Economics & Finance

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The Roles of Speculators and Central Banks in Foreign Exchange Markets

Speculators and central banks are important participants in foreign exchange markets. Speculators invest in assets denominated in different currencies and, therefore, buy or sell currencies. Central banks [more…]

Foreign Exchange Risk of an Importing Firm

Importing firms may have accounts payable in foreign currency. The exchange rate risk these firms face is the risk of appreciation in foreign currency. Remember, appreciation of a foreign currency means [more…]

Foreign Exchange Risk in a Domestic Company–Foreign Subsidiary Setting

If a domestic firm is involved in foreign operations in any way, such as a joint venture or FDI, funds flow between the domestic and foreign firms. These funds may involve the domestic firm’s provision [more…]

How to Figure the Absolute and Relative Purchasing Power Parity (PPP)

The Purchasing Power Parity (PPP) implies that the changes in two countries’ price levels affect the exchange rate. According to the PPP, when a country’s inflation rate rises relative to that of the other [more…]

How to Work with the Purchasing Power Parity (PPP)

You need to understand how the PPP is derived. Understanding the relationship between inflation differentials and changes in the exchange rate enables you to attach a number to the change in the exchange [more…]

Empirical Evidence on the (Relative) Purchasing Power Parity (PPP)

The PPP implies a long-run relationship between the changes in the exchange rate and inflation rate differential between two countries. The idea is that these variables should move together in the same [more…]

An Overview of Foreign Exchange Derivatives

In international finance, derivative instruments imply contracts based on which you can purchase or sell currency at a future date. The three major types of foreign exchange [more…]

Speculation: Taking a Risk to Gain Profit

Speculation involves profiting from the change in the price of an asset. No matter what kind of asset you consider, the desired change in price is an increase when you sell it. In other words, all speculation [more…]

Foreign Exchange Risk of an Exporting Firm

When you’re involved in foreign exchange markets in any capacity, you face foreign exchange risk. Exporting firms may have accounts receivable in foreign currency. The foreign exchange risk of these firms [more…]

Maintain the Internal Balance of the Metallic Standard

The term internal balance refers to full employment with price stability, which is a tall order. Full employment does not refer to 0 percent unemployment. It implies a positive unemployment rate at which [more…]

Forward Contracts in Foreign Exchange

In the context of foreign exchange, forward contracts enable you to buy or sell currency at a future date. Then again, all foreign exchange derivatives do the same. There are differences among foreign [more…]

Futures, Options, and Speculators in Foreign Exchange Markets

First of all, the term speculators implies a variety of people. They may be individuals who are trying to make a buck. In foreign exchange (FX) markets, they are individuals who represent financial firms [more…]

Arbitrage in Foreign Exchange Derivative Markets

Arbitrage implies taking advantage of price differences in the same or similar financial instruments. The golden rule of making money is also embedded in arbitrage: You want to buy low and sell high. Arbitrage [more…]

Foreign Exchange Futures: Marking to Market

After you get a futures contract, you need to keep an eye on the spot rate every day to see whether you want to close your foreign exchange (FX) position or wait until the settlement date. The value of [more…]

The Price of an Option: The Option Premium

The option premium (hereafter, the premium) is also called as the price of an option. The buyer of the call or put option has the right but not obligation to buy or sell currency, respectively. Therefore [more…]

To Exercise or Not to Exercise Call Options

Having a foreign exchange call option means that you have the right to buy foreign currency. If you represent a multinational company, the company may have account payables in foreign currency, which would [more…]

Selling Foreign Exchange Call Options

When you sell a call option, you are selling the right to buy foreign currency. Therefore, you no longer have an option. The buyer of your call option has the option to buy currency from you. In other [more…]

To Exercise or Not to Exercise Put Options

A foreign exchange put option gives you the right to sell foreign currency. As in the case of call options, put options can be used by MNCs and speculators alike. An American exporter may have account [more…]

Selling Foreign Exchange Put Options

When you sell a foreign exchange put option, you are selling the right to sell currency. Therefore, you become the buyer of currency and have no option. The buyer of the put option has the right to sell [more…]

The Pure Commodity Standard of Money

If there had been no money, trade would have been by barter. You can imagine how ineffective the barter system would have been. In a barter system, people exchange goods and services for other goods and [more…]

Convertible Paper Money and Gold Standard

Beyond a bartering system, another type of money appeared toward the end of the Middle Ages (about the 15th century), coinciding with expeditions to distant regions of the world that monarchs financed. [more…]

Fiat Money and the Bretton Woods Era

The Bretton Woods era (1944–1973) was the last period with a metallic standard. Since the end of the Bretton Woods era in 1973, money is the fiat money. [more…]

Exchange Rates in a Commodity Standard System

A metallic standard in more than one country implies a fixed exchange rate. For example, if the international monetary system is a gold standard, each country defines the price of its currency in gold [more…]

Exchange Rates in a Fiat Money System

A fiat currency has no intrinsic value. In other words, its value is not based on a precious metal. Monetary policy determines the purchasing power of the currency. The exchange rate regime involving fiat [more…]

Maintain the External Balance of the Metallic Standard

External balance of the metallic standard implies that the fixed exchange rate is maintained. The most important variable that may prevent the maintenance of the fixed exchange rate is the current account [more…]

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