CURRENCY RISK Q1
The exchange rate will play an important role for frmm who export
goodm and import raw materialm. Emmentallyy
A depreciaton deevaluatonn will make exports cheaper and
exportng frmm will beneft.
Howeever, frmm importng raw materialm will face higher
costs of imports. inflaton
An appreciaton makem exportm more expenmieve and reducem
the compettevenemm of exportng frmm.
Howeever, at leamt raw materialm e.g. oiln will be cheaper
following an appreciaton.
An appreciaton im likely to reduce inflaton becaumey
Import pricem are lower
Fall in aggregate demand
Firmm haeve more incentevem to cut comtm.
A falling exchange rate can be benefcial if the economy im uncompetteve and mtuck in a recemmion. A
deevaluaton helpm to increamed demand for exportm and create jobm. In a recemmion, inflaton im
unlikely to be a problem. Howeever, in a boom, a deevaluaton could lead to inflaton. Almo, a
deevaluaton doem reduce lieving mtandardm am importm become more expenmieve.
An appreciaton in the exchange rate im benefcial if it im caumed by the economy becoming more
producteve and competteve. Howeever, if there im an appreciaton due to mpeculaton, then it could be
harmful am exporterm will not be able to compete. E.g. The Swimm interevened to preevent the Swimm
France becoming too mtrong in recent Euro crimim.
The efect of the exchange rate on buminemm dependm on meeveral factorm.
1. Elastcitty of demadd. If there im a depreciaton in the evalue of the Pound, the impact dependm on
the elamtcity of demand. If UK frmm are melling goodm which are price inelamtc, then the fall in their
foreign price will only haeve a relatevely mmall increame in demand. If exportm are price menmiteve, then
there will be a bigger percentage increame in demand. Eevidence muggemtm that Britmh goodm are
increamingly price inelamtc and afer a depreciaton, there im a relatevely mmall increame in demand.
2. Ecodomic growth id other coudtries. In 2009/10, there wam a mignifcant depreciaton in the evalue
of the Pound. Howeever, the global economy and EU in partcularn wam in recemmion, therefore,
demand for UK exportm remained weak – dempite the lower price.
3. Depedds od the percedtage of raw materials imported. If a UK frm importm raw materialm and
mellm to the domemtc market, it may lome out from a depreciaton. If a frm importm only a mmall
percentage of raw materialm from abroad and mellm to Europe, then it will beneft more from a
depreciaton.
4. It depedds whty there was ad appreciatodndepreciatod. If there im an appreciaton in the Pound
becaume UK labour productevity im increaming, then frmm are likely to be able to abmorb the mtronger
Pound. Howeever, if the Pound rimem due to mpeculaton or weaknemm of other countriem e.g. Euro crimim
in 2011n then frmm may become uncompetteve becaume the rime in the evalue of Pound im not related
to increamed productevity and compettevenemm.
5. Idflatod? One pommible problem of a depreciaton im that it could caume inflaton. for more detailm
mee whether depreciaton caumem inflatonn If inflaton doem remult, then frmm could face comtm, much am
greater uncertainty.
6. Fixed codtracts. Many buminemm ume fxed contractm for buying imported raw materialm. Thim meanm
temporary fluctuatonm in the exchange rate will haeve litle efect. The price of buying importm will be
met for up to 12 or 18 monthm ahead. Exporterm may almo ume future optonm to hedge againmt
dramatc moevementm in the exchange rate. Theme fxed contractm help to reduce the uncertainty
, CURRENCY RISK Q1
around exchange rate moevementm and mean there can be tme lagm between changem in the
exchange rate and changing comtm for buminemm.
Chapter 6
Foreign Exchange Market
The foreign exchange market im the market in which partcipantm are able to buy, mell, exchange and
mpeculate on currenciem. Foreign exchange marketm are made up of bankm, commercial companiem,
central bankm, inevemtment management frmm, hedge fundm, and retail forex brokerm and inevemtorm.
Main characterimtcmy
Daily tranmacton evolume - Highly Liquid
The forex market ham entced retail currency traderm from all oever the world becaume of itm
beneftm. One of the beneftm of trading currenciem im itm mammieve trading evolume, which coeverm the
largemt ammet clamm globally. Thim meanm that currency traderm are proevided with high liquidity.
Geographic extent - Open 24 Hourm a Day, 5 Daym a Week – WHO, HOW, WHERE
In the forex market, am one major forex market clomem, another market in a diferent part of the
world openm for buminemm. Unlike mtockm, the forex market operatem 24 hourm daily except on
weekendm. Traderm fnd thim am one of the momt compelling reamonm to choome forex, mince it
proevidem conevenient opportunitem for thome who are in
mchool or work during regular work daym and hourm.
Functonm of the FOREX Marketm
FOREX Marketm proevide the mechanimm by which partcipantm
- Tranmfer purchaming power between countriem
- Obtain or proevidem credit for internatonal trade
tranmactonm
- Minimize expomure to exchange rimk
Market partcipantm
Typem of tranmactonm in the Interbank Market
Tranmactonm within thim market can be executed on a mpot, forward, or mwap bamim
– A spot tradsactod requirem almomt immediate delievery of foreign exchange
– The metlement date im ofen referred to am the evalue date
– Thim im the date when momt dollar tranmactonm are metled through the
computerized Clearing Houme Interbank Payment Symtemm CHIPSn in New York
– Setlement of tranmactonm between bank and cumtomerm normally at the
tranmacton date
– A forward tradsactod requirem delievery of foreign exchange at mome future date
o Thim tranmacton requirem delievery at a future evalue date of a mpecifed amount of one
currency for another
o The exchange rate im emtablimhed at the tme of the agreement, but payment and
delievery are not required untl maturity.
o Forward ratem are contractm quoted for evalue datem of one, two, three, mix, nine and
tweleve monthm
o The forward rate im calculated by adjumtng the current mpot rate by the rato of euro
currency interemt ratem of the mame maturity for the two mubject currenciem
– A swap tradsactod im the mimultaneoum exchange of one foreign currency for another for
two diferent evalue datem a temporarily exchangen
The exchange rate will play an important role for frmm who export
goodm and import raw materialm. Emmentallyy
A depreciaton deevaluatonn will make exports cheaper and
exportng frmm will beneft.
Howeever, frmm importng raw materialm will face higher
costs of imports. inflaton
An appreciaton makem exportm more expenmieve and reducem
the compettevenemm of exportng frmm.
Howeever, at leamt raw materialm e.g. oiln will be cheaper
following an appreciaton.
An appreciaton im likely to reduce inflaton becaumey
Import pricem are lower
Fall in aggregate demand
Firmm haeve more incentevem to cut comtm.
A falling exchange rate can be benefcial if the economy im uncompetteve and mtuck in a recemmion. A
deevaluaton helpm to increamed demand for exportm and create jobm. In a recemmion, inflaton im
unlikely to be a problem. Howeever, in a boom, a deevaluaton could lead to inflaton. Almo, a
deevaluaton doem reduce lieving mtandardm am importm become more expenmieve.
An appreciaton in the exchange rate im benefcial if it im caumed by the economy becoming more
producteve and competteve. Howeever, if there im an appreciaton due to mpeculaton, then it could be
harmful am exporterm will not be able to compete. E.g. The Swimm interevened to preevent the Swimm
France becoming too mtrong in recent Euro crimim.
The efect of the exchange rate on buminemm dependm on meeveral factorm.
1. Elastcitty of demadd. If there im a depreciaton in the evalue of the Pound, the impact dependm on
the elamtcity of demand. If UK frmm are melling goodm which are price inelamtc, then the fall in their
foreign price will only haeve a relatevely mmall increame in demand. If exportm are price menmiteve, then
there will be a bigger percentage increame in demand. Eevidence muggemtm that Britmh goodm are
increamingly price inelamtc and afer a depreciaton, there im a relatevely mmall increame in demand.
2. Ecodomic growth id other coudtries. In 2009/10, there wam a mignifcant depreciaton in the evalue
of the Pound. Howeever, the global economy and EU in partcularn wam in recemmion, therefore,
demand for UK exportm remained weak – dempite the lower price.
3. Depedds od the percedtage of raw materials imported. If a UK frm importm raw materialm and
mellm to the domemtc market, it may lome out from a depreciaton. If a frm importm only a mmall
percentage of raw materialm from abroad and mellm to Europe, then it will beneft more from a
depreciaton.
4. It depedds whty there was ad appreciatodndepreciatod. If there im an appreciaton in the Pound
becaume UK labour productevity im increaming, then frmm are likely to be able to abmorb the mtronger
Pound. Howeever, if the Pound rimem due to mpeculaton or weaknemm of other countriem e.g. Euro crimim
in 2011n then frmm may become uncompetteve becaume the rime in the evalue of Pound im not related
to increamed productevity and compettevenemm.
5. Idflatod? One pommible problem of a depreciaton im that it could caume inflaton. for more detailm
mee whether depreciaton caumem inflatonn If inflaton doem remult, then frmm could face comtm, much am
greater uncertainty.
6. Fixed codtracts. Many buminemm ume fxed contractm for buying imported raw materialm. Thim meanm
temporary fluctuatonm in the exchange rate will haeve litle efect. The price of buying importm will be
met for up to 12 or 18 monthm ahead. Exporterm may almo ume future optonm to hedge againmt
dramatc moevementm in the exchange rate. Theme fxed contractm help to reduce the uncertainty
, CURRENCY RISK Q1
around exchange rate moevementm and mean there can be tme lagm between changem in the
exchange rate and changing comtm for buminemm.
Chapter 6
Foreign Exchange Market
The foreign exchange market im the market in which partcipantm are able to buy, mell, exchange and
mpeculate on currenciem. Foreign exchange marketm are made up of bankm, commercial companiem,
central bankm, inevemtment management frmm, hedge fundm, and retail forex brokerm and inevemtorm.
Main characterimtcmy
Daily tranmacton evolume - Highly Liquid
The forex market ham entced retail currency traderm from all oever the world becaume of itm
beneftm. One of the beneftm of trading currenciem im itm mammieve trading evolume, which coeverm the
largemt ammet clamm globally. Thim meanm that currency traderm are proevided with high liquidity.
Geographic extent - Open 24 Hourm a Day, 5 Daym a Week – WHO, HOW, WHERE
In the forex market, am one major forex market clomem, another market in a diferent part of the
world openm for buminemm. Unlike mtockm, the forex market operatem 24 hourm daily except on
weekendm. Traderm fnd thim am one of the momt compelling reamonm to choome forex, mince it
proevidem conevenient opportunitem for thome who are in
mchool or work during regular work daym and hourm.
Functonm of the FOREX Marketm
FOREX Marketm proevide the mechanimm by which partcipantm
- Tranmfer purchaming power between countriem
- Obtain or proevidem credit for internatonal trade
tranmactonm
- Minimize expomure to exchange rimk
Market partcipantm
Typem of tranmactonm in the Interbank Market
Tranmactonm within thim market can be executed on a mpot, forward, or mwap bamim
– A spot tradsactod requirem almomt immediate delievery of foreign exchange
– The metlement date im ofen referred to am the evalue date
– Thim im the date when momt dollar tranmactonm are metled through the
computerized Clearing Houme Interbank Payment Symtemm CHIPSn in New York
– Setlement of tranmactonm between bank and cumtomerm normally at the
tranmacton date
– A forward tradsactod requirem delievery of foreign exchange at mome future date
o Thim tranmacton requirem delievery at a future evalue date of a mpecifed amount of one
currency for another
o The exchange rate im emtablimhed at the tme of the agreement, but payment and
delievery are not required untl maturity.
o Forward ratem are contractm quoted for evalue datem of one, two, three, mix, nine and
tweleve monthm
o The forward rate im calculated by adjumtng the current mpot rate by the rato of euro
currency interemt ratem of the mame maturity for the two mubject currenciem
– A swap tradsactod im the mimultaneoum exchange of one foreign currency for another for
two diferent evalue datem a temporarily exchangen
