The Foreign Exchange Market

What are three factors impact future exchange rate movements?

1. A country's price inflation 2. A country's interest rate 3. Market psychology

The foreign exchange market

1. is used to convert the currency of one country into the currency of another 2. provides some insurance against foreign exchange risk - the adverse consequences of unpredictable changes in exchange rates

How are Exchange rates are determine?>

By the demand and supply for different currencies

Forward exchanges

Two parties agree to exchange currency and execute the deal at some specific date in the future

countertrade

barter-like agreements where goods and services are traded for other goods and services

A currency is nonconvertible when

both residents and non-residents are prohibited from converting their holdings of domestic currency into a foreign currency

A currency is freely convertible when a government of a country allows

both residents and non-residents to purchase unlimited amounts of foreign currency with the domestic currency

Spot exchange rate

is the rate at which a foreign exchange dealer converts one currency into another currency on a particular day

Most transactions involve dollars on one side because

it is a vehicle currency

A currency is externally convertible when

non-residents can convert their holdings of domestic currency into a foreign currency, but when the ability of residents to convert currency is limited in some way

Purchasing power parity theory (PPP) predicts

predicts that changes in relative prices will result in a change in exchange rates

What do Exchange Rates Mean For Managers? Managers need to consider three types of foreign exchange risk: 3. Economic exposure-

the extent to which a firm's future international earning power is affected by changes in exchange rates

What do Exchange Rates Mean For Managers? Managers need to consider three types of foreign exchange risk: 1. Transaction exposure-

the extent to which the income from individual transactions is affected by fluctuations in foreign exchange values

What do Exchange Rates Mean For Managers? Managers need to consider three types of foreign exchange risk: 2. Translation exposure-

the impact of currency exchange rate changes on the reported financial statements of a company

What does the law of one price states?

That in competitive markets free of transportation costs and barriers to trade, identical products sold in different countries must sell for the same price when their price is expressed in terms of the same currency