Hedging Flashcards
(11 cards)
What is purchasing power parity
It claims that the rate of exchange between two currencies depends on the relative inflation rates within the respective countries
Higher inflation = depreciation in currency
How to estimate future spot rates with PPP
Current spot rate * 1+foreign inflation/1+uk inflation
What is interest rate parity theory
It claims that the difference between the spot and future exchange rates is equal to the differential between interest rates available in two currencies
How to estimate future spot rates with IRP
Current spot rate * 1+foreign interest rate/1+uk interest rate
Risks of overseas trade
Physical risk
Trade risk
Liquidity risk
Credit risk
Types of financial risk
Transaction risk
Economic risk
Translation risk
What is transaction risk
The risk that the exchange rate will change between date of contract and date of settlement
What is economic risk
Value of the business will be affected by long run changes in exchange rates
What is translation risk
Reported performance will be affected by exchange rate movements
How to manage economic risk
Diversify internationally
How to manage transaction risk
Invoice in sterling
Leading and lagging
Matching assets and liabilities
Foreign currency bank accounts
