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Questions and Answers
What is the purpose of the foreign exchange market?
What is the purpose of the foreign exchange market?
- To regulate interest rates in different countries
- To facilitate international trade agreements
- To provide long-term investment opportunities
- To convert the currency of one country into the currency of another (correct)
What does the term 'exchange rate' refer to?
What does the term 'exchange rate' refer to?
- The rate at which goods are exchanged between countries
- The rate at which one currency is converted into another (correct)
- The rate at which interest is accrued on foreign investments
- The rate at which stocks are traded in the stock market
How does the foreign exchange market provide insurance?
How does the foreign exchange market provide insurance?
- By offering health insurance to foreign investors
- By guaranteeing profits from currency speculation
- By mitigating foreign exchange risk (correct)
- By providing travel insurance for international trips
What is the primary reason for businesses to use the foreign exchange market?
What is the primary reason for businesses to use the foreign exchange market?
What is currency speculation in the context of the foreign exchange market?
What is currency speculation in the context of the foreign exchange market?
What is carry trade in the context of the foreign exchange market?
What is carry trade in the context of the foreign exchange market?
What is the risk associated with changes in exchange rates for businesses?
What is the risk associated with changes in exchange rates for businesses?
In general, where must one use the national currency within a particular country?
In general, where must one use the national currency within a particular country?
What does 'future exchange rates cannot be accurately predicted' imply?
What does 'future exchange rates cannot be accurately predicted' imply?
What does 'converting payments received for exports' refer to?
What does 'converting payments received for exports' refer to?
What is the definition of a freely convertible currency?
What is the definition of a freely convertible currency?
What is the impact of non-convertible currency on international business?
What is the impact of non-convertible currency on international business?
What is the purpose of limiting convertibility of a currency?
What is the purpose of limiting convertibility of a currency?
What is the definition of capital flight?
What is the definition of capital flight?
What is the purpose of countertrade in international trade?
What is the purpose of countertrade in international trade?
What is the purpose of lead strategy in managing foreign exchange risk?
What is the purpose of lead strategy in managing foreign exchange risk?
Which theory involves the simultaneous purchase and sale of foreign exchange for different value dates?
Which theory involves the simultaneous purchase and sale of foreign exchange for different value dates?
Where are the most important trading centers in the foreign exchange market located?
Where are the most important trading centers in the foreign exchange market located?
What percentage of all foreign exchange transactions involve the U.S. dollar?
What percentage of all foreign exchange transactions involve the U.S. dollar?
Which economic theory suggests that money supply growth determines a country's likely future inflation, influencing exchange rates?
Which economic theory suggests that money supply growth determines a country's likely future inflation, influencing exchange rates?
According to empirical tests, which theory is not a strong predictor of short-run movements in exchange rates for countries with high inflation and underdeveloped capital markets?
According to empirical tests, which theory is not a strong predictor of short-run movements in exchange rates for countries with high inflation and underdeveloped capital markets?
'Neither PPP theory nor the international Fisher effect is particularly good at explaining short-term movements in exchange rates' - What other factors are mentioned as playing a role in short-term movements in exchange rates?
'Neither PPP theory nor the international Fisher effect is particularly good at explaining short-term movements in exchange rates' - What other factors are mentioned as playing a role in short-term movements in exchange rates?
What do relative monetary growth, inflation rates, and nominal interest rate differentials predict?
What do relative monetary growth, inflation rates, and nominal interest rate differentials predict?
What does the efficient market school suggest about prices in the foreign exchange market?
What does the efficient market school suggest about prices in the foreign exchange market?
What do approaches to forecasting in the foreign exchange market include?
What do approaches to forecasting in the foreign exchange market include?
What reflects expectations about likely future inflation rates according to the text?
What reflects expectations about likely future inflation rates according to the text?
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Study Notes
Foreign Exchange and Exchange Rate Theories
- Spot exchange rates are the rates at which a foreign exchange dealer converts one currency into another on a specific day, reported in real-time and subject to continual changes.
- Forward exchange rates involve agreements between two parties to exchange currency at a future date, usually quoted for 30, 90, or 180 days.
- Currency swaps involve the simultaneous purchase and sale of foreign exchange for different value dates, commonly used to mitigate foreign exchange rate risk.
- The foreign exchange market is a global network of banks, brokers, and dealers, with the most important trading centers in London, New York, Zurich, Tokyo, and Singapore, operating 24 hours a day.
- About 85% of all foreign exchange transactions involve the U.S. dollar, making it a vehicle currency.
- Economic theories of exchange rate determination include the law of one price, purchasing power parity (PPP), and the Big Mac Index for informal PPP measurement.
- Money supply growth determines a country's likely future inflation, influencing exchange rates.
- Empirical tests of PPP theory suggest that it is not a strong predictor of short-run movements in exchange rates, particularly for countries with high inflation and underdeveloped capital markets.
- Interest rates reflect expectations about likely future inflation rates, and the Fisher Effect equation (i = r + I) explains the relationship between interest rates and inflation.
- Neither PPP theory nor the international Fisher effect is particularly good at explaining short-term movements in exchange rates, with investor psychology and bandwagon effects also playing a role.
- Relative monetary growth, inflation rates, and nominal interest rate differentials are moderately good predictors of long-run changes in exchange rates, but poor predictors of short-run changes.
- The efficient market school suggests that prices reflect all available public information, while the inefficient market school argues that prices do not reflect all available information. Approaches to forecasting include fundamental analysis and technical analysis.
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