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Flashcards in Foreign Currency Issues Deck (11)
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Hard Currencies

"safe haven" currency, strong currency
- stable
- globally traded
- can be transferred across borders easily
--> serve as the reserve assets for many governments
--> full convertibility, free floating rate
Hard currencies: USD, JPY, EUR and GBP


Influencing Currency value

1. Short term
- news
2. long term
-economic factors: Interst rates, inflation, monetary reserves etc
- political factors
- Expectation Factors


Why is Hedging Important?

Translation Risk:
- Variances (gain/losses) between value of assets hold in foreign exchange market (past earnings) and the value of these assets reported on the financial statements of a company
Transaction Risk:
- Variation of currency exchange rate on the day of settlement and the day of exchange in domestic currency (when you get paid or you have to pay)
-Economic Risk
long run effect in exchange rates on future revenue and cost


Hedging method

- natural hedging: spend money in the same currency you earned it (building production sides)
- forward foreign exchange contract


What is a spot rate

current real time relationship between two currencies;


what is a forward rate

exchange rate a bank agrees on to warrant on a specific future date


trading at premium

forward rate is stronger than current spot rate


trading at discount

forward rate is weaker than current spot rate


Forward foreign excange contract

- often for 3,6,9 months
--> why not longer? If you sell something you do not want to get paid later than 6,9 months
- the cost of forward exchange contract is the premium/discount to the spot rate


Fisher Effect

i = r +I
i= nominal interest rate
r= real market interest rate
I = Expectations on Inflation
The difference of nominal interest rates can be traced down to the differences of the expectations of INflation of two currencies (real rate of interest is fixed globally--> free float of money)


Fisher effect example

US dollar 10% , Japanes Yeng 6 %
Excpected depreciation of US dollar against the Yeng of 4 % in one year