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Concepts of the Foreign Exchange Market


The carry trade involves borrowing in one currency where interest rates are low, and then using the proceeds to invest in another currency where interest rates are high.
             INSURING AGAINST FOREIGN EXCHANGE RISK.
             A second function of the foreign exchange market is to provide insurance against foreign exchange risk, which is the possibility that unpredicted changes in future exchange rates will have adverse consequences for the firm.
             Spot Exchange Rates.
             When two parties agree to exchange currency and execute the deal immediately. The spot exchange rate is the rate at which a foreign exchange dealer converts one currency into another currency on a particular day. These are Exchange rates governing such "on the spot " trades. .
             Forward Exchange Rates.
             A forward exchange occurs when two parties agree to exchange currency and execute the deal at some specific date in the future. Exchange rates governing such future transactions are referred to as forward exchange rates.
             Currency Swaps.
             A currency swap is the simultaneous purchase and sale of a given amount of foreign exchange for two different value dates.
             The Nature of The Foreign Exchange Market.
             The foreign exchange market is not located in any one place. It is a global network of banks, brokers, and foreign exchange dealers connected by electronic communications systems.
             Economic Theories of Exchange Rate Determination.
             At the most basic level, exchange rates are determined by the demand and supply of one currency relative to the demand and supply of another.
             The law of one price states that in competitive markets free of transportation costs and barriers to trade (such as tariffs), identical products sold in different countries must sell for the same price when their price is expressed in terms of the same currency.
             Purchasing Power Parity.
             If the law of one price were true for all goods and services, the purchasing power parity (PPP) exchange rate could be found from any individual set of prices.


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