IEU - Lecture 4 - Forward Exchange

IEU - Lecture 4 - Forward Exchange - Izmir University of...

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Izmir University of Economics ECON 306 INTERNATIONAL ECONOMICS Lecture 4 Forward Exchange and International  Financial Investment (Chapter 20 – The Foreign Exchange Market, pages 477-496)
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Exposure to Exchange Rate Risk You are exposed to exchange rate risk if the  value of your income or wealth or net worth will  change if exchange rates in the future change in  ways that are not expected. A forward foreign exchange  contract is an  agreement to exchange one currency for another  on some date in the future at a price set now (the  forward exchange rate).
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Exposure to Exchange Rate Risk Hedging  is taking an action to reduce your exposure to  exchange rate risk. Hedging involves acquiring an asset  in a foreign currency to offset a net liability position  already held in the foreign currency, or acquiring a  liability in a foreign currency to offset a net asset position  already held.  Speculation  is taking an action that increases your  exposure to exchange rate risk, usually to try to profit  from your belief about what future exchange rates will  be. Speculating means committing oneself to an  uncertain future value of one’s net worth in terms of  home currency.  
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Hedging – an example Consider a Turkish company that has bought some  merchandise and will have to pay £100,000 three months from  now.  The company is exposed to exchange rate risk.  One way to hedge its risk exposure is to enter into a forward  contract to buy £100,000 in 90 days. If the current forward rate is 1£ = 2.5 YTL, then the company  must deliver (sell) 250,000 YTL in 90 days.  The company is owed pounds in the contract.  If the future spot exchange rate is 1£ = 2.7 YTL, the company  saves 20,000 YTL (0.2 x 100,000). 
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Hedging – an example Alternatively the company can buy the pound today  at the spot rate (1£ = 2.5 YTL) and invest the  money in England until the payment is due.  If the interest rate in Turkey is higher this will not be 
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This note was uploaded on 08/06/2009 for the course ECONOMICS ECON 306 taught by Professor Alperduman during the Spring '09 term at Izmir University of Economics.

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IEU - Lecture 4 - Forward Exchange - Izmir University of...

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