Week 3: Foreign Currency and Exchange, Sept 28

Question 1

exchange rates

Answer 1

fundamentally the price of one country’s currency in terms of another

-price of most currencies is market driven (ie, the ER at any given time is determined by the supply and demand for that currency)
-the degree to which monetary authorities intervene in the market to manage the value of their currency caries considerably

Question 2

foreign exchange market functions to

Answer 2

-convert the currency of one country into another
-provide instruments to hedge exposure to foreign exchange risk

Question 3

foreign exchange risk

Answer 3

arises as a result of currency appreciations and depreciations (changes in exchange rate)

Question 4

direct exchange rate

Answer 4

the price of the foreign currency in terms of the home currency
-eg, $1 USD costs $1.34 cad

Question 5

indirect exchange rate

Answer 5

price of home currency in terms of foreign currency
-eg, $1CAD costs $0.72 USD

Question 6

spot exchange rate

Answer 6

ER on a given day

Question 7

forward exchange rate

Answer 7

ER for some specified point in the future

Question 8

If 1USD = 1.10CAD

buying 70USD, how much canadian

Answer 8

=70usd x 1.10cad/1usd

=77cad

Question 9

if 1usd = 1.10cad

selling 86cad, how much usd

Answer 9

=86cad x 1usd/1.10cad

=78usd

Question 10

what determined the supply and demand of a currency? choose answer

Answer 10

-demand for the Canadian dollar is derived from foreigners desire to acquire Canadian goods, services, and assets (anything purchased in CAD)
OR
-supply of CAD is driven by the desire of Canadians to acquire foreign goods, services, and assets

Question 11

forex market

Answer 11

-global network of banks, brokers, foreign exchange dealers
-businesses and individuals use forex market to
–convert payables/receivable form one currency to another
–investment opportunities
–currency speculation
-govts also use the forex market

Question 12

forex: consumption

Answer 12

businesses and individuals buy and sell currency as a result of transactions for goods or services

Question 13

forex: investment

Answer 13

search for the highest return

Question 14

forex: arbitrage

Answer 14

attempts to exploit small differences in the price of a currency between markets

Question 15

forex: speculation

Answer 15

deliberate assumption of exchange rate risk in hopes of correctly predicting changes in the value of a currency

Question 16

what determines the value of a currency in the long run

Answer 16

supply and demand
-the long run Econ health of an economy and its assets (exports, firms, real estate, bonds, stocks) - “fundamentals”
-the LR stability of an economy
-possibly purchasing power parity (PPP)

Question 17

Law of one price

Answer 17

if the price of a good differs between two markets, arbitrage will continue until the price of the good is identical in both markets
-this excludes transaction costs, transport costs, taxes etc, and only applies to tradables

Question 18

purchasing power parity (PPP)

Answer 18

-exchange rates are determined by the relative prices of a similar basket of goods
-this occurs bc the process of buying good in the cheap market and reselling affects the demand, and thus, the price of the foreign currency

Question 19

fundamentals

Answer 19

-consumer spending
-unemployment rate
-productivity indices
-GDP
-inflation rate
-interest rate

Question 20

investor psychology and bandwagon effects

Answer 20

-expectations can be self fulfilling prophecies
-when one trader moves, others often follow
-psychology and bandwagon effects may be one of the largest determinants of exchange rates in the short run

Question 21

monetary authorities

Answer 21

monetary authorities step in to influence the value of an exchange rate by intervening in the market
-shifting either the supply or demand curves for their currency to change the price

Question 22

managerial considerations of forex rates

Answer 22

-currency convertibility
-forex risk
–transaction exposure
–translation exposure
–economic exposure

Question 23

forex risk exposure: currency depreciation

exporters

domestic firms

importers and consumers

foreign debt and assets

Answer 23

-exporters tend to be better as their products are less expensive in foreign currency
-domestic firms competing w imports tend to be better off bc competing imports are relatively more expensive in domestic currency
-importers and consumers tend to be worse off as imported products are more expensive in domestic currency
-foreign debt becomes more expensive but foreign assets become more valuable
-the larger, water and more unexpected the depreciation, the greater the turmoil associated