ch. 10-The foreign exchange market
Foreign Exchange Market
A market for converting the currency of one country into that of another country
relatively efficient market
A market in which few impediments to international trade and investment exist.
inefficient market
A market in which prices do not reflect all available information.
efficient market
A market where prices reflect all available information and trade is not restricted
fisher effect
A theory that nominal interest rates (i) in two or more countries should be equal to the required real rate of return to investors (r) plus compensation for the expected amount of inflation(I) in each country over the period of time for which the funds are to be lent i=r+I
Lag Strategy
Delaying the collection of foreign currency receivables if that currency is expected to appreciate, and delaying payables if that currency is expected to depreciate.
one price
In competitive markets that are free of transportation costs and trade barriers, identical products sold in different countries must sell for the same price when price is expressed in terms of the same currency. This is called the law of ___
currency speculation
Moving funds from one currency to another over the short-term in hopes of profiting from shifts in exchange rates.
exchange rates
PPP predicts that changes in relative prices will result in a change in ___
hedging
The process of insuring one's business against foreign exchange risk by using forward exchanges or currency swaps.
foreign exchange risk
The risk that changes in exchange rates will hurt the profitability of a business deal
International Fisher Effect
The theory that for any two countries, the spot exchange rate should change in an equal amount but in the opposite direction to the difference in normal interest rates between countries.
technical analysis
Uses price and volume data to determine past trends, which are expected to continue into the future
nonconvertible currency
When a country's government allows neither residents nor nonresidents to convert its currency into a foreign currency.
externally convertible currency
When a country's government allows only nonresidents to convert the currency into foreign currency.
bandwagon effect
When traders move like a herd, all in the same direction and at the same time, in response to each others' perceived actions
Forward Exchange
When two parties agree to exchange currency and execute a deal at some specific date in the future.
countertrade agreements
___ are barter-like agreements used by countries whose currency is not convertible
foward
a firm that enters into a ___ exchange contract is taking out insurance against the possibility that unfavorable exchange rate movements will make transactions unprofitable
economic
a key to reducing ___ exposure involves distributing a firm's productive assets to various locations so the firm's long-term financial well-being is not severely affected by adverse changes in exchange rates
distributing a firms productive assets to various locations
a key to reducing economic exposure involves __ so the firm is not severely affected by adverse changes in exchange rates
insures against foreign exchange risk
a swap deal is just like a conventional forward deal in that it __-
$4.50
an american tourist in japan is interested in buying a souvenir that costs 1800 yen. how much is this in dollars if the exchange rate is $1 to Y400
hyperinflation
an explosive and seemingly uncontrollable price inflation in which money loses value very rapidly is called ___
lead strategy
attempting to collect foreign currency receivables early when a foreign currency is expected to depreciate and paying foreign currency payables before they are due when a currency is expected to appreciate
low, high
carry trade is borrowing in a currency where interest rates are ___ and then investing in a currency where interest rates are ___
fundmental analysis
draw on economic theory to construct economic models for predicting exchange rate movements
long
economic exposure is concerned with the ___ term effect of changes in exchange rates on future prices, sales, and costs
demand and supply
exchange rates are set by the interaction of __ of one currency relative to those of another currency
future
forward exchange rates are exchange rates that govern ___ transactions
$.01 per japanese yen
if a basket of goods costs $200 in the us and 20000 yen in Japan, PPP theory predicts that the dollar/yen exchange rate should be ___
arbitrage
if a dealer in NYC took 1 mil to purchase y125 mil and then immediately sold the y125 mil for dollars in london yeilding $1041165 it would be an example of,
true
if the foreign exchange market is efficient forward exchange rates should be unbiased predictors of future spot rates t/f
canada's currency will depreciate by 2.5% against the US dollar
if the interest rate in canada is 6.5% and the interest rate in the US is 4%, the international fisher effect predicts ___
4%
if the interest rate in country A is 8% and the interest rate in country B is 4%, the international fisher effect predicts the value of country a's currency will depreciate by ___ against country b's currency
currency
in a ___ swap, businesses banks and/or the government choose to move out of one currency into another for a limited period without incurring foreign exchange risk
inflation rates
in the context of the fisher effect, different interest rates between countries reflect differing expectations about ___ between those countries
inflation
interest rates reflect expectations about future ___ rates, which has been shown to lead to a depreciation in exchange rates
-engage in currency speculation -pay a foreign company for its products or services in its country's currency -invest spare cash for short terms in money markets -convert foreign currencies it receives from transactions into its own currency
international businesses use foreign exchange markets to ___
translation exposure
involves the present measurement of past events using currency exchange rate changes on a company's financial statements
demand
it is difficult to profit through arbitrage bc the ___ for a currency would increase when dealers try to profit from exchange rate discrepancies leading to appreciation of that currency and the price differential between the two currencies would disappear
dollar, euro, yen, pound
match the currency with its level of importance as a vehicle currency
-market psychology -the country's interest rate -the country's price inflation
most economic theories of exchange rate movements agree that which of the following factors have an impact on future exchange rate movements in a country's currency?
investor psychology
one main reason why the IFE is not good at explaining short-term exchange rate movements is the impact of __ on short-run exchange rate movements
law of one price
principle that an identical item must have an identical price in all countries when the price is expressed in a common currency; in competitive markets free of transportation costs and barriers to trade
currency swap
simultaneous purchase and sale of a given amount of foreign exchange for two different value dates
-countries with high inflation rates -countries with underdeveloped capital markets
the PPP seems to predict exchange rate movements best for countries in these situations
purchasing power parity
the ___ exchange rate states that given relatively efficient markets, the price of a product should be roughly equivalent in each country
forward exchange contract
the contract that acts like insurance against insurance against unfavorable exchange rate movements
the big mac
the economist's version of the PPP uses ___ as a proxy for a "basket of goods"
translation
the effect of currency exchange rate changes on required financial statements of companies is called ___ exposure
forward exchange rate
the exchange rate governing forward exchange transactions, calculated at the time of the exchange but based on future expectations
economic exposure
the extent to which a firm's future international earning power is affected by changes in exchange rates
Transaction Exposure
the extent to which the income from individual transactions is affected by fluctuations in foreign exchange values
inflation rates exchange rates
the failure to find a link between which two of the following conditions has been referred to as the purchasing power parity puzzle?
the require real interest rate+expected rate of inflation
the fisher effect equates the nominal interest rate as
london, new york, zurich, tokoyo, singapore
the five most important exchange trading centers are ___
short-term
the impact of psychological factors and investor expectations make it difficult for exchange rate theories to predict __ changes in exchange rates
opposite
the international fisher effect states that for any two countries, the spot exchange rate should change in an equal amount, in the ___ direction to the difference in nominal interest rates between the two countries
government
the link between price changes and changes in exchange is further weakened by ___ intervention in foreign exchange markets in their attempt to affect the value of their currencies
fundamental
the method of forecasting that draws one economic theory to construct sophisticated models is called the __ analysis approach
arbitrage
the purchase of securities in one market for immediate resale in another to profit from a price discrepancy
spot exchange rate
the rate at which a foreign exchange dealer converts one currency into another currency on a particular day
exchange rate
the rate at which one currency is converted into another
countertrade
the trade of goods and services produced in one country for the goods and services of another country
depreciate
theoretically, if a country's price inflation is rising it should expect to see its currency ___ against that of countries in which inflation rates are lower
forecast
to aid in the decision making process, it is important for companies to ___ exchange rates to estimate whether projects based on future exchange rates will be profitable
centralized
to protect resources efficiently and ensure that each subunit adopts the correct mix of tactics and strategies, firms should aim for ___ control of exposure
lead strategy lag strategy
two strategies that can be used to reduce translation and transaction exposure are ___
-entering into forward exchange rate contracts -using swaps
two strategies to reduce translation and economic exposure are:
-the mkt never sleeps -the trading centers are integrated
what are the two most prominent features of the foreign exchange markets
Freely Convertible Currency
when a country's government allows both residents and nonresidents to convert its currency into foreign currency
inflation
when a country's money supply grows faster that the output of goods and services this causes,
discrimination
when a dominant enterprise is able to set different prices in different markets to reflect varying demand conditions, it is practicing price ___
capital flight
when residents and nonresidents rush to convert their holdings of domestic currency into a foreign currency; usually taking place when domestic currency is depreciating rapidly or a country is facing dim economic prospects
bandwagon effect
which psychological term has been applied to the situation in southeast asia in 1997 when the currencies of Thailand, malaysia, south korea, and indonesia lost more than 50% of their value one after the other
translation, economic, transaction
which three types of exposure should companies take into account when managing foreign exchange risk?
