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Chapter_10_Exchange_Rates_and_Foreign_Ex

Example in september a us importer may arrange for a

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Example: In September a U.S. importer may arrange for a special Christmas-season shipment of Japanese radios to arrive in October. The payment must be made in yen on October 20. To guard against the possibility of the yen’s becoming more expensive in terms of the dollar, the importer might contract with a bank to buy yen at the one- month forward rate, but not actually receive them until Oct 20 (maturity date) when they are needed.
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Foreign Exchange Derivatives Forwards : A currency is selling at a forward premium if the forward exchange price of a currency exceeds the current spot price. A currency is selling at a forward discount when the forward rate is less than the current spot rate. Example: is the dollar selling at a premium or at a discount? Spot 3-Month Forward $1 = € 0.88 $1 = € 0.90
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Foreign Exchange Derivatives Swaps A and B agree to trade at set price today and do reverse trade at a set price in the future. Swaps combine two contracts (a spot and a forward) into one. Example : Chase Manhattan Bank may have excess balances of dollars but need pounds to meet the requirements of its corporate clients. At the same time, Royal Bank of Scotland may have excess balances of pounds and insufficient amounts of dollars. The banks could negotiate a swap agreement in which Chase Manhattan Bank agrees to exchange dollars for pounds today and pounds for dollars in the future.
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Foreign Exchange Derivatives Options: an agreement between a holder (buyer) and a writer (seller) that gives the holder the right , but not the obligation, to buy or sell foreign currency at a prearranged price, within a few days or a couple of years. Although the holder is not obligated to buy or sell currency, the writer is obligated to fulfill a transaction. A call option gives the holder the right to buy foreign currency at a specified price. A put option gives the holder the right to sell foreign currency at a specific price. The price at which the option can be exercised (i.e., the price at which the foreign currency is bought or sold) is called the strike price.
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Foreign Exchange Derivatives An example of options: Suppose a U.S. importer is buying equipment from a German manufacturer with a € 1,000,000 payment due in 3 months. The importer can hedge against an euro appreciation by buying a call option that confers the right to purchase Euros over the next 3 months at a specific price. Assume that the strike price is $0.88 per euro. The fee of buying this call option is 1 cent per euro. This fee must be paid no matter the option is exercised or not. 1) If the euro appreciated to $0.92 over the next 3 months, then using the spot market in 3 months would raise the value of the imports in dollars. However, the call option will provide insurance against such change.
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