exam 3 chapter 8 managing transaction risks
What is Indirect quotation?
Indirect Quotation -the value of the documents currency expressed in the units of foreign currency - the currency pair the foreign currency is the quoted currency i.e. the domestic currency is base currency (foreign currency varies and domestic currency remains fixed)
What is the Put Option?
- an option with which a firm agrees to sell a particular currency at a particular price on a given date
What happens if a currency is in-convertible ?
is posses a risk barrier to trade with foreigners who have no need for the domestic currency.
What are the four type of currency convertibility?
Hard Currency- a currency that can easily be converted to another currency Convertible Currency- a currency that can be converted to another currency Soft Currency - a currency that cannot be easily converted into another currency Incontrovertible currency- a currency that cannot be converted into another currency
What is the exchange rate quotations?
* currencies always quoted in pairs- referred to as currency pairs - the base currency is always equal to one unit - the quote is how much of one unit of base currency - one U.S. dollar can buy Japanese -AN INVERSE RELATIONSHIP BETWEEN THE TWO METHODS OF QUOTING A CURRENCY EXCHANGE
what are the 4 types of exchange rates?
* spot exchange rate *forward exchange rate *currency futures *currency options
what are call options?
*an option with which a firm agrees to buy a particular currency at a particular price on a given date. *suppose U.S. firm purchases an option to buy euros for 1.35 on 01/01/2016. it pays U.S. $5000 for that option
If a U.S. firm purchases an option to sell British Pounds from $1.25/euroes on 03/01/2016 it pays U.S. $2000 for that option
*if the spot exchange rate is higher than $1.25/euros the firm will sell the pounds on the spot market,a nd forgo the option *if the spot exchange rate is lower than $1.25/euros, the firm will exercise the option, and option 1.25/euros for its pounds
what is currency options?
- currency options is a method used to protect against FLUCTUATIONS IN THE VALUE OF A CURRENCY IN THE FUTURE -A firm can purchase OPTIONS TO BUY or OPTIONS TO SELL a PARTICULAR CURRENCY AT A PARTICULAR PRICE ON A GIVEN DATE - unlike in the futures market OPTIONS CAN BE FOR ANY AMOUNT, AND AT ANY DATE -an option is the RIGHT TO BUY OR SELL a currency, at a predetermined price (called the strike price) but it is not the obligation to buy or sell at that price. the owner of the option is the one who decides whether to exercise the option.
What is Currency convertibility?
- the ease with which a country's currency can be converted into gold or another currency. - it is EXTREMELY important international commerce.
What is spot exchange rate?
- the spot exchange rate is the exchange rate for a foreign currency for immediate delivery -the "immediate delivery" is some subject toe interpretations that vary from country to country and within one country, from one country to another, however it is roughly the price of a foreign currency to be delivered within 48 hours - the most commonly USED EXCHANGE RATE AND IT CAN BE FOUND IN JUST ABOUT ANY PERIODICAL or financial website
What is Exchange Rate Quotations? Direct Quotation?
-Direct Quotation * The value of the foreign currency expressed in units of the domestic currency * in direct quotations, in the currency pair the domestic currency is the quoted currency (domestic currency varies and foreign currency remains fixed)
what are currency futures?
-currencies traded as commodities in the future market - contracts between a seller (called the short) and a buy (called the long) - IN the US currency futures are limited to fixed quantities * and fixed settlement dates ( the 3rd wednesday of the months of march, june, september, and december ) [because of the limits placed on amounts and dates, futures are rarely used in international trade transactions]
What is the forward exchange rate?
-the exchange rate for a foreign currency to be delivered any number of days in the future -the party entering into a forward currency contract with a bank is committing to purchasing one currency with another at a certain price on a certain date. - the published forward exchange rate quotes are for 30 DAYS, 90 DAYS , 180 DAY OR ONE YEAR IN THE FUTURE
Sales Contract's Currency
2 Factors should be considered when choosing a currency for the sales contract. * Risk of Currency Fluctuation A speculative risk- the risk could result in positive or negative outcomes, depending on which way the exchange rate fluctstion * Risk of Currency Convertibility A pure risk a payment received in a foreign currency cannot be converted into the exporter's currency
what two scenarios can take place in call options?
A) if the spot exchange rate is lower than 1.35/ euros, the firm will purchase the euros on the spot market and forgo the option. B) if the spot exchange is higher than 1.35/euros, the firm will exercise the option, and pay 1.35 for the euros
What are sales currency choices?
An exporter and importer can agree on 3 possible alternative when choosing the currency in which a sales contract will be paid - the emporter's country's currency - the importer's country's currency - a third country's currency
Sales Contract Elements
Terms of Trade * incoterms rules determine the costs the exporter should pay, costs the importer should pay, and the point at which the responsibility for the cargo shifts from one to the other. Terms of Sale * the terms of sale determine the method of payment and the intermediaries involved in the payment and the handling of the documents from the importer to the exporter Currency *the currency in which the transaction is undertaken, it can be the exporter's country currency, the importer's country's currency, or a third cointry's currency.