Foreign Exchange Market

Currency Conversion:
- Converts payments for exports, foreign investments, or licensing agreements.
- Makes foreign payments in local currency.
- Invests in short-term foreign money markets.
- Engages in speculation (e.g., carry trade).
Insuring Against Foreign Exchange Risk:
- Spot Exchange Rates: Rates that fluctuate daily based on supply and demand for immediate currency exchange.
- Forward Exchange Rates: Agreements to exchange currencies at a future date, usually quoted for 30, 90, or 180 days.
- Currency Swaps: Simultaneous buy/sell of currency with different value dates; common among banks and businesses.

Global Network:
- Composed of banks, brokers, and dealers operating via electronic systems.
- Major centers are London, New York, Zurich, Tokyo, and Singapore.
- 24/7 Market: Operates continuously due to high-speed communications.
- Arbitrage Opportunities: Buying low and selling high across different markets, particularly involving USD.

Law of One Price: Identical products must have the same price across countries when expressed in common currency.
Purchasing Power Parity (PPP): Price comparisons of identical goods determine real exchange rates.
Money Supply and Inflation: Growth in money supply indicative of future inflation; higher inflation leads to currency depreciation.
Interest Rates: Impacts exchange rates via the Fisher Effect and International Fisher Effect (IFE); reflects inflation expectations.
Investor Psychology: Short-term rate movements influenced by market sentiment and bandwagon effects.

Efficient Market School: Belief that forward exchange rates should accurately predict future spot rates.
Inefficient Market School: Forward rates may not reflect all information, leading to less accuracy.
Fundamental Analysis: Uses economic theories to model currency movements based on economic indicators.
Technical Analysis: Focuses on past price trends to predict future movements.

Types of Convertibility:
- Freely Convertible: Unlimited conversions allowed for residents and nonresidents.
- Externally Convertible: Residents can convert domestic currency without limitations.
- Nonconvertible: Restrictions on conversions.
Capital Flight: Happens during rapid depreciation of domestic currency; companies may counter this through countertrade.

Transaction Exposure: Effect of exchange rate fluctuations on individual transactions.
Translation Exposure: Impact of currency changes on financial statements.
Economic Exposure: Effect on future international earning power.
Risk Reduction Strategies:
- Forward contracts, buying swaps, lead/lag strategies for receivables management.
- Distributing assets across locations to mitigate risk.
Monitoring Practices:
- Need for central control, distinction between exposure types, forecasting, effective reporting systems.