Foreign Exchange Markets

These flashcards cover key concepts, terminologies, and important facts regarding foreign exchange markets, their history, and relevant economic theories.

What is a foreign exchange (FX) market?

A market where cash flows from sales of products, services, or assets denominated in foreign currency are transacted.

What does a foreign exchange rate represent?

The price at which one currency can be exchanged for another currency.

What is currency depreciation?

When a country’s currency falls in value relative to other currencies.

What system governed FX markets during most of the 1800s?

A gold standard system where currency issuers guaranteed notes in equivalent amounts of gold.

What was the Bretton Woods Agreement?

A system established in 1944 that fixed exchange rates within narrow bands with government intervention until 1971.

What did the Smithsonian Agreement of 1971 allow?

It allowed the dollar to be devalued and increased the exchange rate fluctuation bands from 1% to 2.25%.

What is dollarization?

The use of a foreign currency alongside or instead of the local currency.

What significant currency shift did China undertake in 2005?

China shifted away from pegging its currency (the yuan) to the U.S. dollar.

What are spot FX transactions?

Immediate exchanges of currencies at the current exchange rate.

What percentage of FX transactions were spot transactions in 2019?

30.1% of the average daily trading volume.

What is the purpose of hedging in FX transactions?

To manage exposure to currency risks, thus reducing possible losses.

What is purchasing power parity (PPP)?

A theory explaining changes in foreign currency exchange rates based on inflation rates in different countries.

What does the interest rate parity theorem (IRPT) state?

The domestic interest rate should equal the foreign interest rate minus the expected appreciation of the domestic currency.

What is the 'Big Mac' index?

An example illustrating purchasing power parity, comparing the price of a Big Mac in different countries.

What is the role of financial institutions in FX transactions?

To facilitate international trade, hedge currency exposure, and allow speculation on future exchange rate movements.