Chapter 21 International corporate finance
basic idea behind relative version of purchasing power parity
does not tell us what determines the absolute level of the exchange rate. Instead, it tells what determines the change in the exchange rate over time
what are corporations called with significant foreign operations
international corporations multinationals
what kind of market is the FX market
over the counter market
two basic types of trades in the FX market
spot trades and forward trades
forward exchange rate
the agreed-upon exchange rate to be used in a forward trade
Unbiased forward rates
the condition stating that the current forward rate is an unbiased predictor of the future spot exchange rate
Cross rate
the implicit exchange rate between two currencies (usually non US ) quoted in some third currency (usually the US dollar)
Foreign exchange market (FX market)
the market in which one country's currency is traders for another country's currency
two forms of Purchasing power parity
absolute and relative
Exchange rate risk
risk related to having international operations in a world where relative currency values vary
uncovered interest parity
the condition stating that the expected percentage change in the exchange rate is equal to the difference in interest rates
Interest rate parity (IRP)
the condition stating that the interest rate differential between two countries is equal to the percentage difference between the forward exchange rate and the spot exchange rate
Spot exchange rate
the exchange rate on the spot rate
Purchasing power parity
the idea that the exchange rate adjusts to keep purchasing power constant among currencies
International fisher effect
the theory that real interest rates are equal across countries
Covered Interest arbitrage
we are covered in the event of a change in the exchange rate because we lock in the forward exchange rate today
American Depository Receipts (ADRs)
A security issued in the United States representing shares of a foreign stock and allowing that stock to be traded in the united states
Spot trade
An agreement to trade currencies based on the exchange rate today (on the spot) for settlement within two business days
basic idea behind absolute purchasing power parity
a commodity costs the same regardless of what currency is used to purchase it or where it is selling ex. $1 will buy you the same number of cheeseburgers anywhere in the world
Forward trade
an agreement to exchange currency at some time in the future (normally in the next 12 months)
Triangle arbitrage
arbitrage opportunities that arise due to inconsistencies in cross rates ie. when observed cross rates do not equal implied cross rates