Low interest rates = low demand for currency