Abstract
The notion of foreign exchange market is treated in depth, as well as the various types of exchange rate (spot, forward, real, effective, etc.). The main currency derivatives are also explained.
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Notes
- 1.
An economic transaction is the transfer from one economic agent (individual, corporate body, etc.) to another of title to a good, the rendering of a service, or title to assets, having economic value. It includes both real transfers (i.e., transfer of title to goods or rendering of services) and financial transfers (i.e. of money, credits and financial assets in general). Transactions can either involve a payment, whatever the form (bilateral transfers) or not (unilateral transfers, such as gifts). As we shall see in detail in the next chapter, what qualifies an economic transaction as international is the fact that the parties are residents of different countries.
- 2.
To avoid confusion, the reader should note that demand deposit is here taken to mean a deposit with a bank from which money can be drawn without previous notice and on which cheques can be drawn (synonyms in various countries are: current account deposit, checking deposit, sight deposit).
- 3.
The reader should note that the order of the subscripts is merely conventional, so that many authors (as here) use r j i to denote the price of currency j in terms of currency i, whereas others follow the reverse order and use r i j to denote the same concept. It is therefore important for the reader to carefully check which convention is adopted.
- 4.
Here, as well as subsequently, “spot exchange rate” is used to denote a generic spot exchange rate belonging to the set of all spot exchange rates.
- 5.
Some writers (see, for example, Einzig 1961, 1966) distinguish between covering and hedging. Covering (by means of forward exchange) is an arrangement to safeguard against the exchange risk on a payment of a definite amount to be made or received on a definite date in connection with a self-liquidating commercial or financial transaction. Hedging (by means of forward exchange) is an arrangement to safeguard against an indefinite and indirect exchange risk arising from the existence of assets or liabilities, whose value is liable to be affected by changes in spot rates. More often, however, no distinction is made and hedging (in the broad sense) is taken to include all operations to safeguard against the exchange risk, however it arises.
- 6.
We are abstracting from possible domestic regulations requiring the immediate deposit of a certain proportion of the value (in domestic currency) of the forward contract.
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Gandolfo, G. (2016). The Foreign Exchange Market. In: International Finance and Open-Economy Macroeconomics. Springer Texts in Business and Economics. Springer, Berlin, Heidelberg. https://doi.org/10.1007/978-3-662-49862-0_2
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