BFF1001 Lecture Notes - Lecture 10: Spot Contract, Cash Flow, Libor
Week 10: Foreign Exchange
It is important to appreciate how foreign exchange risk can affect the cash flow
of assets and liabilities.
Foreign exchange risk can be defined as uncertainty in the value of foreign
currency payments and earnings; arising from unexpected appreciation or
depreciation of the foreign currency, in relation to the domestic currency or vice
versa.
When an exchange rate is expressed, e.g. AUD $1 = USD $0.71, to better
understand which is the currency being priced, the currencies are classified as a
commodity currency and a term currency.
• The commodity is the currency in one whole unit (or
denomination).
• The term is the currency for which an amount is exchanged for one
unit of the commodity.
e.g. AUD $1 = USD $0.71, the AUD is the commodity being
priced in terms of USD.
Exchange rates can be quoted in 2 ways …
1. Directly: the domestic currency is used as the term.
2. Indirectly: the foreign currency is used as the term.
Eurocurrency is a currency deposited in a bank or traded outside its country of
origin. It is not to be mistaken for the Euro €, the currency of the European
Monetary Union.
To illustrate:
Document Summary
It is important to appreciate how foreign exchange risk can affect the cash flow of assets and liabilities. Foreign exchange risk can be defined as uncertainty in the value of foreign currency payments and earnings; arising from unexpected appreciation or depreciation of the foreign currency, in relation to the domestic currency or vice versa. Exchange rates can be quoted in 2 ways : directly: the domestic currency is used as the term, indirectly: the foreign currency is used as the term. Eurocurrency is a currency deposited in a bank or traded outside its country of origin. It is not to be mistaken for the euro , the currency of the european. Euro-aussie is aud deposited and traded outside of australia; e. g. you take aud ,000 to the us while on holiday. The aud you have exchanged is termed euro-aussie. A euro-dollar deposit is a usd denominated deposit issued outside the. Us; for example, a us$ denominated deposit in citibank, london.
