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Fiat Money

See Also:
Cash Cycle
Categories of Banks
What are the 7 C’s of banking?
Currency Exchange Rates
Currency Swap

Fiat Money Definition

The definition of fiat money is currency made into legal tender. Furthermore, a governmental entity backs this tender to ensure its legitimacy.

Fiat Money Explained

Normally, fiat money is issued for a government or large grouping of countries. For example, the U.S. Federal Reserve issues dollar bills. When a person uses this, it is assumed that that particular bill has investment power because it is backed by the full faith and backing of the U.S. government. However, in Europe, the European Bank equivalent to the Federal Reserve issues euros to the local population. This process occurs all over the world for different countries and the money is only useful to a person in that particular country. If an American were to try to pay for a pack of gum in Brazil with a U.S. dollar bill, then he/she would be unsuccessful because in Brazil the dollar is of no use within the country of Brazil.

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Currency Swap

See Also:
Currency Exchange Rates
Transaction Exposure
Exchange Traded Funds
Translation Exposure
Hedge Funds

Currency Swap Definition

Currency swaps are used to manage exchange rate risk. In a currency swap, two counterparties exchange the interest and principal payments on loans in different currencies. The counterparties agree to a set exchange rate, a set maturity, and a set schedule to pay interest and principal. By fixing the exchange rate for the transaction, both counterparties hedge the risk of unfavorable exchange rate fluctuations.

Currency Swap Example

For example, a British company may need to borrow US dollars. But the only rate it can get on a dollar loan is too high. At the same time, a US company needs to borrow pounds, but the only rate it can get on a loan in pounds is too high.

The British company, however, can borrow pounds at an attractive interest rate and the US company can borrow dollars at an attractive interest rate. So the two companies decide to enter into a currency swap agreement.

The US company borrows dollars cheaply and then lends them to the British company. Meanwhile, the British company borrows pounds cheaply and lends them to the US company. Through the swap agreement, both companies end up benefiting from the other company’s attractive home-currency borrowing rate. It is a win-win situation.

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currency swap

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Currency Exchange Rates

See Also:
Currency Swap
Transaction Exposure
Hot Money
Exchange Traded Funds
Required Rate of Return
Hedge Funds
Fiat Money

Currency Exchange Rates

An exchange rate gives the value of one currency in terms of another. An exchange rate can be computed for any two currencies. Exchange rates are typically quoted to at least four decimal places.

Foreign currencies are exchanged for investment and speculative purposes and for hedging risk. Foreign currencies are traded all over the world twenty-four hours a day via banks and brokerages. The foreign exchange market is the largest market in the world. Speculating in foreign exchange markets is considered very risky.

Fixed Exchange Rates vs. Floating Exchange Rates

An exchange rate can be fixed or floating. A fixed rate is determined and maintained by government central banks. A floating rate is determined by market forces.

A fixed rate, or peg, maintains a set exchange rate for one currency in terms of another. For example, assume the Chinese Yuan is pegged to the US Dollar. If the US Dollar declines in value, then the Chinese Yuan will also decline in value so that the exchange rate remains unchanged.

A floating rate allows the exchange rate between two currencies to fluctuate freely based on the supply and demand of each currency, as well as other relevant economic factors. For example, the exchange rate between the US Dollar and the Euro is a floating rate. Due to market forces, the exchange rate between these two currencies fluctuates continuously.

Currency Spot Prices

The spot exchange rate for two currencies is the rate of exchange for immediate (within two business days) delivery. For example, if a trader wants to exchange US Dollars for Euros today, he would do so at the spot rate.

Currency Forward Rate

The forward exchange rate for two currencies is the rate of exchange for future delivery. Forward rates are often quoted for 1-month, 3-month, and 6-month contracts. If a trader plans to exchange US Dollars for Euros three months from now, but wants to fix the price of the conversion today, he can do so by purchasing Euros at the 3-month forward rate. In three months the trader would receive the amount of Euros determined by the forward rate contract, regardless of the spot rate at that time.

Appreciation and Depreciation of Currency

Appreciation, or revaluation, refers to an increase in the spot rate value of one currency in relation to another.

Depreciation, or devaluation, refers to a decrease in the spot rate value of one currency in relation to another.

Direct Quote vs. Indirect Quote

A direct quote shows the home currency price of one unit of foreign currency. An indirect quote shows the foreign currency price of one unit of home currency. For example, consider these hypothetical direct and indirect quotes between the Euro and the US Dollar, using the US Dollar as the home currency:

Direct Quote:        $1.5501 = €1        (1/.6451)

Indirect Quote:      €.6451 = $1         (1/1.5501)

FOREX Rates (FX Rates)

Currency exchange rates are also called forex rates or fx rates.

Exchange Rate Converter

For foreign currency conversions, go to: www.oanda.com

Exchange Rates – Historical

For historic exchange rate data, go to: www.oanda.com

Download your free External Analysis whitepaper that guides you through overcoming obstacles and preparing how your company is going to react to external factors.

currency exchange rates

Strategic CFO Lab Member Extra

Access your Projections Execution Plan in SCFO Lab. The step-by-step plan to get ahead of your cash flow.

Click here to access your Execution Plan. Not a Lab Member?

Click here to learn more about SCFO Labs

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