Interaction in foreign currency markets

INTERACTION IN FOREIGN CURRENCY MARKETS

Exchange Rate Determination

exchange rates are determined by the supply of and demand for the currencies.

Fixed Rate Exchange

the government determines the exchange rate for a period of time based on the value of another country’s currency such as dollar.

Trade deficit

a greater quantity of peso is supplied b y Philippine interests than demanded by foreign interest (Imports exceeds Exports)

Trade surplus

a smaller quantity of peso is supplied b y Philippine interests than demanded by foreign interest (Exports exceeds Imports)

Manage float (Manage Exchange Rate)

the government intervenes in the market to influence the exchange rate or set the rate for short periods such as a day or week.

SPOT RATES AND FORWARD RATES

Spot rate for a currency is the exchange rate at which the currency is traded for immediate delivery.Forward rate for a currency is the exchange rate at which the currency for future delivery.

Forward premium (discount)

= Forward rate – spot rate Spot rate

x 12

Length of forward

contract (in months)

x 100

Cross Rates

The currency exchange rate between two currencies, both of which are not official currencies of the country in which the exchange rate quote is given in.

MANAGING FOREIGN EXCHANGE RISK

Foreign Exchange Risk refers to the possibility of a drop in revenue or an increase in cost in an international transaction due to a change in foreign exchange rates.

Exchange rate is a rate at which one currency unit is converted into another.

AVOIDANCE OF EXCHANGE RATE RISK IN FOREIGN CURRENCY MARKETS

• The firm may limit its risk by purchasing or selling forward exchange contracts

• The firm may choose to minimize receivables and liabilities denominate in foreign currencies.

• Maintaining monetary balance between receivables and payables denominated in particular currency

•Trigger pricing

• Diversification.

• Limiting the forward exchange markets, money market and currency future markets.