Foreign

Exchange
Markets
 Foreign Exchange Market

• Markets in which cash flows

from the sale of products or
assets denominated in a
foreign currency are
transacted.
• It is a global decentralized or
over-the-counter market for
the trading of currencies.
 Foreign Exchange Rate

• The price at which one

currency can be exchanged
for another currency.
 Foreign Exchange Risk

• Risk that cash flows will vary

as the actual amount of U.S.
dollars received on a foreign
investment changes due to a
change in foreign exchange
rates.
 Foreign Exchange Transaction
Spot Foreign Exchange Forward Foreign
Transaction Exchange Transaction

Foreign exchange The exchange of

transactions involving the
immediate exchange of
currencies at the current
(or spot) exchange rate. START
currencies at a
specified exchange rate
(or forward exchange
rate) at some specified
date in the future.
Other Basic Foreign Exchange Trading Activities

01 Buying and selling of currencies for international transaction.

02 Foreign Investments.

03 Hedging Activities

04 Speculation
Interaction of Interest
rates, Inflation, and
Exchange Rate
Purchasing Power Parity

The theory explaining the change in

foreign currency exchange rates as
inflation rates in the countries
change.
 Purchasing Power Parity Theory
Absolute Purchasing Relative Purchasing
Power Parity Power Parity

Once two currencies have Exchange rates and inflation

been exchanged, a basket of rates (price level) in two
goods should have the same countries should equal over
value. time.

1st. Deduct the lower inflation from the

higher inflation.
2nd. Increase the value of the currency
that has higher inflation with the
difference.
Recap
 Purchasing Power Parity Theory
Absolute Purchasing Relative Purchase Power
Power Parity Parity
1st. Deduct the lower inflation from the
higher inflation.
2nd. Increase the value of the currency
that has higher inflation with the
difference.

Foreign: $52 3.2%

Domestic: ₱400 6.5%

₱400/$52 = ₱7.69

START 6.5% - 3.2% = 3.3%

1x(1+0.033)=7.69
1.033/1.033 = 7.69/1.033
$1 : ₱7.44
Interest Rate Parity Theorem (IRPT)

There is a relationship between spot exchange rate

and the expected forwards exchange rate of two
currencies based on the interest rates relating to
them.
Formula
ic serves as the interest
in domestic

ib serves as the interest

in foreign
 Interest Rate Differential

Weighs the contrast in interest rates between

two similar interest-bearing assets. Most often
it is the difference between two interest rates.
 Hedging

Strategies that tries to limit risks in financial asset.

It uses financial instruments or market strategies
to offset the risk of any adverse price movement.
Thank you