Chapter_10_Exchange_Rates_and_Foreign_Ex

# 2 if the euro depreciated to 086 per euro the us

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2) If the euro depreciated to \$0.86 per euro, the U.S. importer should use the spot market in 3 months to save money.

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Foreign Exchange Derivatives Futures A and B agree to trade currencies at set price in the future. Either side of contract can be traded to third parties C, D, E,… (on exchanges). Parties left holding contract must deliver.
Foreign Exchange Derivatives Examples of how derivatives work Example 1: Hedging A Chief Financial Officer (CFO) of a U.S. firm expects to receive payment of €1 million in 90 days for exports to France. The current spot rate is \$1.40 per euro. The Chief Executive Officer (CEO) knows that losses would be incurred on the deal, if the dollar strengthened (i.e., the euro weakened) to less than \$1.30 per euro. What should the CFO do? Buy €1 million in put options on \$ at rate of \$1.35 per euro Insures the firm’s euro receipts will sell for at least this rate. The put option guarantees the firm a profit, even if the spot rate falls below \$1.35.

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Foreign Exchange Derivatives Examples of how derivatives work Example 2: Speculation One-year euro futures are currently priced at \$1.20. You expect the dollar will depreciate to \$1.32 in the next 12 months. What should you do? Buy these futures If you are proved right you will earn a 10% profit. Any level above \$1.20 will generate a profit. If the dollar is at or below \$1.20 a year from now, however, your investment in futures will be a total loss.
The Market for Foreign Exchange Private Actors Commercial banks The key players are foreign exchange traders, most of whom work for big commercial banks. They engage in interbank trading (all electronic) between bank accounts in different currencies. Major trading banks (% of volume) The top 5 banks account for 50% of the market. The top 10 banks account for 75% of the market. Bank deposits are the most important influence in the foreign exchange market.

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The Market for Foreign Exchange Private Actors Other players Major corporations (e.g., multinationals) Nonbank financial firms (e.g., mutual funds) By trading directly in the foreign exchange market, other players avoid paying fees and commissions charged by commercial banks. The volume of transactions needs to be large enough to make in-house currency trading worthwhile.
The Market for Foreign Exchange Government Intervention Governments may try to control or regulate the foreign exchange market. The government may: Impose capital controls to limit trading. Establish an official market for foreign exchange at government-set rates. This usually leads to the creation of a black market (illegal transactions at rates that differ from the official ones). Try to shut down the foreign exchange market through outlawing trading. Most often, government takes less drastic measures, relying on intervention to control foreign exchange prices.

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