MBA- H4030 International Business Finance
Let us begin with some terms in order to prevent confusion in reading thisunit:
A foreign currency exchange rate or simply exchange rate
is the price of onecountry’s currency in units of another currency or commodity (typically gold orsilver). If the government of a country- for example, Argentina- regulates therate at which its currency- the peso- is exchanged for other currencies, thesystem or regime is classified as a fixed or managed exchange rate regime. Therate at which the currency is fixed, or pegged, is frequently referred to as its parvalue. if the government does not interfere in the valuation of its currency in anyway, we classify the currency as floating or flexible.
Spot exchange rate
is the quoted price for foreign exchange to be delivered atonce, or in two days for inter-bank transactions. For example, ¥114/$ is a quotefor the exchange rate between the Japanese yen and the U.S. dollar. We wouldneed 114 yen to buy one U.S. dollar for immediate delivery.
is the quoted price for foreign exchange to be delivered at aspecified date in future. For example, assume the 90-day forward rate for theJapanese yen is quoted as ¥112/$. No currency is exchanged today, but in 90days it will take 112 yen to buy one U.S. dollar. This can be guaranteed by aforward exchange contract.
Forward premium or discount
is the percentage difference between the spotand forward exchange rate. To calculate this, using quotes from the previous twoexamples, one formula is: