FINC 3340

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FINC 3340

• Foreign Exchange Markets

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Learning Objectives

• After completing this material you should
• understand the basic functioning of spot and
  forward foreign exchange markets
• understand purchasing power parity (PPP) and its
  relationship to exchange rates
• understand the factors that affect exchange rates
  across countries

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Foreign Currencies and Foreign Exchange

• To invest internationally, an investor must
• Obtain foreign currency
• Engage in a financial transaction
• Receive payment
• Convert proceeds from foreign currency back to
  the domestic currency
• Question what determines the price of foreign
  currency today and what will happen to that price
  in the future when the investor needs to convert
  back to the domestic currency?

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The Markets for Foreign Exchange

• The spot market
• The forward market

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Exchange Rate Basics

• Given that most currencies float in relationship
  to each other, what leads to changes in F/X
  rates?
• Absolute purchasing power parity (PPP)

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PPP U.S. and U.K
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Exchange Rate Basics

• Relative purchasing power parity
• or

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Factors Affecting S in Long Run

• Basic Principle If factor increases demand for
  domestic goods relative to foreign goods, S ?

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Exchange Rate Basics

• An interesting example
• The Economist's
• Big Mac Index for 2004

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Hedging Foreign Exchange Risk

• On the Balance Sheet
• With Forwards

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Interest Rate Parity

• What keeps money from flowing to one or a few
  markets only?