Pros And Cons Of Foreign Exchange Swaps

2.4.3.3. Foreign exchange swaps

“A foreign exchange swap is a spot sale of a currency combined with a forward repurchase of the currency” (Krugman, p. 316) “Swaps are multiperiod extensions of forward contracts” (Bodie, Kane, Marcus, p. 815). It is the purchase and sale of an identical amount of one currency for another with two different value dates. FX Swaps account for an important proportion of all exchange trading.

2.4.3.4. Futures contracts

The futures contract calls for delivery of a specified amount of foreign currency on a specified date in the future. The original aim of using futures contracts was to reduce the risk of change in exchange rates by using fix rates in advance for future transactions.

2.4.3.5. Option contracts

A foreign

In a fixed exchange rate regime, the depreciation and appreciation of domestic currency are determined directly by the government’s desire in order to support such economic goals as encouraging importation or exportation, correcting payment balance deficits. In a floating exchange rate regime, where the government only attempts to regulate the exchange rate indirectly, the fluctuations of exchange rate are the result of not simply one factor but always of a series of several elements and events. The study of these elements therefore approaches the problem in different ways. The following theories called international parity conditions are some of the most essential conditions in economics providing not only logical explanation for fluctuations in exchange rates but also crucial “understanding of international linkages among the market of goods, capital and foreign exchange as well as the movement of interest rates” (Imad A. Mossa, p. 304), namely purchasing power parity, law of one price, interest rate parity, Fisher

In the case of individuals, first of all, their demand of money depends on the opportunity cost holding money instead of other assets with less liquidity. Holding money or even keeping it as bank deposit brings little interest rate for holders, while they can benefit more if investing in other less liquid forms of wealth such as government bond, large time deposit, real estate. From this we can conclude that the higher the interest rate is, the more it is likely for money demand to fall. Second, the main benefit of holding money is its liquidity. For individuals, holding money make it easier and more convenient for them to finance their everyday purchases. And depending on the average value of their daily purchase the money demand will rise or fall accordingly. The money demand of individual households and firms makes up the aggregate money demand, which is determined by three main factors:

Interest rate: when the interest rate is high, the opportunity cost of holding money rises as it is more profitable to keep money in other less liquid forms of wealth rather than hold money. In conclusion, high interest rate causes a fall in money demand of individuals; high interest rate also reduces the aggregate demand for