Flextronics

The Foreign Exchange Market

Learning objectives

• Be conversant with the functions of the foreign exchange market.

• Understand what is meant by spot exchange rates.

• Appreciate the role that foreign exchange rates play in insuring against foreign exchange risk.

• Understand the different theories explaining how currency exchange rates are determined and their relative merits.

• Be familiar with the merits of different approaches towards exchange rate forecasting.

• Understand the differences between transaction, translation, and economic exposure, and what managers do to manage each type of exposure.

The foreign exchange market is the market where currencies are bought and sold and currency prices are determined. It is a network of banks, brokers and dealers that exchange currencies 24 hours a day.

Exchange rates determine the value of one currency in terms of another. While dealing in multiple currencies is a requirement of doing business internationally, it also creates risks and significantly impacts the attractiveness of different investments over time.

The foreign exchange market is used for:

1. Currency conversion, 2. Currency hedging,

3. Currency arbitrage, 4.Currency speculation.

Firms can use the foreign exchange market to minimize the risk of adverse exchange rate movement. Such arrangements can prevent them from benefiting from favorable movements.

OUTLINE OF CHAPTER 9: THE FOREIGN EXCHANGE MARKET

Opening Case: Hyundai and Kia Face a Strong Won

Introduction

The Functions of the Foreign Exchange Market

Currency Conversion

Insuring Against Foreign Exchange Risk

Management Focus: Volkswagen’s Hedging Strategy

The Nature of the Foreign Exchange Market

Economic Theories of Exchange Rate Determination

Prices and Exchange Rates

The Law of One Price

Interest Rates and Exchange Rates

Investor...