– Tells us how many units of money (dollars in the United States, yen in Japan, baht in Thailand, pesos in
Mexico, or yuan in China) we must pay to buy apples, bananas, a car, or a personal computer.
These money prices
must reflect relative prices or opportunity costs.
– Sometimes referred to as the “real price”, it is the price measured in “real” units (that is, other goods)
rather than monetary or “nominal” units (such as dollars or yen).
– The number of units of domestic currency required to purchase 1 unit of the foreign currency.
Foreign Exchange Market
– Generic term for the worldwide institutions that exist to exchange or trade different
– Something of value, such as a house, a diamond, an acre of land, a bank deposit, a share of Microsoft stock, or
a U.S. Treasury bond.
– A set of assets owned by a firm or individual. “Portfolio Choice” refers to allocating one’s wealth
among various types of assets, some of which may produce pleasure from consumption (houses or DVD players or
sports cars), and some which produce income (gains from stock or bank interest).
Spot Foreign Exchange Market
– The market in which participants trade currencies for current delivery.
– Transaction where currencies are exchanged and changed out on the spot foreign exchange market.
– Refers to the process by which banks, firms, or individuals (mainly banks in the case of foreign exchange)
seek to earn a profit by taking advantage of discrepancies among prices that prevail simultaneously in different
Inconsistent Cross Rates
– This is the condition that exists which makes arbitrage possible.
– Where multiple currencies can be traded for a profit.
If you can trade dollars for euros and
then euros for pounds and pounds back for dollars and make a profit, then an inconsistent cross rate exists.
– A way to transfer the foreign exchange risk inherent in all noninstantaneous transactions, such as
international trade, that involve two currencies.
Foreign Exchange Risk
– An inherent risk in all noninstantaneous transactions, such as international trade.
– When you purchase a good in another currency and instead of exchanging the currency right away,
you put it into a deposit to earn interest and trade the currency when the payment comes due.
Balanced (Closed) Position
– The position you are in once you’ve purchased the currency you need for trade and the
exchange rate can no longer affect you.
– Deliberately making your wealth depend on changes in the exchange rate by either buying a deposit
denominated in a foreign currency (taking a long position) in the expectation that the currency’s price will rise,
allowing you to sell it later at a profit, or promising to sell a foreign-currency deposit in the future (taking a short
position) in the expectation that its price will fall, allowing you to buy the currency cheaply and sell it at a profit.
30-day Forward Rate