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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…]

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…]

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 Basics of Interest Rate Parity (IRP)

You need to be aware of three related subjects before you can understand the Interest Rate Parity (IRP) and work with it. The general concept of the IRP relates the expected change in the exchange rate [more…]

Derivation of the Interest Rate Parity (IRP)

Suppose that you consider investing in the home or foreign country for one period. It means that you have some amount of money now (present value or PV) and, given an interest rate, you want to make some [more…]

Covered versus Uncovered Interest Arbitrage

If this speculator relies on his expectations regarding the future spot rate to sell his euros and, therefore, sells those euros in the future spot market, he engages in an [more…]

Graphical Treatment of Arbitrage Opportunities

You can use a graphical way to know which investor, home or foreign, can make use of the covered interest arbitrage to earn excess returns.

In the figure, you see the approximate interest rate differential [more…]

How to Determine Whether the Interest Rate Parity (IRP) Holds

The IRP indicates a long-run relationship between interest rate differentials and forward premium or discount. Although at any given time this relationship may not hold, if appropriate estimation techniques [more…]

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