Global Business Today - Chapter 10 - The Foreign Exchange Market

Foreign Exchange Market

A market converting the currency of one country into that of another country

Exchange Rate

The rate at which one currency is converted into another

Foreign Exchange Risk

The risk that changes in exchanges rates will hurt the profitability of a business deal

Currency Speculation

Involves short-term movement of funds from shifts in exchange rates

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

Spot Exchange Rate

The exchange rate at which a foreign exchange dealer will convert one currency into another that particular day

Forward Exchange

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

Forward Exchange Rate

The exchange rate governing forward exchange transactions

Currency Swap

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

Arbitrage

The purchase of securities in one market for immediate resale in another to profit from a price discrepancy

Law of One Price

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 the same currency

Efficient Market

One in which few impediments to international trade and investment exist

Fisher Effect

Nominal interest rates (i) in each country equal the required real rate of interest (r) and the expected rate of inflation over the period of time for which the funds are to be lent (l); that is, i+r=l

International Fisher Effect

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 countries

Bandwagon Effect

When traders move like a herd, all in the same direction and at the same time, in response to each other's perceived actions

Inefficient Market

One in which prices do not reflect all available information

Freely Convertible Currency

A country's currency is freely convertible when the government of that country allows both residents and nonresidents to purchase unlimited amounts of foreign currency with the domestic currency

Externally Convertible Currency

Nonresidents can convert their holdings of domestic currency into foreign currency, but the ability of residents to convert the currency is limited in some way

Nonconvertible Currency

A currency is not convertible when both residents and nonresidents are prohibited from converting their holdings of that currency into another currency

Capital Flight

Residents convert domestic currency into a foreign currency

Countertrade

The trade of goods and services for other goods and services

Transaction Exposure

The extent to which income from individual transaction is affected by fluctuations in foreign exchange values

Translation Exposure

The extent to which the reported consolidated results and balance sheets of a corporation are affected by fluctuations in foreign exchange values

Economic Exposure

The extent to which a firm's future international earning power is affected by changes in exchange rates

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

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