Foreign Exchange Markets (FRM Part 1 2023 – Book 3 – Chapter 9)

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After completing this reading, you should be able to:
- Explain ad describe the mechanics of spot quotes, forward quotes and future quotes in the foreign exchange market and distinguish between the bid and ask exchange rates
- Calculate bid-ask spread and explain why bid-ask spread for spot quotes may be different from the bid-ask spread for the forward quotes
- Compare outright (forward) and swap transactions
- Define, compare and contrast transaction risk, translation risk and economic risk
- Describe the examples of the transaction, translation, and economic risk and explain how to hedge these risks.
- Describe the rationale for multi-currency hedging using options
- Identify and explain the factors that determine the exchange rates
- Calculate and explain the effect of an appreciation/depreciation of a currency of a currency relative to a foreign currency,
- Explain the purchasing power parity theorem and use this theorem to calculate the appreciation or depreciation of a foreign currency
- Explain how no-arbitrage assumption in the foreign exchange markets leads to the interest rate parity theorem and use this theorem to calculate forward foreign exchange rates.
- Distinguish between covered and uncovered interest rate parity conditions.