Definition of exchange rate

exchange rate

Amount of one currency needed to purchase one unit of another.

Exchange rate

The price of one country's currency expressed in another country's currency.

Exchange Rate Mechanism (ERM)

The methodology by which members of the EMS maintain their
currency exchange rates within an agreed upon range with respect to other member countries.

Exchange rate risk

Also called currency risk, the risk of an investment's value changing because of currency
exchange rates.

Fixed-exchange rate

A country's decision to tie the value of its currency to another country's currency, gold
(or another commodity), or a basket of currencies.

Floating exchange rate

A country's decision to allow its currency value to freely change. The currency is not
constrained by central bank intervention and does not have to maintain its relationship with another currency
in a narrow band. The currency value is determined by trading in the foreign exchange market.

Forward exchange rate

exchange rate fixed today for exchanging currency at some future date.

Historical exchange rate

An accounting term that refers to the exchange rate in effect when an asset or
liability was acquired.

Nominal exchange rate

The actual foreign exchange quotation in contrast to the real exchange rate that has
been adjusted for changes in purchasing power.

Real exchange rates

exchange rates that have been adjusted for the inflation differential between two countries.

Spot exchange rates

exchange rate on currency for immediate delivery. Related: forward exchange rate.

expectations theory of exchange rates

Theory that expected spot exchange rate equals the forward rate.

Effective Exchange Rate

The weighted average of several exchange rates, where the weights are determined by the extent of our trade done with each country.

Exchange Rate, Nominal

The price of one currency in terms of another, in this book defined as number of units of foreign currency per dollar.

Exchange Rate, Real

The nominal exchange rate corrected for price level differences.

Fixed Exchange Rate

An exchange rate held constant by a government promise to buy or sell dollars at the fixed rate on the foreign exchange market.

Flexible Exchange Rate

An exchange rate whose value is determined by the forces of supply and demand on the foreign exchange market.

Floating Exchange Rate

See flexible exchange rate.

Real Exchange Rate

exchange rate adjusted for relative price levels.

forward rate of exchange

exchange rate for a forward transaction.

spot rate of exchange

exchange rate for an immediate transaction.

Accounting exposure

The change in the value of a firm's foreign currency denominated accounts due to a
change in exchange rates.

Bretton Woods Agreement

An agreement signed by the original United Nations members in 1944 that
established the International Monetary Fund (IMF) and the post-World War II international monetary system
of fixed exchange rates.

Cable

exchange rate between British pounds sterling and the U.S.$.

Crawling peg

An automatic system for revising the exchange rate. It involves establishing a par value around
which the rate can vary up to a given percent. The par value is revised regularly according to a formula
determined by the authorities.

Cross rates

The exchange rate between two currencies expressed as the ratio of two foreign exchange rates
that are both expressed in terms of a third currency.

Currency arbitrage

Taking advantage of divergences in exchange rates in different money markets by
buying a currency in one market and selling it in another market.

Currency risk

Related: exchange rate risk

Current maturity

Current time to maturity on an outstanding debt instrument.
Current / noncurrent method
Under this currency translation method, all of a foreign subsidiary's current
assets and liabilities are translated into home currency at the current exchange rate while noncurrent assets
and liabilities are translated at the historical exchange rate, that is, the rate in effect at the time the asset was
acquired or the liability incurred.

Current rate method

Under this currency translation method, all foreign currency balance-sheet and income
statement items are translated at the current exchange rate.

Dirty float

A system of floating exchange rates in which the government occasionally intervenes to change
the direction of the value of the country's currency.

Economic exposure

The extent to which the value of the firm will change because of an exchange rate change.

Exchange risk

The variability of a firm's value that results from unexpected exchange rate changes or the
extent to which the present value of a firm is expected to change as a result of a given currency's appreciation
or depreciation.

Expectations hypothesis theories

Theories of the term structure of interest rates which include the pure
expectations theory, the liquidity theory of the term structure, and the preferred habitat theory. These theories
hold that each forward rate equals the expected future interest rate for the relevant period. These three theories
differ, however, on whether other factors also affect forward rates, and how.
Expectations theory of forward exchange rates A theory of foreign exchange rates that holds that the
expected future spot foreign exchange rate t periods in the future equals the current t-period forward exchange
rate.

Exposure netting

Offsetting exposures in one currency with exposures in the same or another currency,
where exchange rates are expected to move in such a way that losses or gains on the first exposed position
should be offset by gains or losses on the second currency exposure.

Free float

An exchange rate system characterized by the absence of government intervention. Also known as
clean float.

Gold exchange standard

A system of fixing exchange rates adopted in the Bretton Woods agreement. It
involved the U.S. pegging the dollar to gold and other countries pegging their currencies to the dollar.

Interest rate parity theorem

Interest rate differential between two countries is equal to the difference
between the forward foreign exchange rate and the spot rate.

Managed float

Also known as "dirty" float, this is a system of floating exchange rates with central bank
intervention to reduce currency fluctuations.

Operating exposure

Degree to which exchange rate changes, in combination with price changes, will alter a
company's future operating cash flows.

Philadelphia Stock Exchange (PHLX)

A securities exchange where American and European foreign
currency options on spot exchange rates are traded.

Purchasing power parity

The notion that the ratio between domestic and foreign price levels should equal
the equilibrium exchange rate between domestic and foreign currencies.

Quantos

Currency options with a guaranteed exchange rate that enable buyers who like the asset, German
bonds for example, but not the asset's pricing currency, to arrange to be paid in a different currency for a fee.

Range forward

A forward exchange rate contract that places upper and lower bounds on the cost of foreign exchange.

Relative purchasing power parity (RPPP)

Idea that the rate of change in the price level of commodities in
one country relative to the price level in another determines the rate of change of the exchange rate between
the two countries' currencies.

Target zone arrangement

A monetary system under which countries pledge to maintain their exchange rates
within a specific margin around agreed-upon, fixed central exchange rates.

Temporal method

Under this currency translation method, the choice of exchange rate depends on the
underlying method of valuation. Assets and liabilities valued at historical cost (market cost) are translated at
the historical (current market) rate.

Transaction exposure

Risk to a firm with known future cash flows in a foreign currency that arises from
possible changes in the exchange rate. Related:translation exposure.

Translation exposure

Risk of adverse effects on a firm's financial statements that may arise from changes in exchange rates.
Related: transaction exposure.

purchasing power parity (PPP)

Theory that the cost of living in different countries is equal, and exchange rates adjust to offset inflation differentials across countries.

Bretton Woods

Site of a 1944 international monetary conference at which the postwar fixed exchange rate system was structured and the International Monetary Fund (IMF) and World Bank were created.

Clean Float

A flexible exchange rate system in which the government does not intervene.

Depreciation

a) Of capital stock: decline in the value of capital due to its wearing out or becoming obsolete.
b) Of currency: decline in the exchange rate.

Devaluation

Fall in the government-determined fixed exchange rate.

Dirty Float

A flexible exchange rate system in which the government intervenes.

Gold Standard

A fixed exchange rate system in which a currency is directly convertible into gold.

International Monetary Fund (IMF)

Organization originally established to manage the postwar fixed exchange rate system.

Purchasing Power Parity

Theory that says that over the long run exchange rate changes offset any difference between foreign and domestic inflation. This result assumes that the real exchange rate remains constant, something that is not true even in the long run.

Sterilization

Central bank action offsetting money supply changes automatically generated by a balance of payments surplus or deficit under a fixed exchange rate system.

Accumulated Other Comprehensive Income

Cumulative gains or losses reported in shareholders'
equity that arise from changes in the fair value of available-for-sale securities, from the
effects of changes in foreign-currency exchange rates on consolidated foreign-currency financial
statements, certain gains and losses on financial derivatives, and from adjustments for underfunded
pension plans.

discount rate

the rate of return on investment that would be required by a prudent investor to invest in an asset with a specific level risk. Also, a rate of return used to convert a monetary sum, payable or receivable in the future, into present value.

Accelerated cost recovery system (ACRS)

Schedule of depreciation rates allowed for tax purposes.

Accelerated depreciation

Any depreciation method that produces larger deductions for depreciation in the
early years of a project's life. Accelerated cost recovery system (ACRS), which is a depreciation schedule
allowed for tax purposes, is one such example.

Active portfolio strategy

A strategy that uses available information and forecasting techniques to seek a
better performance than a portfolio that is simply diversified broadly. Related: passive portfolio strategy

Adjustable rate preferred stock (ARPS)

Publicly traded issues that may be collateralized by mortgages and MBSs.

After-tax real rate of return

Money after-tax rate of return minus the inflation rate.

All equity rate

The discount rate that reflects only the business risks of a project and abstracts from the
effects of financing.

American Stock Exchange (AMEX)

The second-largest stock exchange in the United States. It trades
mostly in small-to medium-sized companies.

Amortizing interest rate swap

Swap in which the principal or national amount rises (falls) as interest rates
rise (decline).

Annual percentage rate (APR)

The periodic rate times the number of periods in a year. For example, a 5%
quarterly return has an APR of 20%.

Arithmetic average (mean) rate of return

Arithmetic mean return.

Auction rate preferred stock (ARPS)

Floating rate preferred stock, the dividend on which is adjusted every
seven weeks through a Dutch auction.

Average rate of return (ARR)

The ratio of the average cash inflow to the amount invested.

Average tax rate

Taxes as a fraction of income; total taxes divided by total taxable income.

Barbell strategy

A strategy in which the maturities of the securities included in the portfolio are concentrated
at two extremes.

Base interest rate

Related: Benchmark interest rate.

Basic business strategies

Key strategies a firm intends to pursue in carrying out its business plan.

Benchmark interest rate

Also called the base interest rate, it is the minimum interest rate investors will
demand for investing in a non-Treasury security. It is also tied to the yield to maturity offered on a
comparable-maturity Treasury security that was most recently issued ("on-the-run").

Bill of exchange

General term for a document demanding payment.

Break-even payment rate

The prepayment rate of a MBS coupon that will produce the same CFY as that of
a predetermined benchmark MBS coupon. Used to identify for coupons higher than the benchmark coupon
the prepayment rate that will produce the same CFY as that of the benchmark coupon; and for coupons lower
than the benchmark coupon the lowest prepayment rate that will do so.

Break-even tax rate

The tax rate at which a party to a prospective transaction is indifferent between entering
into and not entering into the transaction.

Broker loan rate

Related: Call money rate.

Bullet strategy

A strategy in which a portfolio is constructed so that the maturities of its securities are highly
concentrated at one point on the yield curve.

Buy-and-hold strategy

A passive investment strategy with no active buying and selling of stocks from the
time the portfolio is created until the end of the investment horizon.

Call money rate

Also called the broker loan rate , the interest rate that banks charge brokers to finance
margin loans to investors. The broker charges the investor the call money rate plus a service charge.

Chicago Mercantile Exchange (CME)

A not-for-profit corporation owned by its members. Its primary
functions are to provide a location for trading futures and options, collect and disseminate market information,
maintain a clearing mechanism and enforce trading rules.

Combination strategy

A strategy in which a put and with the same strike price and expiration are either both
bought or both sold. Related: Straddle

Commodities Exchange Center (CEC)

The location of five New York futures exchanges: Commodity
exchange, Inc. (COMEX), the New York Mercantile exchange (NYMEX), the New York Cotton exchange,
the Coffee, Sugar and Cocoa exchange (CSC), and the New York futures exchange (NYFE). common size
statement A statement in which all items are expressed as a percentage of a base figure, useful for purposes of
analyzing trends and the changing relationship between financial statement items. For example, all items in
each year's income statement could be presented as a percentage of net sales.

Conglomerate

A firm engaged in two or more unrelated businesses.

Conglomerate merger

A merger involving two or more firms that are in unrelated businesses.

Convertible exchangeable preferred stock

Convertible preferred stock that may be exchanged, at the
issuer's option, into convertible bonds that have the same conversion features as the convertible preferred
stock.

Corporate acquisition

The acquisition of one firm by anther firm.

Corporate bonds

Debt obligations issued by corporations.

Corporate charter

A legal document creating a corporation.

Corporate finance

One of the three areas of the discipline of finance. It deals with the operation of the firm
(both the investment decision and the financing decision) from that firm's point of view.

Corporate financial management

The application of financial principals within a corporation to create and
maintain value through decision making and proper resource management.

Corporate financial planning

Financial planning conducted by a firm that encompasses preparation of both
long- and short-term financial plans.

Corporate processing float

The time that elapses between receipt of payment from a customer and the
depositing of the customer's check in the firm's bank account; the time required to process customer
payments.

Corporate tax view

The argument that double (corporate and individual) taxation of equity returns makes
debt a cheaper financing method.

Corporate taxable equivalent

rate of return required on a par bond to produce the same after-tax yield to
maturity that the premium or discount bond quoted would.

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