Question

Answer one question per page, double space:

1. How are foreign exchange rates affected by differences in the interest rates prevailing in various countries?
2. In foreign exchange, what are spot and forward transactions? How do they differ?
3. Please provide your discussion about the risks associated with foreign exchange rate fluctuations focusing on economic, transaction, and translation risks, and hedging methods in response to those currency risks.

Answer 1

Rate of interest in the a particular economy is critical for ascertaining the foreign exchange rate, a higher rate of interest will attract more foreign investment in the country as it becomes attractive to lend the money in country which have higher rate of interest, and it leads to rise of exchange rate, similarly its reverse happens when the rate of interest is lower, it leads to downfall of exchange rate. However, it is also critical to monitor the inflation rate as a higher will decrease the impact of higher rate of interest.

Foreign Exchange Spot and forward transactions:

Spot transactions are usually for immediate requirement of exchange of two currency at the prevailing rate as on date or immediate delivery(usually with in two days) However the forward foreign exchange contract is for a specified price on a predetermined date also called as closed or with in specified range of date which is also known as open.

In both the contracts It is binding on both the parties.

Foreign exchange rate fluctuations may lead to difficult situations if not planned well in advance consider all the factors which may impact, he foreign exchange rate. There are various ways to hedge the risk of foreign exchange rate such as put or call options or by holding short a long-term position in same currency pairs. This will lead to managing the risk against the fluctuations in currency exchange rate.