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Forward Exchange and International Financial Investment

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  1. Exchange Rate Risk
  2. Forward Foreign Exchange Rate Contracts
  3. International Investment
  4. International Financial Investment
  5. Covered international investment

Example:
Imagine you take a vacation in GB and bring € with you, and you convert them as £ as needed.
-What is the risk here?
Appreciation of the £ ( depreciation of €)=> decreased buying power of your €.

-How can you ?protect? yourself against it? Convert before you go to GB you € into £.

As soon as we need to do transaction in another currency there is a risk due to the fluctuation of the two currencies.

Exposure to exchange rate risk:
You are exposed to exchange rate risk if the value of you income or wealth or net worth will change if exchange rates change unexpectedly in the future.
(unexpectedly because if you expect it, then you can protect yourself from it)

Hedging is taking an action to reduce your exposure to exchange rate risk.
Speculation is taking an action that increases your exposure to exchange rate risk, usually to try to profit from your belief about what future exchange rates will be.
(basically : hedging = not taking risk = se couvrir/se protéger, speculation = the contrary)

[...] if the 12 months forward exchange rate is 1.30 ? ( f = 1.30 = 0.769 f = pas 1.30 ) F = = ( 0.769 0.757 0.757 = The foreign currency here) is expected to appreciate by (if = - 0.015 The interest rate is lower in the USA than in France. CD = F + (if = 0.01580 0.015 = 0.0008 We earn more if we invest in the US. Covered interest Parity: (Keynes) As a result of pressure from covered interest arbitrage: - Covered interest parity: the domestic return equals the overall return on a covered foreign investment. [...]


[...] The forward exchange rate should be an average expectation of the future spot value. (due to the fact that anticipations come true; Forward rate = expected (future spot rate)) International Investment: - Firms can increase their market shares by: o Exporting. o Investing abroad (opening new plants abroad). That's Foreign Direct Investment (FDI). - Firms can also invest to diversify their portfolios. ( Portfolio Investment. NB ?Firm' is a large term here, and include, for example, commercial banks. NB Most of the international flows of money are between advanced countries. [...]


[...] You will want to reinvest them in France. You are in a long position. Long (SFr in the future) Forward Foreign Exchange Rate Contracts: Forward Foreign Exchange Rate Contracts is an agreement to exchange a certain amount of one currency for a certain amount of another currency in the future, with the amounts based on the price (forward exchange rate/locked-in forward price) set when the contract is entered. Example Agree to buy: $1000; at a rate of = 1.31 ; in 60 days ((How much, at which price and when). [...]


[...] - He can use a forward exchange contract (?covered international investment?) at a rate f = 1/f). - Or he can wait until the future and convert at the future spot rate (?uncovered international investment?). He can estimate earning with his expected future spot rate of eex = eex = ?expected value of ( expected future spot rate, e stand for expected value) For covered investment: For uncovered investment: If we are speaking of an uncovered investment, it is exactly the same thing, except that instead of the rate is eex. [...]

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