Chapter 7: Foreign Exchange and Currency Markets

Foreign Exchange (Forex)

The market where currencies from different countries are bought and sold.

Foreign Exchange Rate

The price of one currency in terms of another.

Foreign Exchange Market

A global marketplace for exchanging national currencies.

Spot Transaction

A foreign exchange transaction involving the immediate exchange of currencies at the current (spot) rate.

Forward Transaction

A foreign exchange transaction in which participants agree to exchange currencies at a future date and at a predetermined rate.

Currency Swap

The conversion of one currency into another at one point in time with an agreement to reverse the transaction at a later date.

Currency Hedging

The use of financial instruments (like forwards or swaps) to protect against potential losses from exchange rate fluctuations.

Strategic Hedging

The spreading of operations and investments across different currency zones to offset potential currency losses in one region with gains in another.

Foreign Exchange Risk (Currency Risk)

The potential for losses due to unpredictable changes in exchange rates.

Exchange Rate Policy

A government’s approach to managing its national currency in relation to other currencies.

Floating Exchange Rate

A currency value determined by supply and demand in the foreign exchange market.

Fixed Exchange Rate

A system in which a currency’s value is tied to another major currency or a basket of currencies.

Pegged Exchange Rate

A specific type of fixed rate where a country’s currency is pegged to a stronger or more stable currency.

Devaluation

A deliberate downward adjustment of a country’s currency value relative to another currency or standard.

Revaluation

A deliberate upward adjustment of a country’s currency value.

Purchasing Power Parity (PPP)

The theory that exchange rates should adjust to equalize the price of identical goods and services in different countries.

Interest Rate Parity

A financial principle stating that the difference in interest rates between two countries equals the expected change in their exchange rates.

Arbitrage

The practice of profiting from price differences of the same asset or currency in different markets.

International Monetary Fund (IMF)

An international organization that provides financial assistance and advice to member countries facing balance of payments or currency crises.

Balance of Payments (BOP)

A record of a country’s international transactions, including trade, investment, and capital flows.

Current Account

The part of the BOP that records exports and imports of goods and services, plus income and transfers.

Capital Account

The part of the BOP that records transactions of assets such as stocks, bonds, and real estate between countries.

Speculation

The buying or selling of currencies in anticipation of future exchange rate movements.

Currency Crisis

A sudden and dramatic decline in the value of a nation’s currency, often triggered by loss of investor confidence.

Devaluation Risk

The potential loss that occurs when a country lowers the value of its currency.

IMF Conditionality

Policy reforms required by the IMF as a condition for providing loans to member countries.

Law of One Price

The principle that identical goods should sell for the same price in different countries when prices are expressed in a common currency.

Bid-Ask Spread

The difference between the price at which dealers buy (bid) and sell (ask) a currency.

Hard Currency

A currency that is widely accepted and stable in value (e.g., U.S. dollar, euro, yen).

Soft Currency

A currency that is less stable and not widely accepted internationally.