Chapter 10
Foreign Exchange Market
Market for converting the currency of one country into another
freely convertible currency
a country's currency is freely convertible when the government of that country allows both residents and nonresidents to purchase unlimited amounts of foreign currency with the domestic currency
carry trade
a kind of speculation that involves borrowing in one currency where interest rates are low, and then using the proceeds to invest in another currency where interest rates are high
efficient market
a market where prices reflect all available information
lead strategy
collecting 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.
capital flight
converting domestic currency into foreign currency
nonconvertible currency
currency is not convertible when both residents and nonresidents are prohibited from converting their holdings of that currency into another currency
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
international Fisher effect
for any two countries, the spot exchange rate should change in an equal amount but in the opposite direction to the difference in nominal interest rates between countries
law of one price
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 the same currency
currency speculation
involves short term movement of funds from one currency to another in hopes of profiting from shifting exchange rates
externally convertible currency
limitations on the ability of residents to convert domestic currency, though nonresidents can convert their holdings of domestic currency into foreign currency exchange
bandwagon effect
movement of traders like a herd, all in the same direction and at the same time, in response to each other's perceived actions
Fisher effect
nominal interest rates in each country equal the required real rate of interest and the expected rate of inflation over the period of time for which the funds are to be lent
inefficient market
one in which prices do not reflect all available information
currency swap
simultaneous purchase and sale of a given amount of foreign exchange for two different value dates
spot exchange trade
the exchange rate at which a foreign exchange dealer will convert one currency into another that particular day
forward exchange rate
the exchange rate governing a forward exchange transaction
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 income from individual transactions is affected by fluctuations in foreign exchange values
translation exposure
the extent to which the reported consolidated results and balance sheets of a corporation are affected by fluctuations in foreign exchange rates
arbitrage
the purchase of securities in one market for immediate resale in another to profit from a price discrepancy
exchange rate
the rate at which one currency is converted into another
countertrade
trade of goods and services for other goods and services
forward exchange
when two parties agree to exchange currency and execute a deal at some specific date in the future