Term
| The foreign exchange market |
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Definition
¡is a market for converting the currency of one country into that of another country |
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| the rate at which one currency is converted into another |
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| What is the purpose of the foreign exchange market? |
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1.enables the conversion of the currency of one country into the currency of another
2.provides some insurance against foreign exchange risk (the adverse consequences of unpredictable changes in exchange rates) |
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The rate at which one currency is converted into another is the |
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| (the short-term movement of funds from one currency to another in the hopes of profiting from shifts in exchange rates) |
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| (the possibility that unpredicted changes in future exchange rates will have adverse consequences for the firm) |
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A firm that protects itself against foreign exchange risk
¡The market performs this function using
1.spot exchange rates
2.forward exchange rates
currency swaps |
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¡the rate at which a foreign exchange dealer converts one currency into another currency on a particular day
¡Spot rates are determined by the interaction between supply and demand, and so change continually |
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2. Forward Exchange Rates |
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Definition
| occurs when two parties agree to exchange currency and execute the deal at some specific date in the future |
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¡is the exchange rate governing such a future transaction
¡Forward rates are typically quoted for 30, 90, or 180 days into the future |
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the simultaneous purchase and sale of a given amount of foreign exchange for two different value dates
¡Swaps are used when it is desirable to move out of one currency into another for a limited period without incurring foreign exchange rate risk |
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Definition
The rate at which a foreign exchange dealer converts one currency into another currency on a particular day is the |
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| The foreign exchange market |
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| a global network of banks, brokers, and foreign exchange dealers connected by electronic communications systems |
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| the process of buying a currency low and selling it high |
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1. a country’s price inflation
2. a country’s interest rate
3. market psychology |
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Definition
¡Three factors that have an important impact on future exchange rate movements are |
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| states that 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 terms of the same currency |
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Term
| Purchasing power parity theory |
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Definition
¡argues that given relatively efficient markets (markets in which few impediments to international trade and investment exist) the price of a “basket of goods” should be roughly equivalent in each country |
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| markets in which few impediments to international trade and investment exist) |
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occurs when expectations on the part of traders turn into self-fulfilling prophecies, and traders join the bandwagon and move exchange rates based on group expectations
¡Governmental intervention can prevent the bandwagon from starting, but is not always effective |
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Term
| The efficient market school |
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Definition
¡argues that forward exchange rates are the best predictors of future spot exchange rates
¡Therefore, investing in forecasting services would be a waste of money |
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| inefficient market school |
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Definition
¡argues that companies should invest in forecasting services
¡This school of thought does not believe that forward rates are the best predictor of future spot rates |
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¡is one in which prices reflect all available information
¡If the foreign exchange market is efficient, forward exchange rates should be unbiased predictors of future spot rates
¡Most empirical tests confirm the efficient market hypothesis suggesting that companies should not waste their money on forecasting services, but some recent studies have challenged the theory |
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is one in which prices do not reflect all available information
¡In an inefficient market, forward exchange rates are not the best predictors of future spot exchange rates and it may be worthwhile for international businesses to invest in forecasting services
¡However, the track record of forecasting services is questionable
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1. fundamental analysis
2. technical analysis |
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Definition
¡There are two approaches to exchange rate forecasting |
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Definition
draws upon economic factors like interest rates, monetary policy, inflation rates, or balance of payments information to predict exchange rates |
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¡focuses on trends and believes that past trends and waves are reasonable predictors of future trends and waves |
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Term
| A currency is freely convertible |
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Definition
| when both residents and non-residents can purchase unlimited amounts of foreign currency with the domestic currency |
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| A currency is externally convertible |
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Definition
| when only non-residents can convert their holdings of domestic currency into a foreign currency |
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| A currency is nonconvertible |
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Definition
| when both residents and non-residents are prohibited from converting their holdings of domestic currency into a foreign currency |
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| when residents and nonresidents rush to convert their holdings of domestic currency into a foreign currency |
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| barter like agreements by which goods and services can be traded for other goods and services |
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Term
1. Transaction exposure
2. Translation exposure
3. Economic exposure |
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Definition
¡This exchange rate risk can be divided into |
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¡is the extent to which the income from individual transactions is affected by fluctuations in foreign exchange values
¡It can lead to a real monetary loss |
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¡is the impact of currency exchange rate changes on the reported financial statements of a company
¡it deals with the present measurement of past events
¡Gains and losses from translation exposure are reflected only on paper |
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Term
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Definition
¡is the extent to which a firm’s future international earning power is affected by changes in exchange rates
¡It is concerned with the long-term effect of changes in exchange rates on future prices, sales, and costs |
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| leading and lagging payables and receivables |
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Definition
| paying suppliers and collecting payment from customers early or late depending on expected exchange rate movements |
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Definition
| involves 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 |
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¡involves delaying collection of foreign currency receivables if that currency is expected to appreciate and delaying payables if the currency is expected to depreciate
¡Lead and lag strategies can be difficult to implement |
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Definition
The extent to which income from individual transactions is affected by fluctuations in foreign exchange values is |
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1. establish central control to protect resources efficiently and ensure that each subunit adopts the correct mix of tactics and strategies
2.distinguish between transaction and translation exposure
on the one hand, and economic exposure on the other hand
3. attempt to forecast future exchange rates
4.establish good reporting systems so the central finance function can regularly monitor the firm’s exposure position
5.produce monthly foreign exchange exposure reports |
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Definition
¡To further manage foreign exchange risk, firms should |
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