ADM 3318 Lecture Notes - Lecture 10: Foreign Exchange Risk, The Foreign Exchange, Exchange Rate
16 Jun 2018
School
Department
Course
Professor
The Foreign Exchange Market (FEM)
Impact
A vital cog in the interdependent global economy
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On firm's strategy on costs, profitability, profits
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On a nation's trade, economy, fiscal and monetary policy
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On the levels of vulnerability of a nation state
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Functions
A market to convert currency
Exchange rate - the rate at which one currency is exchanged for
another
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Protection against adverse consequences of
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Foreign exchange risk
Risks are inherent in all of the following cases
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Receive payments from other companies for services rendered, licensing,
foreign investments
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To pay a foreign company for its services in that currency
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Investing spare cash in money markets over short term
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Speculation to take advantage of arbitrage differences between different
currencies
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Protecting/insuring against currency exchange risk
Spot exchange rates
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Forward exchange rates
Exchange rates governing transactions - when two parties agree to
exchange currency and execute the deal at some specific data in the
future
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Currency swaps
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Global money markets
There should be as many markets are there are countries
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Constructs to understand FEX rate determination
Exchange rate and price
Law of one price
Every product should cost the same in every country with the
local currency
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There is one price for all products□
Unfortunately this law isn't necessarily true □
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Purchasing Power Parity
The big mac index□
Finding out if all countries have the same price of the basket
of goods
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PPP uses the law of one price and expands its □
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Money supply and price inflation
If a country isn't doing well, they start printing a lot of money
The more money being printed, the higher the inflation
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Most global comparisons happen I the context of the USD
This automatically can take inflation trends into account
as well
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Some points to note on PPP theory
Assumption of other factors as having no impact
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Empirical tests seem to substantiate PPP and exchange theory when
inflation rates are high
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Relatively ineffective in predicting exchange rates where
inflationary trends are small and under tight leash
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Dependant on levels of competition in a country
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Levels of multinational reach and importance of arbitraging
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Governmental intervention in propping currency - the country list
could be endless
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Exchange rate and relation to interest rates
High interest rates --> high inflation
Concept of nominal interest and real interest □
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The Fisher Effect --> i = r + I
i = nominal rate of interest rate
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r = real rate of interest
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I = expected rate of inflation
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The fisher effect says that the real interest rates should be the
same in each country, while the nominal rate will include both
real rate and expected inflation
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Investor psychology
Like most theories, it is hard to estimate the effect of
psychology on Fx rates
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Some people/firms seem to have a multiplier effect on rates
and can cause havoc
The Tipping Point
Probability of chance - on seemingly synchronised
behaviour
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Unpredictable
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Move as a herd
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Triggered at macro level by politics, economic factors and correct or
incorrect perception of such effects
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Class 10 - Feb. 7th
Wednesday, February 7, 2018
08:56
Document Summary
A vital cog in the interdependent global economy. On a nation"s trade, economy, fiscal and monetary policy. On the levels of vulnerability of a nation state. Exchange rate - the rate at which one currency is exchanged for another. Risks are inherent in all of the following cases. Receive payments from other companies for services rendered, licensing, foreign investments. To pay a foreign company for its services in that currency. Investing spare cash in money markets over short term. Speculation to take advantage of arbitrage differences between different currencies. Exchange rates governing transactions - when two parties agree to exchange currency and execute the deal at some specific data in the future. There should be as many markets are there are countries. Every product should cost the same in every country with the local currency. Finding out if all countries have the same price of the basket of goods. Ppp uses the law of one price and expands its.
