Summary
Currency Risk summary IBO Y3
- Course
- Institution
Chapter 6: The Foreign Exchange Market (FOREX) | Chapter 7: International Parity Conditions | Chapter 8: Foreign currency derivatives and swaps | Chapter 11: Operating exposure |
[Show more]
Seller
Followisabelvanrees
Reviews received
Content preview
Currency RiskWeek 1
Chapter 6: The Foreign Exchange Market (FOREX)
Foreign exchange transaction = an agreement between a buyer and a seller that a fixed
amount of one currency will be delivered for some other currency at a specified rate.
The FOREX markets provide the physical and institutional structure through which:
- The money of one country (currency) is exchanged for that of another country.
- The rate of exchange between currencies is determined.
- Foreign exchange transactions are physically completed.
Main characteristics of FOREX markets:
1. The geographic extent: 24/7 worldwide on business days.
2. Functions of FOREX markets:
FOREX markets provide the mechanism by which participants:
- Transfer purchasing power between countries. Necessary for international trade and
capital transaction which can only be invoiced in one currency.
- Provides credit for international trade transactions because in transit inventory
between countries must be financed.
- Minimize exposure to exchange rate risk, provided “hedging” facilities.
3. Market participants operating in the wholesale and/or retail markets:
The FOREX markets consist of two tiers: the interbank or wholesale market / the client- or
retail (‘over the counter’)
,4. Types of transaction in the interbank market:
Transaction within this market can be executed on a spot, forward, or swap basis.
- Spot transaction = required almost immediate delivery of foreign exchange.
- Forward transaction = requires delivery at a future value date of specified amount of
one currency for another.
- Swap transaction = the simultaneous exchange of one foreign currency for another
for two different value dates (a temporarily exchange).
(Outright) forward transactions:
- The exchange rate is established at the time of the agreement, but payment and
delivery are not required until maturity.
- Forward rates are contract quoted for value dates of one, two, three, six, nine, and
twelve months.
Swap transactions:
- Forward-forward swap.
- Non-deliverable forwards (NDFs): are only settled in the US.
Floating, fixed, managed exchange rates:
- Free floating currencies = no state intervention on FOREX markets: exchange rates
reflect supply and demand conditions. E.g. $, €, ¥ (yen).
- Fixed exchange rates = Central Bank buys or sells its currency at a fixed price in
order to stabilize the value to another currency. E.g. gold standard, EU currencies
before the €.
- Managed floating exchange rates. E.g. ¥ (Chinese yuan).
5. Size of the FOREX markets (transaction volume):
6. Methods stating foreign exchange rates and quotations.
Foreign exchange rate = the price of one currency expressed in terms of another currency.
Foreign exchange quote = a statement of willingness to buy or sell at an announced rate.
In the retail market (newspapers and exchange-shops), quotes are often given as the home
currency price of the foreign currency. £(GBP)1.770/$
, Exchange quotations: €2.75 / cup of coffee
- Price (base) = €2.75
- Unit = cup of coffee
The US dollar is the base currency of comparing currencies.
Quotes = professional dealers or brokers may state quotes in one of two ways:
- The foreign currency price of the unit one dollar. E.g. Sfr1,600/$ = I have to pay 1,600
Swiss francs for one dollar.
- The dollar price of a unit of foreign currency. E.g. $0.625/Sfr = I have to pay 0.625
dollars per Swiss franc.
Direct and indirect quotes:
- Direct quote = a home currency price of a unit of a foreign currency. E.g.
€0.8214/USD1.00 is a direct quote in Europe.
- Indirect quote = a foreign currency price in a unit of the home currency. E.g.
€0.8214/USD1.00 is an indirect quote in the US.
Interbank quotes are given as a bid and ask:
- The bid = the price at which a dealer will buy another currency.
- The ask / offer = the price at which a dealer will sell another currency.
Expressing forward quotations on a point basis:
- Forward outright quotes are different and typically quoted in terms of points.
- A point is the last digit of a quotation, with convention dictating the number of digits to
the right of the decimal. E.g. hence a point is equal to 0.0001 of most currencies (1
point is 1 dollar/10,000).
e.g. Swiss franc / $, 3 months forward; Bid = 14, Ask = 22 points.
The benefits of buying summaries with Stuvia:
Guaranteed quality through customer reviews
Stuvia customers have reviewed more than 700,000 summaries. This how you know that you are buying the best documents.
Quick and easy check-out
You can quickly pay through credit card or Stuvia-credit for the summaries. There is no membership needed.
Focus on what matters
Your fellow students write the study notes themselves, which is why the documents are always reliable and up-to-date. This ensures you quickly get to the core!
Frequently asked questions
What do I get when I buy this document?
You get a PDF, available immediately after your purchase. The purchased document is accessible anytime, anywhere and indefinitely through your profile.
Satisfaction guarantee: how does it work?
Our satisfaction guarantee ensures that you always find a study document that suits you well. You fill out a form, and our customer service team takes care of the rest.
Who am I buying these notes from?
Stuvia is a marketplace, so you are not buying this document from us, but from seller isabelvanrees. Stuvia facilitates payment to the seller.
Will I be stuck with a subscription?
No, you only buy these notes for $7.54. You're not tied to anything after your purchase.
Can Stuvia be trusted?
4.6 stars on Google & Trustpilot (+1000 reviews)
56326 documents were sold in the last 30 days
Founded in 2010, the go-to place to buy study notes for 14 years now