FOREIGN EXCHANGE

THEORIES OF FOREIGN EXCHANGE

MINT THEORY

GOLD STANDARD PREVAILED UPTO 1931 UNDER MINT PARITY ARRANGEMENT, RATE OF EXCHANGE IS DETERMINED BY REFERENCE TO THE GOLD CONTENTS OF THE TWO CURRENCIES FOR EX:

FOR US$ 1 = 0.04 GRAMS OF GOLD FOR INR 1 = 0.001 GRAMS OF GOLD SO 1 US$ = 40 INR

PURCHASING POWER PARITY THEORY

WAS GIVEN BY SWEDISH ECONOMIST GUSTAV CASSEL AFTER WW1 PPP IS USED IN PAPER CURRENCY MODEL, WHERE EXTERNAL VALUE OF THE CURRENCY IS DETERMINED BY ON THE BASIS OF ITS INTERNAL VALUE THE THEORY IS BASED ON LAW OF ONE PRICE NOT ONLY THE PRICE OF THE PRODUCT INFLUENCES THE THEORY BUT ALSO THE INFLATION

INTEREST RATE PARITY THEORY

INTEREST RATE PARITY THEORY BRINGS OUT THE DIFFERENCE BETWEEN SPOT AND FORWARD EXCHANGE RATES THE CURRENCY OF THE COUNTRY WITH A LOWER INTEREST RATE SHOULD BE AT A FORWARD PREMIUM IN TERMS OF THE CURRENCY OF THE HIGHER INTEREST RATE COUNTRY.

FOREIGN EXCHANGE RISK

FOREX RISK ARE OF THREE TYPES

ACCOUNTING OR TRANSLATION RISK TRANSACTION RISK OPERATING RISK

ACCOUNTING OR TRANSLATION RISK

Translation risk is a measure of variation of home currency value of assets and liabilities appearing in balance sheet denominated in foreign currency. It is also called as balance sheet or accounting risk. It does not create Fresh Cash flows

TRANSACTION RISK

Transaction Risk is the measure of variation of home currency value of receivables and payables denominated in foreign currencies due to unanticipated changes in exchange rate.

TRANSACTION RISK OVERCOMING STRATERGIES

INTERNAL STRATERGIES

EXTERNAL STRATERGIES

NETTING RISK SHIFTING RISK SHARING RISK OFF-SETTING PRICING

MONEY MARKET HEDGE

CURRENCY OVERDRAFTS BORROW, CONVERT & INVEST

FOREX MARKET HEDGING

OPTIONS FUTURES FORWARD SWAPS

OPERATING ECONOMIC RISK

In operating risk, the manufacturing trading and financial transactions activities- are to fulfill an export of obligation. The Input Prices May Change The Revenue side may Change The Expected fluctuate Currency Value may

DETERMINANTS OF OPERATING ECONOMIC RISK

The structure of the markets in which the firm gets inputs, and sells its products, The level of fluctuations in exchange rates and uncertainty over there The firms ability to mitigate the effect of exchange rate changes by adjusting its markets, product mix, and sourcing (operating hedges) and The firms ability to mitigate the effect of exchange rate changes by some financial hedging

OPERATING ECONOMIC RISK HEDGING STRATERGIES