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    Forex Ch. 9

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    leo850731
    The document discusses key aspects of the foreign exchange market including: the formation and functions; differences between spot and forward exchange rates; determinants of currency values; and methods to minimize exchange rate risk. It also covers money supply and inflation influences on currencies; interest rate impacts; approaches to exchange rate forecasting; and issues of currency convertibility and countertrade arrangements.

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    Forex Ch. 9

    Uploaded by

    leo850731
    29 views13 pages
    The document discusses key aspects of the foreign exchange market including: the formation and functions; differences between spot and forward exchange rates; determinants of currency values; and methods to minimize exchange rate risk. It also covers money supply and inflation influences on currencies; interest rate impacts; approaches to exchange rate forecasting; and issues of currency convertibility and countertrade arrangements.

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    Foreign Exchange

    Original Title

    Forex Ch. 9 (1)

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    The document discusses key aspects of the foreign exchange market including: the formation and functions; differences between spot and forward exchange rates; determinants of currency values; and methods to minimize exchange rate risk. It also covers money supply and inflation influences on currencies; interest rate impacts; approaches to exchange rate forecasting; and issues of currency convertibility and countertrade arrangements.

    Copyright:

    © All Rights Reserved
    Download as PPT, PDF, TXT or read online from Scribd
    Download as ppt, pdf, or txt
    29 views13 pages

    Forex Ch. 9

    Uploaded by

    leo850731
    The document discusses key aspects of the foreign exchange market including: the formation and functions; differences between spot and forward exchange rates; determinants of currency values; and methods to minimize exchange rate risk. It also covers money supply and inflation influences on currencies; interest rate impacts; approaches to exchange rate forecasting; and issues of currency convertibility and countertrade arrangements.

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    You are on page 1of 13

    The Foreign Exchange Market

    The Foreign Exchange Market


    Form

    and function of the foreign exchange


    market
    Difference between spot and forward rates
    Determinants of currency exchange rates
    Foreign exchange risk and the exchange
    market
    Exchange rate forecasting
    Convertibility of currencies
    Countertrade as convertibility mitigation factor

    Foreign Exchange
    The foreign exchange market
    Is the market where one buys or sells

    the currency of country A with


    the currency of country B
    A currency exchange
    Is simply the ratio of

    rate

    a unit of currency of country A to


    a unit of the currency of country B
    at the time of the buy or sell transaction

    The Foreign Exchange Market

    Currency conversion in the foreign exchange


    market
    Is necessary to complete private and commercial

    transactions across borders


    A tourist needs to pay expenses on the road in local
    currency
    A firm

    Buys/sells goods and services in the other countrys local


    currency
    Uses the foreign exchange market to invest excess funds

    Is used to speculate on currency movements

    The Foreign Exchange Market

    Minimizes foreign exchange risk (unpredictable rate


    swings)
    To do so there are different ways to trade currencies
    Spot exchange rates: the days rate offered by a

    dealer/bank
    Forward exchange rates:

    Agreed in advance rates to buy/sell a currency on a future


    date
    Usually quoted 30, 90, 120 days in advance

    The market is open 24 hours


    Arbitrage is the process of buying low and selling high
    given slightly different exchange rate quotes in one
    location vs another (e.g., London vs Tokyo)

    Prices and Exchange Rates

    The law of one price:


    Identical products sold in different countries must sell

    for one price if their price is expressed in one currency


    Assumptions:

    Competitive markets

    No transportation costs; no trade barriers

    Purchasing Power Parity (PPP):


    If the law of one price holds for all goods / services, the

    PPP exchange rate is found by comparing prices of


    identical products in different countries

    Money Supply and Currency Value


    Inflation

    occurs when the quantity of money in


    circulation rises faster than the stock of goods
    and services
    Money supply growth related to currency value
    Relative inflation rates and trends can predict
    relative exchange rate movements
    When changes in relative prices in two
    countries change their currencies exchange
    rate, then the currency of the country with the
    highest inflation should decline in value

    Interest Rates and Exchange Rates

    Interest rates reflect expectations of inflation rates;


    high interest rates reflect high inflation expectation

    Fisher Effect: i = r + I
    i: nominal interest rate in a country
    r: real interest rate
    I: inflation over the period the funds are to be lent
    International Fisher Effect: (S1-S2)/S2 X 100 = i$ - i
    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 the two
    countries
    S1: spot rate at time 1, S2 : spot rate at time 1; i$, i: nominal
    interest rates in the US and Japan

    Exchange Rate Forecasting


    The

    efficient market school

    Prices reflect all available public information


    The

    inefficient market school

    Prices do not reflect all available public information


    Approaches

    to forecasting

    Fundamental analysis

    Econometric models draw on economic theory to


    forecast future movements
    Technical analysis
    Extrapolation/interpretation of past trends
    assuming they predict future movements

    Convertibility

    Currency convertibility and government policy


    Freely convertible: residents/non-residents allowed to

    purchase unlimited amounts of a foreign currency with


    the local currency
    Not freely convertible: residents/non-residents not
    allowed to purchase unlimited amounts of a foreign
    currency with the local currency

    Countertrade
    Barter agreements by which goods and services can

    be traded for other goods and services


    Used to get around the non-convertibility of
    currencies

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