Exchange Rate Basic Questions

Currency

Appreciate, depreciate

Changes in the spot rate of exchange between two countries can occur as the result of a change in the relative interest rates in those countries, a change in the balance of trade between those countries and changes in the inflation rates in those countries (Van Bergen, 2015).

The two that are most closely followed are the differences in the interest rates, and the differences in the inflation rates.

A forward is a contract that is written between a party and a counterparty, to exchange currency in a set amount at a set rate in the future. This is proprietary between the parties. A future is publicly-traded. So while it also sets a future date and price for a currency, it is publicly traded, the dates do not change, and the amount is fixed -- to increase the amount you have to buy or sell more futures.

A put option is an option to sell a security, and a call option is an option to buy a security. These are options in the future, at a certain price, which is known as the strike price.

6. The maximum risk is $2.50. This is the amount that has been paid, and if the option is out of the money at expiry, you will lose this $2.50 as the option will expire worthless. There is no other downside, since you do not own the security.

7. The four regimes are floating, pegged float, managed float and fixed.

8. The government might weaken the dollar in order to spur exports, making U.S. exports cheaper overseas. By doing this, the U.S. government would spur economic growth via exporting. This would theoretically stimulate the economy, since that production would come at the expense of imported goods, which would be more expensive and thus see a reduction in demand.

9. The government could strength the dollar as a means of cooling the economy. A strong dollar makes exports more expensive, reducing demand for U.S. goods. But it also decreases the cost of foreign goods.

10. PPP is not a great determinant of exchange rates because of all the other factors that influence prices in an economy. There are a lot of other factors and these contribute to price differentials -- PPP would only work if all other factors are equal, but they are not even close to equal.

11. The parent and subsidiary are free to determine what cash flows between them. The subsidiary will remit back this amount. But that amount is determined by the cash flow needs of the subsidiary, the cash flow needs of the parent, expansion plants and reinvestment rates for the subsidiary, what the company expects the exchanges rates to be, any number of other business factors.