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exam%202%20study%20guide%20finished[1] - Foreign Exchange...

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Foreign Exchange Market - 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 of an investment’s value changing due to changes in currency exchange rates Arbitrage - the purchase of a product in one market for immediate resale in a second market in order to profit from a price discrepancy Currency Speculation - short-term movement of funds from one currency to another in hopes of profiting from shifts in exchange rates Spot Exchanges - the exchange rate at which a foreign exchange dealer would convert one currency into another currency on that day Forward Exchange Rate - the exchange rate at which a foreign exchange dealer will agree to convert one currency into another currency on a specific date in the future Forward Exchanges – when two parties agree to exchange currency and execute a deal at some specific date in the future Hedging: Forward Contracts - provide for two parties to exchange currencies on a future date at an agreed upon exchange rate. Usually for 30, 90, or 180 days. Changes in the spot rate at the end of the contract will result in equal but opposite gains and losses by the two parties. Options - Give the right, but not the obligation, to buy or sell a certain amount of foreign currency at a set exchange rate at a specified time. Result in asymmetric risk; only the holder of the option will gain if there is a change in the value of the currencies. Currency Swaps - A foreign exchange transaction between two firms in which one currency is converted into another at Time 1, with an agreement to revert back to the original currency at a specific Time 2 in the future. Swaps bring together two counter-parties with opposite hedging needs. Selling on a Discount - foreign exchange dealers expect the currency to depreciate; a USD could buy more euro today than in the future at the forward rate Selling at a Premium - foreign exchange dealers expect the currency to appreciate; a USD could buy fewer euro today than in the future at the forward rate Economic Theories of Exchange Rate Determination – includes price inflation and exchange rates, interest and exchange rates, and investor psychology and “Bandwagon” effects Law of One Price – in competitive markets free of transportation costs and barriers to trade, identical products sold in different countries must sell for the same price when their price is expressed in the same currency
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Purchasing Power Parity – an adjustment in gross domestic product per capita to reflect differences in the cost of living Purchasing Power Parity Puzzle- the failure to find a strong link between relative inflation rates and exchange rate movements.
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