Lecture 11 - Lecture 11 Foreign Exchange Market 1 Outline A...

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1 Lecture 11 Foreign Exchange Market
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2 Outline A. Foreign Exchange Market and Its Functions B. The Nature of Foreign Exchange Market C. Exchange Rate Determination D. Convertibility and Government Policy E. Managerial Implications
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3 A. Foreign Exchange Market and Its Functions Foreign exchange market A global network of banks, brokers and foreign exchange dealers connected by electronic communications systems A market for converting the currency of one country into the currency of another Exchange rate The rate at which one currency is converted into another Foreign exchange risk The risk that arises from changes in exchange rates Two functions of foreign exchange market: Converting currencies Providing insurance against foreign exchange risk
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4 A. Foreign Exchange Market and Its Functions Currency conversion occurs when: companies receive payment in foreign currencies and they have to convert these payments to their home currency companies pay foreign businesses for goods or services companies invest spare cash for short terms in money market accounts companies take advantage of changing exchange rates (Currency speculation) The short-term movement of funds from one currency to another in the hopes of profiting from shifts in exchange rates
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5 A. Foreign Exchange Market and Its Functions To understand how the foreign exchange market provides insurance to protect against foreign exchange risk: Spot exchange rate Forward exchange rate Currency swap
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6 A. Foreign Exchange Market and Its Functions Spot exchange rate The rate of currency exchange on a particular day Example: When a HK tourist in London goes to a bank to convert HK$ into £, the exchange rate is the spot rate for that day
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7 A. Foreign Exchange Market and Its Functions Forward exchange occurs when: two parties agree to exchange currencies and execute the deal at some specific future date forward exchange rates are the exchange rates governing such future transactions Example: A US firm imports PCs (¥200,000) from Japan Pay ¥ in 30 days when the shipment arrives Spot exchange rate $1 = ¥120 Costs $1,667 (¥200,000/ ¥120) Over next 30 days, $1 = ¥95 (US$ depreciates against ¥) Pay ¥200,000 (or $2,105) to a Japanese supplier Loss Enters into a 30-day forward exchange transaction $1 = ¥110 Pay ¥200,000 (or $1,818) to a Japanese supplier
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8 A. Foreign Exchange Market and Its Functions Currency swap Simultaneous purchase and sale of a given amount of foreign exchange for two different value dates. Moving out of one currency into another for a limited period without incurring foreign exchange risk. “spot against forward”
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This note was uploaded on 11/02/2009 for the course FB AF2602 taught by Professor Aliceshiu during the Winter '08 term at Polytechnic University of Puerto Rico.

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Lecture 11 - Lecture 11 Foreign Exchange Market 1 Outline A...

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