Forward Exchange and International Financial Investment

Thèmes abordés

Forward Exchange , International Financial Investment

Résumé du document

Example:
Imagine you take a vacation in GB and bring € with you, and you convert them as £ as needed.
-What is the risk here?
Appreciation of the £ ( depreciation of €)=> decreased buying power of your €.

-How can you “protect” yourself against it? Convert before you go to GB you € into £.

As soon as we need to do transaction in another currency there is a risk due to the fluctuation of the two currencies.

Exposure to exchange rate risk:
You are exposed to exchange rate risk if the value of you income or wealth or net worth will change if exchange rates change unexpectedly in the future.
(unexpectedly because if you expect it, then you can protect yourself from it)

Hedging is taking an action to reduce your exposure to exchange rate risk.
Speculation is taking an action that increases your exposure to exchange rate risk, usually to try to profit from your belief about what future exchange rates will be.
(basically : hedging = not taking risk = se couvrir/se protéger, speculation = the contrary)

Extraits

[...] - That is, approximately. The forward premium on the foreign currency equals the difference between the domestic interest rate and the foreign interest rate ( i - if Uncovered interest parity: Demand-supply pressures on market rates will drive rates to eliminate the return differential: EUD = 0. Where EUD = Fex + (if , where Fex = (eex / and where eex = expected future spot rate: Evidence on Parity: - Covered interest parity seems to hold well between currencies of countries whose governments permit free movements of international capital. [...]

[...] So I would prefer to invest in England. Covered international investment: An investor can compare the return on a covered international investment to the return on a home investment using the covered interest differential CD = If CD > it is more profitable to invest abroad. A useful approximation is: CD = F + (if Where F is the forward premium (discount if negative) on the foreign currency. Forward Premium: F = F is the difference between the current forward rate and the spot rate in Application: Spot rate is: = 0.9 so 0.9 = Forward rate in 12 months is: = 0.8 so f = 0.8 = F = = ( 1.25 - 1.11 1.11 = 0.126 > 0 The foreign currency gains (between the spot and the forward). [...]

[...] if the 12 months forward exchange rate is 1.30 ? ( f = 1.30 = 0.769 \ f = pas 1.30 ) F = = ( 0.769 0.757 0.757 = The foreign currency here) is expected to appreciate by (if = - 0.015 The interest rate is lower in the USA than in France. CD = F + (if = 0.01580 0.015 = 0.0008 We earn more if we invest in the US. Covered interest Parity: (Keynes) As a result of pressure from covered interest arbitrage: - Covered interest parity: the domestic return equals the overall return on a covered foreign investment. [...]

[...] The forward exchange rate should be an average expectation of the future spot value. (due to the fact that anticipations come true; Forward rate = expected (future spot rate)) International Investment: - Firms can increase their market shares by: o Exporting. o Investing abroad (opening new plants abroad). That's Foreign Direct Investment (FDI). - Firms can also invest to diversify their portfolios. ( Portfolio Investment. NB ‘Firm' is a large term here, and include, for example, commercial banks. NB Most of the international flows of money are between advanced countries. [...]

[...] You will want to reinvest them in France. You are in a long position. Long (SFr in the future) Forward Foreign Exchange Rate Contracts: Forward Foreign Exchange Rate Contracts is an agreement to exchange a certain amount of one currency for a certain amount of another currency in the future, with the amounts based on the price (forward exchange rate/locked-in forward price) set when the contract is entered. Example Agree to buy: $1000; at a rate of = 1.31 ; in 60 days ((How much, at which price and when). [...]