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Foreign Exchange Markets BOOK

The document provides an overview of foreign exchange markets, including definitions of currency, exchange rates, and factors influencing them such as supply and demand, interest rate differentials, and economic indicators. It discusses currency risk and its implications for international business, as well as various strategies for managing currency risk, including hedging and natural hedging. Additionally, it analyzes the impact of exchange rate fluctuations on international transactions and business profitability.

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2 views10 pages

Foreign Exchange Markets BOOK

The document provides an overview of foreign exchange markets, including definitions of currency, exchange rates, and factors influencing them such as supply and demand, interest rate differentials, and economic indicators. It discusses currency risk and its implications for international business, as well as various strategies for managing currency risk, including hedging and natural hedging. Additionally, it analyzes the impact of exchange rate fluctuations on international transactions and business profitability.

Uploaded by

wagud09pinukpuk
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPTX, PDF, TXT or read online on Scribd
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Foreign Exchange Markets

At the end of this lesson the student should be able to:


• Define currency, exchange rate and how they determined by supply and demand,
interest rate differentials, and other economic factors.
• Explain the concept of currency risk and its implications for international business,
including translation exposure and economic exposure.
• Understand the different methods of currency risk management, such as hedging and
forward contracts, and how they can be used to mitigate currency.
• Analyze the impact of exchange rate fluctuations on international transactions and
business profitability.
• Evaluate the effectiveness of different currency risk management strategies in various
business context.
Currency of different countries

•US Dollar (USD)-1 USD TO PHP=57.61


•Euro (EUR)-1 EUR TO PHP=62.18
•Japanese Yen (JPY)-1JPY TO PHP=38.34
•British Pound (GBP)-1 GBP TO PHP=74.11
•Australian Dollar (AUD)-1 AUD TO PHP=36.47
Currency is a system of money that is used as a medium of exchange to facilitate transactions for goods,
services, or debts.

Exchange Rates:
are the prices at which one currency can be exchange for another.
According to MacDonald (2007),they are influenced by variety of factors including:

Supply and Demand


-is the relative supply and demand for currencies in the foreign
exchange market determine their exchange rates. When demand of currency increases relative to
supply, its value appreciates. Conversely, when supply exceeds demand, the currency depreciates.

>Currency Demand: Imports, foreign investments, and tourism drive demand for currency.
When a country imports goods and services from other contries,it needs to purchase foreign
currency to pay for them, increasing demand for foreign currency and decreasing demand for the
domestic currency.

>Currency Supply: The supply of currency is influenced by factors such as exports, foreign
investment in the country and government policies. When a country exports goods and services to
other countries, it received foreign currency, increasing the supply of domestic currency.
Interest Rate Differentials:
>If a country’s interest rates are higher than those of other
countries, investors may be attracted to invest its currency, increasing
demand and raising its value. Conversely, investors may sell the
currency if interest rates are lower, leading to depreciation.
> Changes in the interest rate differentials can affect
capital flows into and out of a country. If the interest rates rise, foreign
investors maybe attracted to invest in the country’s bonds and other
securities, increasing demand for the currency.

Economic Indicators>such as GDP growth, inflation, and trade balances


can influence exchange rates.
According to Cottani, Cavallo and Khan (1990), A strong economy with a
low inflation and a positive trade balance tends to ha strong currency
ECONOMIC
INDICATORS
GDP Growth A strong economy with high GDP growth tends to have a stronger
currency as investors are more confident in the court’s prospects

Inflation High inflation can erode the purchasing power of a currency,


leading to depreciation. Investors maybe less willing to hold a
currency if they believe its value will be eroded by inflation.

Trade Balance A positive trade balance(export exceeding imports) can lead to


stronger currency as there is a greater demand for the currency
to purchase exports.
Political stability
> Political instability or uncertainty can lead to currency depreciation
as investors may lose confidence in the country’s economy.

Factors affecting political stability:


1. Investor Confidence: Political instability or uncertainty can
reduce investor confidence, weakening currency. Investors may
be reluctant to invest in a country with political turmoil or
uncertainty.
2. Capital Flight: In times of political instability, investors may
withdraw their funds from the country, leading to a currency
depreciation.
Currency Risk and its Implications
Currency Risk: is the risk that the value of a currency will change, affecting
the profitability of international transactions. This risk ca areise from:

1. Exchange Rate Fluctuation>Unfavorable changes in exchange rate can lead to


losses or gains on foreign currency-denominated assets or liabilities.
> If a country’s currency depreciates, its export
become more competitive in foreign markets as they become cheaper.
> A depreciating currency can increase the cost of
imports , as it takes more domestic currency to purchase foreign currency. This
can lead to higher prices for imported goods and services.
2. Translation Exposure>The risk of losses or gains arising from translating
foreign currency denominated assets and liabilities into the domestic currency.

3. Economic Exposure: The risk of exchange rate changes affecting a business’s


future cash flows. Ex. If a company imports raw materials from a country with
depreciating currency,the cost of those materials will decrease.

>Changes in exchange rates can affect a company’s operating cash flows .


Currency Risk Management Strategies
*to mitigate currency risk, businesses can use VARIOUS STRATEGIES:
A.Hedging: is uses of financial instruments, such as forward or future contracts, to
lock in a future exchange rate. Wanga (2017) This can help protect against
unfavorable exchange rate movements.

TYPES OF HEDGING

1. Forward contracts:
>Agreement to buy or sell a currency at a predetermined exchange rate on a
future date.This allows businesses to lock in a specific exchange rate, eliminating the
uncertainty of future price fluctuations.
2. Future Contracts
>Similar to forward contracts, they are traded on organized exchanges.
Future contracts are standardized contracts with specific delivwery dates and sizes.
3. Currency Swaps
>Agreement tp exchange currencies at a predetermined exchange rate on a
specified date, with a reverse exchange occurring later. This can be used to hedge
long-term currency exposures.
B. Currency Option
> Contracts that give the holder the right, but not the obligation, to
buy or sell a currency at a specified exchange rate.
TYPES OF CURRENCY OPTIONS
1. Call options> Give the holder the right but not the obligation to buy a currency
at the specified exchange rate. This can be used to protect against potential
losses from a depreciating currency.
2. Put Options> Give the holder the right, but not the obligation to sell a currency
in a specified exchange rate. This can be used to protect against potential losses
from depreciating currency.
C. Natural HEDGING
>Matching foreign currency-denominated assets with liabilities to
offset currency risk. For example: a company that exports to a country with a
depreciating currency can also source supplies from that country to offset the
negative impact on its profits.
Impact of Exchange Rate Fluctuations on International
Transactions

a. A depreciating currency can make exports more competitive in foreign markets, while
an appreciating currency can make exports less competitive.
b. A depreciating currency can increase the cost of imports , While an appreciating
currency can make imports less expensive
c. Exchange rate fluctuations can affect the profitability of international businesses,
particularly those –denominated with significant foreign currency-denominated assets or
liabilities.
IMPACT OF EXCHANGE RATE FLUCTUATION ON EXPORT COMPETETIVENESS
>Adepreciating currency makes esports more competitive in foreign market as they
become cheaper for foreign buyers.
According to Gopinath (2015) This can increase demand for exports and boost export
revenue.
>A more competitive export price can help company gain market share in foreign market
and increase its sale.
>Conversely, an appreciating currency can make exports less competitive, reducing

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