But changed economic realities not speculation are

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International Financial Management
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Chapter 6 / Exercise 2
International Financial Management
Madura
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But changed economic realities, not speculation, are normally the underlying causes of changes currency values. That was largely the case with the southeast Asian countries in which actual an threatened bankruptcies in the financial and manufacturing sectors undermined confidence in th strength of the currencies. Anticipating the eventual declines in currency values, speculators sim hastened those declines. That is, the declines in value probably would have occurred with or wit speculators. Moreover, on a daily basis, speculation clearly has positive effects in foreign exchange markets. Smoothing Out Short-Term Fluctuations in Currency Prices When temporarily weak demand or s supply reduces a currency's value, speculators quickly buy the currency, adding to its demand a strengthening its value. When temporarily strong demand or weak supply increases a currency's value, speculators sell the currency. That selling increases the supply of the currency and reduc value. In this way speculators smooth out supply and demand, and thus exchange rates, over sh time periods. This day-to-day exchange-rate stabilization aids international trade. Absorbing Risk Speculators also absorb risk that others do not want to bear. Because of potenti adverse changes in exchange rates, international transactions are riskier than domestic transac
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International Financial Management
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Chapter 6 / Exercise 2
International Financial Management
Madura
Expert Verified
Suppose AnyTime, a hypothetical retailer, signs a contract with a Swiss manufacturer to buy 10, Swatch watches to be delivered in three months. The stipulated price is 75 Swiss francs per wat which in dollars is $50 per watch at the present exchange rate of, say, $1 = 1.5 francs. AnyTime bill for the 10,000 watches will be $500,000 (= 750,000 francs). But if the Swiss franc were to appreciate, say, to $1 = 1 franc, the dollar price per watch would ri from $50 to $75 and AnyTime would owe $750,000 for the watches (= 750,000 francs). AnyTime reduce the risk of such an unfavorable exchange-rate fluctuation by hedging in the futures mark Hedging is an action by a buyer or a seller to protect against a change in future prices. The futur market is a market in which currencies are bought and sold at prices fixed now, for delivery at a specified date in the future. Anytime can purchase the needed 750,000 francs at the current $1 = 1.5 francs exchange rate, with delivery in three months when the Swiss watches are delivered. And here is where specula come in. For a price determined in the futures market, they agree to deliver the 750,000 francs t AnyTime in three months at the $1 = 1.5 francs exchange rate, regardless of the exchange rate The speculators need not own francs when the agreement is made. If the Swiss franc depreciate say, $1 = 2 francs in this period, the speculators profit. They can buy the 750,000 francs stipulat the contract for $375,000, pocketing the difference between that amount and the $500,000 Any has agreed to pay for the 750,000 francs. If the Swiss franc appreciates, the speculators, but no AnyTime, suffer a loss. The amount AnyTime must pay for this “exchange-rate insurance” will depend on how the marke

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