Foreign exchange market
is used to convert the currency of one country into the currency of another
Exchange rate
is the rate at which one currency is converted into another
Events in the foreign exchange market
affect firm sales, profits, and strategy
Currency speculation
the short-term movement of funds from one currency to another in the hopes of profiting from shifts in exchange rates
Spot exchange rate
is the rate at which a foreign exchange dealer converts one currency into another currency on a particular day
Spot rates change continually depending on
the supply and demand for that currency and other currencies
Spot exchange rates can be quoted as
--the amount of foreign currency one U.S. dollar can buy
--the value of a dollar for one unit of foreign currency
The foreign exchange market
is a global network of banks, brokers, and foreign exchange dealers connected by electronic communications systems
The most important trading center is
London
Exchange rates are determined by
the demand and supply for different currencies
Three factors impact future exchange rate movements
A country's price inflation, a country's interest rate, Market psychology
Inflation
when the growth in the money supply is greater than the growth in output
A country with high inflation
should see its currency depreciate relative to others
The bandwagon effect
occurs when expectations on the part of traders turn into self-fulfilling prophecies - traders can join the bandwagon and move exchange rates based on group expectations
Bandwagon effects greatly influence
short term exchange rate movements
A currency is freely convertible
when a government of a country allows both residents and non-residents to purchase unlimited amounts of foreign currency with the domestic currency
Transaction exposure
the extent to which the income from individual transactions is affected by fluctuations in foreign exchange values
Transaction exposure includes
obligations for the purchase or sale of goods and services at previously agreed prices and the borrowing or lending of funds in foreign currencies
Impacts future exchange rate movements
Price inflation AND interest rate