KYLA R.

DAYAWON BSA-2A
FINACIAL MARKETS AND INSTITUTIONS

REVIEW QUESTIONS (CHAPTER 9)

1. List the factors that affect the value of a currency in foreign exchange markets.
1. Inflation. Inflation tends to deflate the value of a currency because holding the currency results
in reduced purchasing power.
2. Interest rates. If interest returns in a particular country are higher relative to other countries,
individuals and companies will be enticed to invest in that country. As a result, there will be an
increased demand in the country’s currency.
3. Balance of payments. Is used to refer to a system of accounts that catalogs the flow of goods
between the residents of two countries. For instance, if the Philippines is a net exporter of goods
and therefore has a surplus balance of trade. Countries purchasing the goods must use the
country’s currency. This increases the demand for currency and its relative value.
4. Government Intervention. Through intervention (e.g., buying or selling the currency in the
foreign exchange market), the central bank of a country may support or depress the value of the
currency.
5. Other Factors. Other factors that may affect exchange rate are political and economic stability,
expanded stock market rallies and significant declines in demand for major exports.

2. Explain how imports and exports tend to influence the value of the currency.
- When a country’s currency appreciates (rises in value relative to other currencies), the country’s
goods abroad become more expensive and foreign goods in that country become cheaper (holding
domestic prices constant in the two countries). Conversely when a country’s currency depreciates
its goods abroad become cheaper and foreign goods in that country become more expensive.
Appreciation of a currency can make it harder for domestic manufactures to sell their goods
abroad and can increase competition at home from foreign goods because they cost less.

3. Differentiate between the spot exchange rate and the forward exchange rate.
- Spot Exchange Rates. If we are exchanging one currency for another immediately, we participate
in spot transaction. A typical spot transaction may involve a Philippine firm buying foreign
currency from its bank and paying for it in Philippine peso (or an American firm buying currency
from its bank and paying it in US dollars. The price of the foreign currency in terms of domestic
currency is the exchange rate0 in this instance, the Philippine Peso. The Spot rate for a currency
is the exchange rate at which the currency is traded for immediate delivery.
- Forward exchange Rate on other hand is for currency is the exchange at which rate at which the
currency for future delivery is quoted. The trading currencies for future delivery is called forward
market transaction. The forward exchange rate could be slightly different from the spot rate, since
the forward rate deals with a future time, the expectation regarding the future value of that
currency are reflected in that forward rate. Forward rates may be greater than the current spot rate
(premium) or less than the current spot rate (discount).

4. What is meant by the translation exposure in terms of foreign exchange risk?

- Translation exposure (also known as translation risk) is the risk that a company's equities, assets,
liabilities, or income will change in value as a result of exchange rate changes. This occurs when
a firm denominates a portion of its equities, assets, liabilities, or income in a foreign currency. It
is also known as "accounting exposure.”
5. What procedure (s) would you recommend for a multinational company in studying exposure to
political risk? What actual strategies can be used to guard against such risk?
- The simplest solution is to research the riskiness of a country, either by paying for reports from
consultants that specialize in making these assessments or doing research yourself using the many
free sources available on the internet (such as the U.S. Department of State's background notes).
Then you will have the more informed option to not set up operations in countries considered
political risk hot spots.

While that strategy can be effective for some companies, sometimes the prospect of entering a
riskier country is so lucrative that it is worth taking a calculated risk. In those cases, companies
can sometimes negotiate terms of compensation with the host country, so there would be a legal
basis for recourse if something happens to disrupt the company's operations.

However, the problem with this solution is that the legal system in the host country may be
substantially different from the company's country, and in some places, foreigners rarely win
cases against a host country. Even worse, a revolution could spawn a new government that does
not honor the actions of the previous government.

6. What is LIBOR? How does it compare to the U.S. prime rate.

- The London Interbank Offered Rate (LIBOR) is a benchmark interest rate at which major global
banks lend to one another in the international interbank market for short-term loans.
- Libor is an average derived from the rates at which major banks lend to each other in
London’s money markets. Whereas, US Prime Rate is typically set at three percentage points
above the federal funds rate. Setting Libor is more complicated than setting US Prime Rate.
- Libor is a floating rate as it fluctuates continually. US Prime Rate is a fixed rate, which means it
typically remains unchanged for extended periods of time. Prime Rate versus Libor: Prime rate is
a fixed rate, whereas Libor is a floating rate.
- Libor is used by banks – it is the interest rate at which banks lend to each other in certain
London money markets. (Borrowers, lenders, and investors may use Libor as a reference rate.)
Comparatively, US Prime Rate is used by consumers – it is the rate at which banks lend to their
best customers. (Borrowers, lenders, and investors may use prime rate as a reference rate.) Libor
is used primarily by banks (in theory). Prime is used primarily by consumers.
- Libor is a benchmark interest rate used as a reference in lending and
borrowing transactions around the globe. (Keep in mind, Libor bank rates are also used as
reference rates in various financial derivatives.) Comparatively, US Prime Rate is a
benchmark interest rate used as a reference in lending and borrowing transactions in the United
States and elsewhere. When we look at Libor versus Prime Rate, we find both rates are
benchmark interest rates with wide global usage.