Chapter 21 International corporate finance

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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


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