Ch 1 - 7

Quote Currency

in foreign exchange trading, the pair of prices (bid and ask) at which dealer is willing to buy or sell foreign exchange.

Currency Board

A currency board exists when a country's central bank commits to back its money supply entirely with foreign reserves at all times.

Margin

A deposit made as security for a financial transaction otherwise financed on credit.

Option

A financial derivative contract providing rights to exchange but not obligations. In foreign exchange, a contract giving the purchaser the right, but not the obligation, to buy or sell a given amount of foreign exchange at a fixed price per unit for a specified time period. Options to buy are calls and options to sell are puts.

Balance of Payments

A financial statement summarizing the flow of goods, services, and investment funds between residents of a given country and residents of the rest of the world.

Spot Transaction

A foreign exchange transaction to be settled (paid for) on the second following business day.

Over the Counter

A marker for share of stock, options (including foreign currency options), or other financial contracts conducted via electronic connections between dealers. The over the counter market has no physical location or address, and is thus differentiated from organized exchanges that have a physical location where trading takes place.

Lambda

A measure of the sensitivity of an option premium to a unit change in volatility.

Gold Standard

A monetary system in which currencies are defined in terms of their gold content, and payment imbalances between countries are settled in gold.

Comparative Advantage

A theory that everyone gains if each nation specializes in the production of those goods that it produces relatively most efficiently and imports those goods that other countries produce relatively more efficiently. The theory supports free trade arguments.

Fisher Effect

A theory that nominal interest rates in two or more countries should be equal to the required real rate of return to investors plus compensation for the expected amount of inflation in each country.

Unbiased Predictor

A theory that spot prices at some future date will be equal to today's forward rates.

Interest Rate Parity (IRP)

A theory that the differences in national interest rates for securities of similar risk and maturity should be equal to but opposite in sign (+/-) to the forward exchange rate discount or premium for the foreign currency.

Purchasing Power Parity

A theory that the price of internationally traded commodities should be the same in every country, and hence the exchange rate between the two currencies should be the ratio of prices in the two countries.

International Fisher Effect

A theory that the spot exchange rate should change by an amount equal to the difference in interest rates between two countries.

Arbitrage

A trading strategy based on the purchase of a commodity, including foreign exchange, in one market at one price while simultaneously selling it in another market at a more advantageous price, in order to obtain a risk-free profit on the price differential.

Premium

In a foreign exchange market, the amount by which a currency is more expensive for future delivery than for spot (immediate) delivery. The opposite of premium is discount.

Current Account

In the balance of payments, the net flow of goods, services, and unilateral transfers (such as gifts) between a country and all foreign countries.

Shareholder

Individual that owns part of a company through stock ownership.

Stakeholder

Individuals that are interested in the performance of a company for reasons other than just stock appreciation.

Capital Flight

Movement of funds out of a country because of political risk.

Gross Domestic Product (GDP)

One of the primary indicators used to gauge the health of a country's economy. It represents the total dollar value of all goods and services produced over a specific time period

Exercise Price

Same as the strike price; the agreed upon rate of exchange within an option contract to buy or sell the underlying asset.

Writer of an Option

Seller

Swap

Simultaneous purchase and sale of foreign exchange or securities, with the purchase executed at once and the sale back to the same party carried out at an agreed upon price to be completed at a specified future date.

Current Account Balance

Sum of net imports/exports of goods and services, net income and net transfers.

Counterparty Risk

The potential exposure any individual firm bears that the second party to any financial contract may be unable to fulfill its obligations under the contract's specifications.

Ask

The price at which a dealer is willing to sell foreign exchange, securities or commodities. Also called offer price.

Indirect Quote

The price of a unit of a home country's currency expressed in terms of a foreign country's currency.

Direct Quote

The price of a unit of foreign exchange expressed in the home country's currency. The term has meaning only when the home country is specified.

Foreign Exchange Rate

The price of one country's currency in terms of another currency, or in the terms of a commodity such as gold or silver.

Bid

The price that a dealer is willing to pay to purchase a foreign exchange or a security.

Uncovered Interest Arbitrage

The process by which investors borrow in countries and currencies exhibiting relatively low interest rates and convert the proceeds into currencies that offer much higher interest rates. The transaction is "uncovered" because the investor does not sell the higher yielding currency proceeds forward.

Covered Interest Arbitrage (CIA)

The process whereby an investor earns a risk-free profit by 1) borrowing funds in one currency, 2) exchanging those funds in the spot market for a foreign currency, 3) investing the foreign currency at interest rates in a foreign country, 4) selling forward, at the time of original investment, the investment proceeds to be received at maturity, 5) using the proceeds of the forward sale to repay the original loan, and 6) sustaining a remaining profit balance.

Corporate Governance

The relationship among stakeholders used to determine and control the strategic direction and performance of an organization.

Balance of Trade

An entry in the balance of payments measuring the difference between the monetary value of merchandise exports and merchandise imports.

Cross Rate

An exchange rate between two currencies derived by dividing each currency's exchange rate with a third currency. Colloquially, it is often used to refer a specific currency pair such as the euro/yen cross rate, as the yen/dollar and dollar/euro are the most common currency quotations.

Forward Rate

An exchange rate quoted for settlement at some future date. The Rate used in a forward transaction.

Impossible Trinity

An ideal currency would have exchange rate stability, full financial integration, and monetary independence.

Real Exchange Rate

An index of foreign exchange adjusted for relative price-level changes from a base point in time, typically a month or a year. Sometimes referred to as real effective exchange rate, it is used to measure purchasing power adjusted changes in exchange rates.

Broker

An individual or firm that arranges foreign exchange transactions between two parties, but is not itself a principal in the trade. Foreign exchange brokers earn a commission for their efforts.

Dealer

An individual or firm that buys foreign exchange from one party (at a bid price), and then sells it (at an ask price) to another party. The dealer is a principal in two transactions and profits via the spread between the bid and ask prices.

American Option

An option that can be exercised at any time up to and including the expiration date.

European Option

An option that can be exercised only on the day on which it expires.

Out of the Money

An option that would not be profitable, excluding the cost of the premium, if exercised immediately.

Put

An option to sell foreign exchange or financial contracts.

At The Money (ATM)

An option whose exercise price is the same as the spot price of the underlying currency.

Call

An option with the right, but not the obligation, to buy foreign exchange or another financial contract at a specific price within a specified time.

Publicly Traded Shares

Both public and private enterprises may have a portion of their ownership publicly traded (usually represent <50% ownership for public shares).

Privately Held Business

Businesses that are owned by a sole proprietor.

In The Money

Circumstance in which an option is profitable, excluding the cost of the premium, if exercised immediately.

Base Currency

Considered the domestic currency or accounting currency. For accounting purposes, a firm may use the base currency to represent all profits and losses.

Public Enterprise

Enterprise that is owned by a government or the state; if owned by the state that can be operated for profit or not for profit

Private Enterprise

Enterprise that is owned by a private individual or organization; may be owned in whole or part by families as well as can be operate for profit or not for profit

Futures Contract

Exchange traded agreements calling for future delivery of a standard amount of any good.

Hard Peg

Extreme currency regime peg forms such as Currency Boards and Dollarization.

Soft Peg

Fixed Exchange Rates where authorities maintain a set but variable band about some other currency.

American Terms

Foreign exchange quotations for the U.S. dollar, expressed as the number of U.S. dollars per unit of non-U.S. currency.

European Terms

Foreign exchange quotations for the U.S. dollar, expressed as the number of non-U.S. currency units per U.S. dollar.

Floating Exchange Rate

Foreign exchange rates determined by demand and supply in an open market that is presumably free of government interference.

Fixed Exchange Rate

Foreign exchange rates tied to the currency of a major country (such as the United States), to gold, or to a basket of currencies such as Special Drawing Rights.

Inflation

Sustained increase in the general price level of goods and services in an economy over a period of time

Absolute Advantage

The ability of an individual party or country to produce more of a product or service with the same inputs as another party. It is therefore possible for a country to have no absolute advantage in any international trade activity.

Nominal Interest Rate

The actual foreign exchange quotation, in contrast to real exchange rate, which is adjusted for changes in purchasing power.

Delta

The change in an option's price divided by the change in the price of the underlying instrument. Hedging strategies are based on delta ratios.

Law of One Price

The concept that if an identical product or service can be sold in two different markets, and no restrictions exist on the sale or transpiration costs of moving the product between markets, the product's price should be the same in both markets.

Mark to Market

The condition in which the value of a futures contract is assigned to market value daily, and all changes in value are paid in cash daily. The value of the contract is revalued using the closing price for the day. The amount to be paid is called the variation margin.

Shareholder Wealth Maximization

The corporate goal of maximizing the total value of the shareholders' investment in the company.

Stakeholder Capitalization Model

The corporate goal of maximizing the total wealth of the corporation rather than just the shareholders' wealth. Wealth is defined to include not just financial wealth but also the technical, marketing, and human resources of the corporation.

Agency Theory

The costs and risks of aligning interests between shareholders of the firm and their agents, management, in the conduct of firm business and strategy.

Home Currency

The currency of a company's incorporation; the currency for financial reporting purposes.

Capital Mobility

The degree to which private capital moves freely from country to country in search of the most promising investment opportunities.

Exchange Rate Pass-Through

The degree to which the prices of imported and exported goods change as a result of exchange rate changes.

Rho

The expected change in an option premium caused by a small change in the domestic interest rate.

Phi

The expected change in an option premium caused by a small change in the foreign interest rate.

Theta

The expected change in an option premium caused by a small change in the time to expiration.

Intrinsic Value

The financial gain if n option is exercised immediately.

Notional Principal

The size of a derivative contract, in total currency value, as used in futures contracts, forward contracts, or swap agreements.

Dollarization

The use of the U.S. dollar as the official currency of a country.