IBUS chapter 10

What are foreign exchange loses?

Occur when the value of a foreign currency decreases relative to a company's home currency, leading to a financial loss when transactions denominated in that foreign currency are settled

How can changes in Currency rates effect companies and their operation costs.

In the case of Asian airlines they pay for jet fuel in dollars, and borrow money in dollars. so when their home currency drops it becomes more expensive for them to pay for these necessities.

What were the three main objectives of this chapter ?

1. To explain how the Foreign exchange market works

2. To examine the forces that determine exchange rates and discuss the degree to which it is possible to predict future exchange rate movements

3. To map the implications for international business of exchange rate movements

Foreign Exchange Market

A Market for converting the currency of one country into that of another country.

Exchange rate

The rate at which one currency is converted into another.

Without the foreign exchange market,

International trade and international investment on the scale that we see today would be impossible; companies would have to resort to barter.

True or False

true

The rate at which one currency is converted into another cannot change over time.

True or False

False

Let’s say the United States Dollar fell in value compared to the Euro. Would American Companies sales increase in Europe why or why not

Yes because American Goods would be cheaper in Europe boosting sales.

Foreign Exchange Risk

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

1. To convert the currency of one country into the currency of another.

2. To provide some insurance against Foreign exchange risk, or the adverse consequences of unpredictable changes in exchange rates.

These two are the main functions of what …

Foreign exchange market.

What are the 3 uses for the foreign exchange market by International Businesses

1. To convert money they receive from exports and foreign investments

2. To convert money so they can pat foreign countries in their foreign currency

3. To convert money to invest in foreign short term money markets, where interest rates could possibly be higher

currency speculation

Involves short-term movement of funds from one currency to another in hopes of profiting from shifts in exchange rates.

T or F “In general, however, companies should beware, for speculation by definition is a very risky business. The company cannot know for sure what will happen to exchange rates.”

True

carry trade

A kind of speculation that 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.

This is an Example of ….

For example, if

The interest rate on borrowings in Japan is 1 percent but the interest rate on deposits in American banks is 6 percent,

it can make sense to borrow in Japanese yen, convert the money into

U.S. dollars, and deposit it in an American bank. The trader can make a 5 percent margin by

doing so, minus the transaction costs associated with changing one currency into another.

Carry Trade

spot exchange rate

The exchange rate at which a foreign exchange dealer

will convert one currency into another that particular day.

Choose the example that show how Spot Exchange rate can change over time?

Imagine the spot exchange rate is £1 =

$1.25 when the market opens. As the day progresses, dealers demand more dollars and fewer

pounds. By the end of the day, the spot exchange rate might be £1 = $1.23. Each pound now

buys fewer dollars than at the start of the day. The dollar has appreciated, and the pound has

depreciated.

For example, a U.S. company that imports high-end cameras from Japan knows that in 30 days it must pay yen

to a Japanese supplier when a shipment arrives. The company will pay the Japanese supplier

¥200,000 for each camera, and the current dollar/yen spot exchange rate is $1 = ¥120. At this

rate, each camera costs the importer $1,667 (i.e., 1,667 = 200,000/120). The importer knows

she can sell the cameras the day they arrive for $2,000 each, which yields a gross profit of $333

on each ($2,000 − $1,667). However, the importer will not have the funds to pay the Japanese

supplier until the cameras are sold. If, over the next 30 days, the dollar unexpectedly depreci-

ates against the yen, say, to $1 = ¥95, the importer will still have to pay the Japanese company

¥200,000 per camera but in dollar terms that would be equivalent to $2,105 per camera, which is more than she can sell the cameras for.

This is an Example of…

How Spot exchange rates can be problematic for an international business

forward exchange

When two parties agree to exchange currency and exe-

cute a deal at some specific date in the future.

forward exchange rate

The exchange rate governing a forward exchange transaction.

For most major currencies, forward exchange rates are quoted for…

30 days, 90 days, 180days. Into the future. Sometimes even several years into the future.

According to the most recent data, forward instruments (Exchange rates) account for about ______ of all foreign exchange transactions.

2/3

currency swap

Simultaneous purchase and sale of a given amount of

foreign exchange for two different value dates.

which country is the most important trading center in the world

London, England.

arbitrage

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

What are the two features of the Foreign exchange market.

1. The market never sleeps - When London and Tokyo close, San Francisco and Sydney are still open.

2. The integration of various trading centers - High Speed computer linkages among trading centers around the globe have effectively created a single market.

T or F “The purchase of securities in one market for immediate resale in another to profit from a price discrepancy.

True

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.

What is Purchasing Power Parity (PPP)

is a theory that suggests exchange rates between two currencies should reflect the difference in the price levels of a basket of goods and services between the two countries, aiming to equalize the purchasing power of different currencies.