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Exchange Rate Essentials (Chap. 2) (Easy way to solve exchange rates:…
Exchange Rate Essentials (Chap. 2)
Easy way to solve exchange rates: number of home currencies needed to purchase one foreign currency
ex) If the dollar/euro exchange rate is $1.15 per euro, one euro costs $1.15, euro is stronger
appreciation: one currency buys more of another, value is
higher
depreciation: currency buys less of another currency, value has fallen
Multilateral Exchange Rates: wold of many currencies, calculated using trade rates
Link Title
Classification of exchange rate regimes around the world
Currency Board: fixed regime with legal rules that make the peg more durable
FX market: collection of private individuals, corporations, and public institutions that buy and sell
FX is not organized; trades are conducted at numerous locations worldwide
Spot Contract: contract for the immediate exchange of one currency for another between two countries; essentially diskless; happens 'on the spot'
Forward: two parties make a contract and the settlement date is in the future; price is fixed TODAY so there is no risk
Swap: sale of forward currency with a forward repurchase of the same currency
Future: currencies will be delivered at a specified future date; standardized, mature at regular dates, and can be traded
Options: buyer can buy (call) or sell (put) a currency in exchange for another at a specified future date
Derivatives: contracts and pricing are derived from the spot rate
includes spot contracts, forwards, swaps, futures, and options
Spots and forwards are the most important
Arbitrage: buy low and sell high to make a profit
if arbitrage opportunities exist the market is out of equilibrium
if there is no arbitrage, the market is in equilibrium
Key points for future reference