abhishreshthaa
Abhijeet S
Exchange Rates
Types of Exchange Rates
Uses of Foreign Exchange Market
Determination of Exchange Rates
- Foreign Exchange includes all currencies and special instruments that are used to make payments abroad
- Exchange rate is the # of units of a currency that is given in exchange for one unit of another currency
Types of Exchange Rates
- Spot Rate - is the exchange rate quoted for delivery within two business days
- Forward Rate - exchange rate quoted for delivery more than two business days in the future.
- Most transactions take place in the spot market
- The futures contracts (IMM) and the Options market are the other major places where money is traded.
- Currency swaps, Convertibility and Countertrade.
Uses of Foreign Exchange Market
- Commercial Transactions - buying foreign exchange to facilitate trade of goods.
- Making the Market - interbank transactions to replenish reserves of banks.
- Arbitrage - buying and selling foreign exchange for profit due to price discrepancies.
- Risk/Hedging buying and selling to protect against risk
Determination of Exchange Rates
- Law of one price, Purchasing Power Parity
- Increase or decrease in money supply
- International Fisher Effect (relationship between interest rate and exchange rate.)
- Fisher Effect is relationship between inflation and interest rate, i.e. nominal interest rate is the sum of real interest rate and expected rate of inflation
- Interest rate differentials
- Confidence in the economy.
- Balance of payments of countries.
- Seasonal demands.