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Chapter 31 – Foreign Exchange

Chapter 31 – Foreign Exchange. Every Government Issues Currency The purchasing power of currencies vary across countries The exchange rate is the rate at which one currency can buy another currency such that the buying or purchasing power is not changed

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Chapter 31 – Foreign Exchange

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  1. Chapter 31 – Foreign Exchange • Every Government Issues Currency • The purchasing power of currencies vary across countries • The exchange rate is the rate at which one currency can buy another currency such that the buying or purchasing power is not changed • The relative value of currencies change over time, some rather rapidly • Currency Risk is the exposure to these changes

  2. Chapter 31 – Foreign Exchange • Exchange Rates • Direct Rate is the home or domestic currency needed to purchase one unit of the foreign currency • $0.008006 can buy one Yen (American) • Indirect Rate is the amount of home currency that can be purchase with a single foreign currency (reciprocal of direct) • 124 Yen can buy $1 (European) • Cross-Rate is the exchange rate of two foreign currencies • Triangular Arbitrage of Exchange Rates or the relationship of cross-rates, direct and indirect rates

  3. Chapter 31 – Foreign Exchange • Forward Rates • Making the international real rate the same • The Spot or Cash Exchange rate is for buying or selling a foreign currency today • The forward rate is the expected spot rate a specific future date • Forward Direct RateT = Spot Rate x (1+ inflation in foreign country over 1 + inflation rate in US ])T • Example…purchasing power the same through investment alternative

  4. Chapter 31 – Foreign Exchange • Currency Futures and Options • Locking in Forward Exchange Rates • Based on the expected inflations rates • Currency Swaps • Hedging Long-term Exchange Risk exposure • Arbitrage based motives • And Now a new multi-country Currency, the Euro

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