chapter 11- foreign exchange

Question 1

functions of the foreign exchange market

Answer 1

1.) income- payment for exports: income from foreign investments or other income must be converted to home currency
- ex: toyota must convert US sales to Jap yen
2.) expenses- payment for production costs and services
- ex: dell buys computer components from Malaysia converting dollars to Malaysian ringgits for payment
3.) short-term investments- potential for higher gains short term in other countries
- ex: profit short. term on currency fluctuations through investments
4.) currency speculations- short term movement of funds from one currency to another and profiting from shifts in exchange rates (deliberate investment)

Question 2

spot exchange rate

Answer 2

the rate at which a foreign exchange dealer converts one currency into another currency on a particular day
- right now, what is the exchange rate between dollar and euro
- float against one another based on supply and demand

Question 3

forward exchange rate

Answer 3

rate used future transactions- typically quotes for 30, 90, 180 days into the future
- exchange rates have been locked in

Question 4

Example of computing currency exchange

Answer 4

info given:
- the spot exchange for dollars to euros was 1.00= .8628 euros
- one euro= 1.1590 dollars
- exchange rate tomorrow is $1= .85 euros

what is happening tomorrow if $1 only buys now .85 euors
- euors are appreciating, dollar is depreciating

Question 5

example conversion problem

Answer 5

• designer handbag costs 50 euros in paris. the same bag cost 100$ in the US, which is better deal?
• 50 euros times 1.159 dollars equals $57.95
• so, paris is better deal

Question 6

example conversion problem (confused?)

Answer 6

sneaker in US cost 100. same shoes cost 150 euros in paris. which is better?
- 100$ x .8638 euros = 86.38 euros
- US is better deal almost by two times

Question 7

how are exchange rates predicted (how is risk predicted)

Answer 7

• fundamental analysis
• technical analysis

Question 8

fundamental analysis

Answer 8

• draws upon ECONOMIC factors like:
  
  • interest rates,
  • monetary policy
  • inflation rates
  • balance of payments
    uses these to predict exchange rates
• effects demand of currency

Question 9

if demand is up

Answer 9

value of that currency appreciates

Question 10

technical anaylis

Answer 10

• regression analysis
• charts trends with the assumption that past trend and waves are reasonable predictors of future trends and waves
• based strictly on trends

Question 11

freely convertible

Answer 11

when a gov of a country allows both residents and non-residents to purchase unlimited amounts of foreign currency with the domestic currency (Mexican peso) traded on the markets

Question 12

externally convertible

Answer 12

when non-residents can convert their holdings of domestic currency into a foreign currency, but ability of residents to convert currency is limited in some way (Russia)

Question 13

nonconvertible currency

Answer 13

when both residents and non-residents are prohibited from converting their holdings of domestic currency into a foreign currency (brazil, columbia, china)
- they want to control the supply of their currency

Question 14

exchange rates and managers- key terms

Answer 14

(from least to biggest concern)
- transaction exposure
- translation exposure
- economic exposure (long term)

Question 15

transaction exposure- smaller

Answer 15

extent to which income from individual transactions is affected by fluctuations in foreign exchange values
- smaller risk but might want to use forward exchange rates)

Question 16

translation exposure- significant

Answer 16

impact of currency exchange rate changes on the reported financial - - - - statements of a company (like yen depreciating)

Question 17

economic exposure- significant and long term

Answer 17

extend to which a firm’s future international earning power is affected by changes in exchange rates
(profits-earnings)

Question 18

timing of payments in int business

Answer 18

lead strategy
lag strategy

Question 19

lead strategy

Answer 19

pay me early if currency is to appreciate
- bc you want to hold an appreciating asset as long as you can

Question 20

lag strategy

Answer 20

pay me late if the currency is to depreciate

Question 21

T/F: to insure against the risk of an unanticipated change in exchange rates, a company can protect itself by entering into a forward exchange contract

Answer 21

True

Question 22

the extend to which income from individual transactions are affected by foreign exchange fluctuations is know as —- exposure

Answer 22

a.) economic
b.) financial
c.) translation
d.) transaction
ANSWER: d.) transaction