Chap009 - Chapter 9 Chapter 9 The Foreign Exchange Market...

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Unformatted text preview: Chapter 9 Chapter 9 The Foreign Exchange Market 9-2 Introduction Question: What is the foreign exchange market? The foreign exchange market is a market for converting the currency of one country into that of another country Question: What is the exchange rate? The exchange rate is the rate at which one currency is converted into another 9-3 The Functions of the Foreign Exchange Market Question: What is the purpose of the foreign exchange market? The foreign exchange market 1. enables the conversion of the currency of one country into the currency of another 2. provides some insurance against foreign exchange risk (the adverse consequences of unpredictable changes in exchange rates) 9-4 Currency Conversion International firms use foreign exchange markets to convert export receipts, income received from foreign investments, or income received from licensing agreements to pay a foreign company for products or services to invest spare cash for short terms in money markets for currency speculation (the short-term movement of funds from one currency to another in the hopes of profiting from shifts in exchange rates) 9-5 Insuring Against Foreign Exchange Risk The foreign exchange market can be used to provide insurance to protect against foreign exchange risk (the possibility that unpredicted changes in future exchange rates will have adverse consequences for the firm) A firm that protects itself against foreign exchange risk is hedging The market performs this function using 1. spot exchange rates 2. forward exchange rates 3. currency swaps 9-6 Insuring Against Foreign Exchange Risk 1. Spot Exchange Rates The spot exchange rate is the rate at which a foreign exchange dealer converts one currency into another currency on a particular day Spot rates are determined by the interaction between supply and demand, and so change continually 9-7 Insuring Against Foreign Exchange Risk 2. Forward Exchange Rates A forward exchange occurs when two parties agree to exchange currency and execute the deal at some specific date in the future A forward exchange rate is the exchange rate governing such a future transaction Forward rates are typically quoted for 30, 90, or 180 days into the future 9-8 Insuring Against Foreign Exchange Risk 3. Currency Swaps A currency swap is the simultaneous purchase and sale of a given amount of foreign exchange for two different value dates Swaps are used when it is desirable to move out of one currency into another for a limited period without incurring foreign exchange rate risk 9-9 The Nature of the Foreign Exchange Market The foreign exchange market is a global network of banks, brokers, and foreign exchange dealers connected by electronic communications systems The market is always open somewhere in the world If exchange rates quoted in different markets were not essentially the same, there would be an opportunity for arbitrage (the process of buying a currency low and selling it high) Most transactions involve U.S. dollars on one side The U.S. dollar is a vehicle currency 9-10...
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Chap009 - Chapter 9 Chapter 9 The Foreign Exchange Market...

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