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Exchange Rate - Lesson Summary
The system which protects the organism against invading pathogens is known as the immune system.A deficit on the current account means that the value of goods and services being imported is greater than the value of goods and services being exported.An exchange rate system establishes the way in which the value of the domestic currency will be determined against other currencies.In a fixed exchange rate environment, multinational companies may be able to engage in international trade, direct foreign investments and international finance without worrying about the future exchange rate since it is simple and clear.In a freely floating exchange rate system, the exchange rate values are determined by market forces without any intervention by the government.In the managed float exchange rate system, exchange rates are allowed to move freely on a daily basis and no official boundaries exist. However, governments may intervene to prevent the rates from moving too much in a certain direction.Currency convertibility refers to the freedom to convert the domestic currency into other internationally accepted currencies at market-determined rates of exchange.The Purchasing Power Parity theory is an economic theory that allows the comparison of the purchasing power of various currencies against each other. It is a theoretical exchange rate that allows people to buy the same amount of goods and services in every country.The law of one price states that in the absence of trade frictions and conditions of free competition and price flexibility, all identical goods whatever the market must have only one price if they are using a common currency.The Absolute Purchasing Power Parity theory postulates that the equilibrium exchange rate between currencies of two countries are equal to the ratio of the price levels in the two nations.The Relative Purchasing Power Parity theory predicts a relationship between the inflation rates of two countries over a specified period and the movement in the exchange rate between their two currencies over the same period.The Interest Rate Parity is a theory in which the interest rate differential between two countries is equal to the differential between the forward exchange rate and the spot exchange rate.The Fisher Effect is an economic theory that describes the relationship between inflation and both real and nominal interest rates.The Foreign Exchange Exposure is a measure of the potential change in a firm’s profitability, net cash flow, and market value due to a change in exchange rates.The translation exposure measures the impact of changes in the foreign currency exchange rate on the value of assets and liabilities.The transaction exposure measures the changes in the value of the outstanding financial obligations. This arises due to the fluctuation in the exchange rate between the time at which the contract is concluded in foreign currency and its final settlement.The operating exposure measures the extent to which a firm’s operating cash flows are affected by the exchange rate.