International Money and Finance by Michael Melvin & Stefan C. Norrbin

Author:Michael Melvin & Stefan C. Norrbin
Language: eng
Format: epub
ISBN: 9780123852489
Publisher: Elsevier Science
Published: 2012-08-31T16:00:00+00:00

Summary

1. Foreign exchange risk includes translation exposure, transaction exposure, and economic exposure.

2. Foreign exchange risk could be minimized by trading in forward-looking market instruments, invoicing prices in domestic currency, speeding payments of currencies expected to appreciate, and speeding collections of currencies expected to depreciate.

3. The foreign exchange risk premium is the difference between the forward exchange rate and the expected future spot exchange rate.

4. A risk-averse investor will prefer an investment with a lower risk when he/she faces two investments of similar expected returns.

5. The difference between the return on a domestic asset and the effective return on a foreign asset depends on the risk of the assets and the degree of risk aversion.

6. The effective return differential is equal to the risk premium in the forward exchange market.

7. If the effective return differential is zero, then there would be no risk premium. If the effective return differential is positive, then there would be a positive risk premium on the domestic currency.

8. If a positive risk premium on the domestic currency exists, investors would be willing to hold foreign investments even if the foreign investments yield lower effective returns than the domestic investments.

9. In an efficient market, prices reflect all available information. If the foreign exchange market is efficient, the forward exchange rate would differ from the expected future spot exchange rate only by a risk premium.

10. For multinational firms, a good forecast is not necessarily minimizing forecasting errors, but it should be on the correct side of the forward exchange rate.

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