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Unit 3: Foreign Exchange Market and Exchange Rates

Forward Rate: The forward rate is the rate quoted by foreign exchange traders for the purchase Notes
or sale of foreign exchange in the future.
Forward Transaction: Forward transaction is defined as an agreement to buy or sell a specified
amount of a foreign Currency any time in the future.
Indirect Quotations: Indirect quotations refer to the Price of foreign Currency in terms of one
unit of home Currency.
Pip: Pip is the smallest amount a price can move in any Currency quote.
Spot Rate: Spot rate is the theoretical yield on a zero-coupon Treasury.
Spot Transaction: Spot transaction can be defined as an agreement to buy or sell a specified
amount of a foreign Currency within two business days of the transaction.
Spread: The difference between the Bid Price and the Ask Price.

3.6 Review Questions

1. Why do companies involved in international trade have to hedge their foreign exchange
exposure?
2. Should an exporter use the Spot rate or forward rate for quotation?
3. Is devaluation good for exports and imports? Why is the impact of devaluation usually
not immediate?
4. What problems do you think you would face as a business trying to operate in two foreign
exchange markets?

5. What risks confront dealers in the Foreign Exchange Market? How can they cope with
those risks?
6. Assume that the Spot rate of the British pound is $1.70. The expected Spot rate one year
from now is assumed to be $1.68. What percentage depreciation does this reflect?
7. What are foreign exchange markets? What is their most important function? How is this
function performed? What are the four different levels of participants in foreign exchange
markets? What are the other functions of foreign exchange markets?
8. Differentiate between Speculation and Hedging. Also, discuss the appropriate role for
each in the equity market.
9. The Spot rate for the Deutschmark in New York is $0.41.
(a) What should the Spot price for the US dollar be in Frankfurt?

(b) Should the dollar be quoted at DM 2.50 in Frankfurt, how would the market react?
10. Who is authorised to exchange foreign Currency?

Answers: Self Assessment

1. False 2. True
3. True 4. Swap
5. Spread 6. Risks

7. Pip 8. Bid-ask
9. Bid 10. Premium

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