Exchange Rate - ANS price at which the foreign currency can be acquired or sold
Currency Arrangements - ANS 1) Independent Float
2) Pegged to Another Currency
3) European Monetary System (i.e., multiple countries share the same currency with one central
bank representing the interests of all of them)
Independent Float - ANS value of the currency is allowed to fluctuate freely according to market
forces with little to no intervention from central bank
Ex: U.S., Canada, UK, Japan
Pegged to Another Currency - ANS value of currency is pegged (i.e., fixed) in terms of a
particular foreign currency and the central bank intervenes to maintain the fixed value
Interbank Prices - ANS the wholesale price offered between banks who are looking to trade
currencies
Ask Rates - ANS price banks are willing to sell currency
Bid Rates - ANS price banks are willing to buy currency
T/F: Bid Rates are usually a little lower than the ask rates - ANS T
T/F: The spread between the bid and ask rates represent the profit a bank could potentially
make on the trade - ANS T
Direct Quote - ANS the rate at which domestic currency buys foreign currency
Indirect Quote - ANS the rate at which foreign currency would be received for domestic
currency
Spot Rate - ANS the price at which a foreign currency can be purchased or sold today
Forward Rate - ANS the price available today at which foreign currency can be provided or sold
sometime in the future; often used by international firms to lock in prices today
,Foreign Currency Forward Contract - ANS negotiated agreement between a firm and its bank
to exchange foreign currency for domestic currency (or vice versa) on a specified future date at
a predetermined exchange rate
T/F: there is no upfront cost in entering a Foreign Currency Forward Contract - ANS T
Forward Points - ANS difference between the forward rate and the spot rate for a currency on a
given day
T/F: premiums and discounts in forward points occur because of interest rate differences in two
countries - ANS T
When is a forward point a premium or discount? - ANS Foreign Interest % > Domestic Interest
% = Discount
Foreign Interest % < Domestic Interest % = Premium
Foreign Currency Option - ANS financial instrument that gives holders the right, but not the
obligation, to trade foreign currency in the future at a particular strike price
Where to Buy Foreign Currency Options? - ANS Philadelphia Stock Exchange
Chicago Mercantile Exchange
Most are bought directly from bank or in the OTC market
T/F: Options purchased from banks or in OTC market usually have a strike price that is equal to
the spot rate on that date (i.e., at the money) - ANS T
Put - ANS the right to sell foreign currency by holder
Call - ANS the right to buy foreign currency by holder
Option Premium - ANS price paid for the value of the option; it serves as the way a bank can
make money from the option without the spread that exists in forward contracts
T/F: the option premium is made up of intrinsic value and time value - ANS T
Intrinsic Value - ANS equal to the gain that could be realized by exercising the option
immediately (= Spot Rate - Strike Price)
cannot go below 0
positive = "in the money"
Time Value - ANS related to the fact that the spot rate can change over time and cause the
option's intrinsic value to increase; as time passes, the time value decreases until it equals zero
at expiration
, T/F: the time value of an option will not go below zero until expiration date even though the
option's intrinsic value is zero because there is the chance that the intrinsic value could change -
ANS T
T/F: the fair value of a foreign currency option = Intrinsic Value + Time Value - ANS T
Factors Affecting the FV of a Foreign Currency Option - ANS 1) difference between the current
spot rate and strike price
2) difference between the domestic and foreign interest rates
3) length of time to expiration
4) Potential volatility of changes in the spot rate
T/F: the fair value of a foreign currency option can be determined by applying an adaptation of
the Black-Scholes option pricing formula - ANS T
Foreign Exchange risk - ANS the probability that the exchange rate changes in a way that
negatively affects a participant due to currency appreication/depreciation
Relationships Between Exchange Rate Changes and Accounts - ANS Export Sale -->
appreciation means gain; depreciation means loss
Import Purchase --. appreciation means loss; depreciation means gain
T/F: companies making international transactions need to keep separate receivable accounts
(and payables) for each of the currencies they use - ANS T
T.F: if a receivable or payable from a foreign currency is still on the books at balance sheet date,
the gain or loss due to the exchange rate should be recognized in net income (followed by
another gain/loss when it is collected or paid in the following period) - ANS T
T/F: most companies include foreign currency gains/losses in a section called "Other Income
(Expenses)" - ANS T
T/F: any foreign currency - denominated assets or liabilities must be evaluated to determine if
there is a gain/loss on currency fluctuation - ANS T
T/F: when there is an intra-entity foreign currency loan, changes in the exchange rate that effect
the principal are recorded in (deferred) accumulated other comprehensive income until the loan
is repaid - ANS T ; only foreign exchange gain/loss from interest is recorded currently in net
income
Foreign Currency Firm Commitment - ANS a noncancelable order that specifies the foreign
currency price and date of delivery; companies will usually enter into hedging arrangements as
soon as they receive this
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 ALICE12. Stuvia facilitates payment to the seller.
Will I be stuck with a subscription?
No, you only buy these notes for $10.99. You're not tied to anything after your purchase.
