1. Foreign exchange markets
Financial Management
Foreign exchange markets

2. Foreign Exchange Rates
Currency quotation
Indirect: $1 = AED 3.67
Direct: $ = AED 1
Inverse relationship: 1/indirect = direct
Currency appreciation/depreciation
Indirect quote increase = appreciation
Direct quote increase = depreciation
FX rate driver: supply and demand of currency

3. Spot and Forward Exchange Rates
Spot rate: foreign exchange rate now
Forward rate: foreign exchange rate in future
Why are they different? Why do FX rates change?
Interest rate differences between countries
Inflation differences between countries
Default risk differences between countries

4. Forward Exchange Rate Premium/Discount
Formula: (spot-forward) / spot
Example:

5. Purchasing Power Parity
“Balancing” relationship between prices and FX rates

6. Fixed Exchange Rates
Some countries “override” market factors by created a fixed exchange rate with a major currency
Examples:
Oman: OMR = USD $1
Mali: CFA = €1
Nepal: NPR = INR 1

7. Exchange Rate Risk Risk that exchange rates change unfavorably
Example:

8. Hedging and Derivatives
To protect against exchange rate risk, a company can use a hedge transaction
Example: option to buy $2,500 at MXN 20/USD 1 by date of loan repayment