w7 : currency risk measurement & management

Question 1

what is an exchange rate?

Answer 1

amount of one currency needed to purchase one unit of another currency

Question 2

what is a spot exchange rate?

Answer 2

exchange rate for an immediate transaction

Question 3

what is a forward exchange rate?

Answer 3

exchange rate for a forward transaction

Question 4

state five factors that affect exchange rates.

Answer 4

• change in relative inflation rate
• change in relative interest rate
• change in relative income level
• change in government controls
• change in expectations of future exchange rates

Question 5

what is the equation for real inflation?

Answer 5

nominal rate - expected rate

Question 6

what is the benefit of a forward contract?

Answer 6

firm can lock in exchange rate in advance and reduce / eliminate exposure to rate fluctuations. however, eliminates risk - whether movement of rate is favourable or unfavourable. once locked in, cant benefit if becomes more favourable rate.

Question 7

what does the fisher effect explain?

Answer 7

relationship between interest rates and inflation rates. states that nominal rate of return (int. rate) is equal to required real rate of return plus compensation for expected inflation

Question 8

what is the expectations theory in relation to currency?

Answer 8

forward discounts / premiums supposed to be unbiased predictors of future spot rates

Question 9

state the international fisher effect.

Answer 9

currencies with higher IR will depreciate because higher nominal IR reflect higher future inflation