Global Final: Chapter 10 study guide
Global Final: Chapter 10 study guide INTB3080
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This 3 page Study Guide was uploaded by Madison Morman on Wednesday April 20, 2016. The Study Guide belongs to INTB3080 at University of Cincinnati taught by Dr. Ratee Apana in Spring 2016. Since its upload, it has received 217 views. For similar materials see Global Environment of Business in International Business at University of Cincinnati.
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Date Created: 04/20/16
Chapter 10 - The Foreign Exchange Market The Foreign Exchange Market Please know definitions and following terms. This covers the material that will be asked on the test. The foreign exchange market : Market for converting the currency of one country into that of another country. The exchange rate : The rate at which one country is into that of another country THE FUNCTIONS OF THE FOREIGN EXCHANGE MARKET Currency Conversion Currency speculation: Short-term movement of funds from one currency to another in the hopes of profiting from shifts in exchange rates. Insuring Against Foreign Exchange Risk Foreign exchange risk: The adverse consequences of unpredictable change in exchange rates Spot Exchange Rates: Rate at which a foreign exchange dealer converts one currency into another currency on a particular day. Forward Exchange Rates: Exchange rates when two parties agree to exchange currency and execute a deal at a certain date in the future. Currency Swaps: Simultaneous purchase and sale of a given amount of foreign exchange for tow different value dates. THE NATURE OF THE FOREIGN EXCHANGE MARKET Arbitrage: Buying a currency low and selling it high The U.S. dollar frequently serves as a vehicle currency to facilitate the exchange of two other currencies. ECONOMIC THEORIES OF EXCHANGE RATE DETERMINATION: Prices and Exchange Rates To understand how prices are linked to exchange rates, it is important to understand the law of one price. The Law of One Price: States that in competitive markets free of transportation costs and barriers to trade (tariffs), identical products sold in different countries must sell for the same price when their prie is expressed in terms of the same currency. 9-1 Chapter 09 - The Foreign Exchange M arket Purchasing Power Parity: Predicts that exchange rates are determined by relative prices and that changes in relative prices will result in a change in exchange rates. Money Supply and Price Inflation: A country where price inflation is running wild should expect to see its currency depreciate against that of countries where inflation is lower. (There is a positive relationship between the inflation rate and the level of money supply. When the growth in a country’s money supply is greater than the growth in its output, inflation will occur. A country with a high inflation rate will see its currency depreciate) Investor Psychology and Bandwagon Effects Country Focus: Anatomy of a Currency Crisis (Korea compare this with the Mexican crisis) CURRENCY CONVERTIBILITY Freely convertible: When the country’s government allows both residents and nonresidents to purchase unlimited amounts of a foreign currency Externally convertible: When obly nonresidents may convert currency into a foreign currency without any limitations Non-convertible: When neither residents or nonresidents are allowed to convert into a foreign currency Capital flight: When residents and nonresidents rush to convert their holdings of domestic currency into a foreign currency Countertrade: A range of barter-like agreements by which goods and services can be traded for other goods and services. IMPLICATIONS FOR MANAGERS Transaction Exposure: The extent to which the income from individual transactions is affected by fluctuations in foreign exchange values Translation Exposure: Impact of currency exchange rate changes on the reported financial statements of a company Economic exposure: The extent to which a firm’s future international earning power is affected by changes in exchange rates 9-2 Chapter 10 - The Foreign Exchange Market Reducing Translation and Transaction and Economic Exposure A lead strategy: Involves attempting to collect foreign currency receivables early when a foreign currency is expected A lag strategy: Delaying collection of foreign currency receivables if that currency is expected to appreciate and delaying payables if that currency is expected to depreciate. Some other Steps for Managing Foreign Exchange Risk To manage foreign exchange risk: (a) Central control of exposure is needed to protect resources efficiently and ensure that each subunit adopts the correct mix of tactics and strategies; (b) Firms should distinguish between transaction and translation exposure on the one hand, and economic exposure on the other hand; (c) The need to forecast future exchange rates cannot be overstated; (d) Firms need to establish good reporting systems so the central finance function can regularly monitor the firm’s exposure position; (e) The firm should produce monthly foreign exchange exposure reports. Read the cases as per the schedule. 9-3
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