Topic 9 Foreign Exchange Markets Flashcards Preview

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Flashcards in Topic 9 Foreign Exchange Markets Deck (41)
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1
Q

Exchange Rate

A

The value of one currency relative to another

2
Q

Floating Exchange rate

A

an exchange rate is determined by supply and demand factors in the FX market

3
Q

Managed Float

A

an exchange rate is held within a defined band relative to another currency, limited fluctuations allowed

4
Q

FX markets

A

markets that facilitate the buying and selling of foreign currencies

5
Q

FX market participants can be classified as

A
  • FX dealers and brokers
  • Central banks
  • Firms conducting international trade transactions
  • Investors and borrowers in the international capital markets
  • Foreign currency speculators
  • Arbitrageurs
6
Q

FX dealers

A
  • institutions that quote buy (bid) and sell (offer) prices and act as pricipals in the FX market
7
Q

FX dealers

A

Obtain the best prices in the global FX markets and match FX dealers buy and sell orders for a fee

8
Q

Two-way Prices

A

The dealer quotes both a buy (bid) and a sell (offer) price on a currency

9
Q

Why do Central Banks enter FX markets

A
  • pay for their government’s purchase of imports.
  • To change the composition of the central bank’s holdings of foreign currencies
  • To influence the floating exchange rate
10
Q

How can central bank influence floating exchange rate

A
  • To increase the domestic currency value, central bank may buy some of the domestic currency and sell foreign currencies. This would decrease supply of the domestic currency and will eventually increase its value.
  • To decrease the value of currency, the central bank can sell the domestic currency and buy foreign currency.
11
Q

Firms conducting international trade transactions

A
  • Exporters receive foreign currency for the sale of their goods and services.
  • Exporters use the FX market to sell foreign currency and buy AUD.
  • Importers use the FX market to buy foreign currency (sell AUD) for purchasing imports.
12
Q

Investors and borrowers in the international capital markets

A
  • Commercial bank foreign borrowings are usually converted into the home currency. Payment of interest and principal need to be made in the denominated currency of the loan.
  • Corporations and financial institutions investing overseas
    Need to purchase FX in order to make investments;
    Dividends or interest payments received from overseas investments will be denominated in a foreign currency.
13
Q

FX Speculators

A

Businesses and financial institutions may attempt to anticipate future exchange rate movements to make a profit.

14
Q

2 speculative transactions positions

A

Long and Short

15
Q

Long Position

A

Occurs when the underlying asset has been bought forward

e.g. a FX dealer buys foreign currency from a client and holds the currency on its own account.

16
Q

Short Position

A

Entering into a forward contract to sell an asset that is not held at that time
e.g. a FX dealer sells foreign currency forward in the expectation that the currency will depreciate before the forward contract expires.

17
Q

Arbitrage Transactions

A

Profit is made through FX transactions that involve no FX risk exposure

18
Q

Arbitrageur

A

A party that simultaneously conducts buy and sell transactions in two or more markets in order to take advantage of price differentials between markets

19
Q

Types of arbitrage

A

Geographic

Triangular

20
Q

Geographic Arbitrage

A

where two dealers in different locations quote different rates on the same currency
eg: you find ta retailer FX dealer in Burwood offers $1.4 AUD per USD. Another retailer broker in Dandenong offers $1.41 AUD per USD

21
Q

Triangular Arbitrage

A

occurs when exchange rates between 3 or more currencies are out of perfect alignment

22
Q

2 types of FX Market Transactions

A

Spot and Forward

23
Q

Spot transactions

A

Have maturity date two business days after the FX contract is entered into
e.g. used if an Australian importer has an account in USD to pay within the next few days.

24
Q

Forward transactions

A

Have maturity date more than two days after FX contract is entered into
e.g. used if Australian importer has to pay a USD liability in 2 months, and covers or hedges against an appreciation of the USD.

25
Q

Dealers may also provide short-dated transactions if necessary

A

‘Tod’ value transactions

‘Tom’ value transactions

26
Q

‘Tod’ value transactions

A

same-day settlement;

27
Q

‘Tom’ value transactions

A

settlement tomorrow

28
Q

Base Currency

A

The first named currency in an FX quote

one unit expressed in terms of another currency

29
Q

Terms Currency

A

The second named currency in a FX quotes;

used to express the value of the base currency

30
Q

Two-way quotations

A

The two numbers indicate the dealer’s buy (bid) and sell (offer) price

EUR/AUD 1.6155 – 1.6165

31
Q

Bid Price

A

Price at which dealer will buy base currency

32
Q

Ask/Offer Price

A

Price at which dealer will sell the base currency

33
Q

Spread

A

the points difference between bid and ask price

34
Q

There are two ways currencies can be quoted against the USD

A
  • Direct quote—USD is the base currency; i.e. USD 1 = x in FX
  • Indirect quote—USD is the terms currency and the other currency is the base currency; i.e. FX 1 = quantity of USD.
35
Q

Cross Rate

A

The exchnage rate of 2 currencies, neither being USD

36
Q

The forward exchange rate

A
  • is the FX bid/offer rates applicable at a specified date beyond the spot value date
  • The forward exchange rate varies from the spot rate due to interest rate parity
37
Q

Interest Rate Parity

A

principle that exchange rates will adjust to reflect interest rate differentials between countries.

38
Q

Forward exchange rates are quoted as

A

forward points, either above or below the spot rate

39
Q

Forward points

A

represent the forward exchange rate variation to a spot rate based on interest rate differentials

40
Q

If the forward points are rising

A

then add them to the spot rate (i.e. base currency is at a forward premium; interest rate of the base currency is lower)

41
Q

If the forward points are falling

A

then subtract them from the spot rate (i.e. base currency is at a forward discount; interest rate of the base currency is higher)