International Financial Markets

Question 1

Exchange Rate

Answer 1

Price of one currency in terms of another currency

Question 2

Fixed Exchange Rates

Answer 2

The rate at which the currency is pegged
Pros: Currency stability for the conduct of international trade. Lesser risks for businesses. Discourages currency speculation.
Cons: Requires central bank to maintain international reserves to defend currency’s par value. If BOP is deficit, govt sell international reserves which affects it’s ability to repay foreign debt
-Restrictive monetary and fiscal policies

Question 3

Flexible Exchange Rates

Answer 3

Pros: BOP equilibrium achieved allows govt to conduct independent monetary and fiscal policy.
Government can concentrate of domestic policy making without worrying about the BOP consequences of their actions
Con: Currency is subject to fluctuations and speculations

Question 4

Spot Rate

Answer 4

Exchange rate requiring delivery of traded currency within the business days. This

• Repatriates income from sales abroad
• Pays supplier in own currency
• Invest in another national market

Question 5

Forward Rate

Answer 5

Rate at which two parties will exchange currencies on specified future date.

Question 6

Transaction Risk

Answer 6

When financial benefits and costs of an international transaction can be affected by exchange-rate movements that occur after the firm is legally obligated to complete the transaction.

Question 7

Hedging against Transaction Risk

Answer 7

Protecting the amount it has to pay in foreign currency from increasing due to appreciation. It does this by entering a contract with a bank.

Question 8

Transaction Risk - Hedging - Currency Forward Contract

Answer 8

Enter forward contract with bank that fixes the exchange of foreign currency at a specific rate in a future date.

Question 9

Transaction Risk - Hedging - Currency Future Contract

Answer 9

Same as forward contract but the contract can be traded in a futures market as a commodity.

Question 10

Transaction Risk - Hedging - Currency Option

Answer 10

Same but option not obligation

Question 11

Translation Risk

Answer 11

Impact on the firm’s consolidated financial statements of fluctuations in exchange rates that change the value of foreign subsidiaries as measured in the parent’s currency

Question 12

Translation Risk - Balance Sheet Hedge

Answer 12

MNC matches its assets and liabilities which are denominated in the same currency

Question 13

Economic Risk

Answer 13

Impact on the value of a firm’s operations of unanticipated exchange rate changes. Firms need to analyse likely changes in exchange rates. Then adjust the mix of assets/liabilities/cash flows in terms of the currencies of denomination.

Question 14

Economic Risk - Diversification of Operations

Answer 14

MNC should diversify both production locations as well as markets across as many countries as possible.

Question 15

Economic Risk - Export-Oriented Production

Answer 15

Will not be fully exposed to poor market conditions in economy of operations.

Question 16

Economic Risk - Diversification of Financing

Answer 16

MNC should take financing in several currencies so that it is not fully exposed to sudden movements in Forex or interest rates in any single currency.