Comprehensive Guide to Exchange Rates, Market Mechanics, and Regimes

What is an exchange rate?

The relative price of different currencies.

What happens when a currency appreciates?

It buys more of another currency.

What happens when a currency depreciates?

It buys less of another currency.

How do changes in exchange rates affect prices?

They affect the relative prices of goods and assets from different countries.

What was the dollar value of the euro in 2018?

$1.1325.

What was the dollar value of the euro in 2019?

$1.1045.

What was the percentage change of the euro against the dollar from 2018 to 2019?

−2.47%.

What was the euro value of the dollar in 2018?

€0.8830.

What was the euro value of the dollar in 2019?

€0.9054.

What was the percentage change of the dollar against the euro from 2018 to 2019?

+2.53%.

How do you calculate the average change in currency value?

By weighing the changes based on trade percentages.

If country 1's currency depreciates by 10% and country 2's currency appreciates by 30%, what is the average change for Home currency?

+14%.

What does a bilateral exchange rate show?

The price at which one currency is exchanged for another.

What is the impact of a currency appreciating relative to one currency but depreciating relative to another?

It can appreciate against one currency while depreciating against another.

What is the effective exchange rate?

It reflects the average change in the value of a currency against a basket of currencies.

What is the effect of a currency that appreciates by 30% against Home currency?

Home's effective exchange rate appreciates.

What is the effect of a currency that depreciates by 10% against Home currency?

Home's effective exchange rate depreciates.

What does the term 'purchasing power parity' refer to?

The relationship between exchange rates and price levels.

What is the balance of payments?

A record of all economic transactions between residents of a country and the rest of the world.

What is the relationship between exchange rates and interest rates?

Interest rate parity explains how exchange rates are influenced by interest rates.

What is the significance of the euro-dollar exchange rate?

It indicates the value of euros in terms of dollars.

What is arbitrage in the context of foreign exchange?

The practice of taking advantage of price differences in different markets.

What does it mean if the euro-dollar exchange rate changes from €0.780 to €0.745?

Fewer euros are needed to buy a dollar.

What is the relationship between trade flows and currency value?

A country's overall transactions affect its currency value.

What is the role of the foreign exchange market?

To facilitate the exchange of currencies.

What is the impact of exchange rate fluctuations on international finance?

They affect trade balances and investment flows.

What is the importance of understanding exchange rate behavior?

It helps in making informed financial decisions.

What happened to the value of the U.S. dollar against a basket of 7 major currencies by early 2008?

It depreciated by 35%.

What was the depreciation of the U.S. dollar against a broad basket of 26 currencies by 2008?

It lost only 25%.

What are the two channels through which exchange rates affect the economy?

Relative prices of goods and relative prices of assets across countries.

How did the dollar-euro exchange rate change from May 2014 to February 2019?

It changed from $1.4 per € to $1.1 per €.

How much did a pair of Italian boots cost in dollars in 2014?

$140.

How much did a pair of Italian boots cost in dollars in 2019?

$110.

What happens to the relative price of European goods to American goods when the dollar-euro exchange rate decreases?

It decreases.

What was the worth of €714 in dollars in February 2019?

$785.

What was the worth of $1400 in euros in February 2019?

€1273.

What does a decrease in the dollar-euro exchange rate imply for Americans owning Eurozone assets?

It leads to a reduction in their wealth.

What does a decrease in the dollar-euro exchange rate imply for Eurozone residents owning American assets?

It leads to an increase in their wealth.

What does a change in the dollar-euro exchange rate from $0.9 per € to $1.3 per € imply?

The euro has strengthened against the dollar and the dollar price of the book has risen.

What happens to VW's profits in euros if the exchange rate changes from $0.9 per € to $1.3 per €?

VW's profits in euros will decrease.

What is a fixed exchange rate?

An exchange rate that does not fluctuate against some base currency over a sustained period.

What is a floating exchange rate?

An exchange rate that typically fluctuates over time without government intervention.

What is an advantage of fixed exchange rates?

They reduce uncertainty in trade and investment.

What is a disadvantage of fixed exchange rates?

They require substantial foreign exchange reserves.

What is the relationship of the U.S. dollar to the yen, pound, and Canadian dollar?

The U.S. dollar is in a floating relationship with these currencies.

What is the nature of the U.S. dollar's exchange rate regime?

It is subject to a great deal of volatility because it is in a floating regime.

What currencies float against the euro?

The pound and the yen float against the euro.

What is a fixed exchange rate example?

The Danish krone provides an example of a fixed exchange rate.

What is a band in exchange rate regimes?

A fixed regime with tiny variation, no more than plus or minus 2%.

What is a managed float?

A type of exchange rate between a fixed rate and a free float, as seen in India, Thailand, and Korea.

What financial crises affected Thailand and South Korea?

The 1997 Asian financial crises.

What happened to Argentina's currency after financial crises?

Argentina was forced to abandon a hard peg.

What is a crawling peg?

A system where a currency is allowed to gradually depreciate, as seen with the Colombian peso.

What is dollarization?

The process when a country unilaterally adopts the currency of another country, as occurred in Ecuador in 2000.

What is the forex market?

A market where exchange rates are set, conducted 'over the counter' between parties.

What was the daily trading volume of the global forex market in April 2019?

$6.6 trillion per day.

Where is the largest foreign exchange center located?

In the United Kingdom, mostly in London.

What is a spot contract?

A contract for the immediate exchange of one currency for another.

What percentage of forex transactions are spot contracts?

More than 80%.

What happens if the exchange rate is $1/€ and a firm expects €1 million?

The firm will break even.

What is the result if the exchange rate turns to $0.90/€?

The firm will make a loss of $100,000.

What are derivatives in the context of foreign exchange?

Contracts with pricing derived from the spot rate.

What is a forward contract?

A contract where the settlement date for currency delivery is in the future.

What is a forward premium?

When the current forward exchange rate exceeds the current spot rate.

What is a forward discount?

When the current forward rate is less than the current spot rate.

What is the current spot rate for the US dollar if $1 = €0.88?

The dollar is selling at a forward premium if the forward rate is $1= €0.90.

What does it mean when the dollar is selling at a forward discount?

The dollar is expected to depreciate in the future.

What should a trader do if they expect the euro to appreciate from $1.20 to $1.32?

Buy euro forwards today.

What profit will a trader earn if the euro appreciates to $1.32?

10% profit.

What happens if the euro is at or below $1.20 in one year?

The investment in forwards will result in a total loss.

What is the exchange rate in New York for dollars to pounds?

£0.50 per dollar.

What is the exchange rate in London for dollars to pounds?

£0.55 per dollar.

What profit does a trader make by arbitraging between New York and London?

$10 million profit.

What is arbitrage?

A trading strategy that exploits price differences.

What is the no-arbitrage condition?

No opportunities to make a profit exist.

What happens to the demand for dollars in New York when arbitrage occurs?

The demand for dollars rises.

What happens to the supply of dollars in London when arbitrage occurs?

The supply of dollars rises.

What is a vehicle currency?

A third currency used in foreign exchange transactions.

What percentage of foreign exchange transactions use the U.S. dollar as a vehicle currency?

87%.

What is the exchange rate for Singaporean dollar (SGD) in terms of South Korean won (SKW) given ESGD/$ = 1.3391 and ESKW/$ = 1337.65?

ESKW/SGD = ESKW/$ / ESGD/$.

What is the purpose of arbitrage in the foreign exchange market?

To exploit price differences for profit.

How many distinct currencies are there in the world?

167 distinct currencies.

How many active exchange markets are there if every possible currency pair is counted?

13,861 active exchange markets.

What happens to the spot rate in New York when the supply of dollars rises?

The spot rate decreases.

What happens to the spot rate in London when the demand for dollars rises?

The spot rate increases.

What is the effect of arbitrage on exchange rates?

It causes exchange rates to converge to the same level.

What is the impact of transaction costs on arbitrage opportunities?

They can create minuscule spreads.

What is the relationship between exchange rates in different locations under capital mobility?

They tend to equalize due to arbitrage.