Quiz #2

• Foreign Exchange (forex or FX)


  The trading of one currency for another

  
• Forex market


  • Largest, most liquid market in the world, with trillions of dollars changing hands every day
  • No centralized location, rather an electronic network of banks, brokers, institutions, and individual traders (mostly trading through brokers or banks)
• Market makers (or Quoting Party)

  Professional traders who offer to sell securities at a given price (the ask price) and will also bid to purchase securities at a given price (the bid price)
• Price takers (or Calling Party)


  Come into the market and trade on existing orders, must deal at the price of Market Maker
• Elements of an FX Cash Flow

  • Cash Flow Direction (Inflow or Outflow)
  • Currency Involved (Currency bought and currency sold)
  • Value Date (Spot or Forward)
  • Domicile (Locus of Settlement)
• Commodity Currency


  A currency in forex that comes from a country with large reserves of some specific valuable item, or commodity
• Terms Currency


  The currency in which an exchange rate is quoted
• ISO International Standard 4217 (International Currency Codes)
• Reciprocal Currency


  A currency pair involving the U.S. dollar (USD), but the USD is not the base currency; instead, it is the quote currency (also known as the counter currency)
• Major currency pairs that involve the USD as the quote currency

  • EUR/USD (euro to U.S. dollar)
  • GBP/USD (British pound to U.S. dollar)
  • NZD/USD (New Zealand dollar to U.S. dollar)
  • AUD/USD (Australian dollar to U.S. dollar)
• K.A.P.E.


  Abbreviation for remembering reciprocal currency pairs: Kiwi (NZD/USD), Aussie (AUD/USD), Pound (GBP/USD), Euro (EUR/USD)
• Two-way (or two-sided) quote


  Indicates both the current bid price and the current ask price of a security during a trading day on an exchange

  
• Bid price


  The maximum price that a buyer is willing to pay for a share of stock or other security
• Ask price


  The minimum price that a seller is willing to take for that same security
• Spread


  The difference between the bid and the ask, giving traders an idea of the current liquidity in the security
• Determining Forward Value Date

  1. Fix the Spot Date

  2. Date-to-Date Rule (1-month Forward = July 18)

  3. Month-end to month-end Rule (1-month Forward = July 31)
• Calculation of FX Transactions
• Foreign exchange risk is the most common form of market price risk managed by treasurers – the other common ones being interest rate and commodity risk. Market price risk is one of several groups of risks that businesses must manage within their ERM (Enterprise Risk Management) framework.
• Since the financial crisis, national regulators have been tasked by industry bodies and international market participants to create frameworks that reflect the global nature of financial markets. However, with national regulators driving their own agenda, informed by regional political climate, regimes have diverged somewhat, creating both frictions and opportunities for those market participants active in different geographies.
• Foreign exchange risk


  It arises principally from the requirement to convert a cash flow or amount in one currency into another as the result of a transaction or internal transfer. As the value of two currencies changes in relation to each other, the value of a cash flow in terms of the other currency will also change.
• Foreign exchange risk


  • It can present a variety of challenges, but the opportunities possible for those in the know who utilise the spot and futures markets also allows firms not only the ability to dilute the risks of moving funds between currencies but to also profit from each transaction.
• When entering the market, a thorough assessment of different currency risks and currency hedging strategies should be undertaken in order to consider positions, strategies, and timing of deals and transactions.
• Main risks to take into consideration

  • Economic risk
  • Transaction risk
  • Translation risk
• Economic risk


  The possibility that macroeconomic conditions such as government regulation, political stability and interest rates will impact a firm's net cash inflows from business activities carried out abroad – can have adverse impacts on that company's competitive advantages.
• Transaction risk


  The risk raised as fluctuations in the exchange rate between the signing of a transaction and it actually going ahead.
• Translation risk


  The concern that for organisations operating in foreign markets, currency fluctuations arise between the time of funds being received from third parties or exchanged among subsidiaries, and the firm reporting its quarterly and annual financial statements.
• The larger proportions of assets and liabilities denominated in a foreign currency, the greater the translation risk.
• The difference between translation and transaction exposure is that with the former an actual cash flow may not be involved at the time that the risk arises.
• Currency hedging


  • If assessed and performed successfully – is considered a useful tool in financial risk management.