International Business Chapter 10

Four main uses of foreign exchange markets

1. Income/money from exports, foreign investments, or licensing agreements must be converted to home country's currency to be used 2. Businesses used FEM when they must pay for a foreign company for its products or services in its country's currency 3. business uses FEM when they have spare cash they want to invest for short terms in money markets 4. currency speculation

an exchange rate can be quoted in two ways:

1. as the amount of foreign currency one USD will buy 2. as the value of the dollar for one unit of foreign currency

Two functions of the foreign exchange market

1. to convert the currency of one country into the currency of another 2. to provide some insurance against foreign exchange risk

spot exchanges account for

1/3 of foreign exchange transactions

forward instruments account for

2/3 of all foreign exchange transactions

For most major currencies, forward exchange rates are quoted for

30 days, 90 days, and 180 days into the future

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.

France, Germany, and 17 other countries

Euro

Major secondary trading centers

Frankfurt, Pairs, Hong Kong, and Sydney

The most important trading centers

London, New York, Zurich, Tokyo, and Singapore

lead strategy

attempting to collect 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

Major participants in FEM

companies engaged in international trade and investment

spot rates change

continually, often on a minute-by-minute basis

forward exchange rates

exchange rates governing such future transactions

Currency swaps are transacted between

international businesses and their banks, between banks, and between governments when it is desirable to move out of one currency into another for a limited period without incurring foreign exchange risk.

carry trade

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

location of the foreign exchange market

not located in one place; it is a global network of banks, brokers, and foreign exchange dealers connected by electric communications systems

forward exchange

occurs when two parties agree to exchange currency and execute the deal at some specific date in the future

spot exchange rates are reported on

real-time basis on many financial websites

foreign exchange risk

the adverse consequences of unpredictable changes in exchange rates

when is a carry trade a success

the belief that there will be no adverse movement in exchange rates that will make the trade unprofitable

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 the income from individual transactions is affected by fluctuations in foreign exchange values

Translation Exposure

the impact of currency exchange rate changes on the reported financial statements of a company

provide insurance against the foreign exchange risk

the possibility that unpredicted changes in future exchange rates will have adverse consequences on the firm

Great Britain

the pound

Spot exchange rate

the rate at which a foreign exchange dealer converts one currency into another currency on a particular day

The exchange rate

the rate at which the market converts one currency into another

currency speculation

the short-term movement of funds from one currency to another in the hopes of profiting from shifts in exchange rates

currency swap

the simultaneous purchase and sale of a given amount of foreign exchange for two different value dates

when companies wish to convert currency, they go through

their banks

the key to reducing a firm's economic exposure

to distribute the firm's productive assets to various locations so the firm's long-term financial well-being is not severely affected by adverse changes in exchange rates

Minor participants in FEM

tourists

hedging

when a firm insures itself against foreign exchange risk

spot exchange

when two parties agree to exchange currency and execute the deal immediately

United States

US dollar

Japan

Yen

Countertrade

a range of barter-like agreements that facilitate the trade of goods and services for other goods and services when they cannot be traded for money