Transcript International Finance

Unit 4 Foreign Exchange Market
I. Definitions of Foreign
Exchange & Foreign Exchange
Market
A. Foreign exchange is defined as the currency of another
country.
E.g. To a Japanese, u.s. dollar is foreign exchange, and to an
American, Japanese Yen is foreign exchange.
B. The foreign exchange market is a market for converting the
currency of one country into that of another country. The
major participants in the foreign exchange market are large
commercial banks that operate at two levels-retail and interbank:
a) at the retail level, they deal with bank customers who want to buy
or sell foreign exchange;
b) at the inter-bank level, usually through foreign exchange brokers,
they trade in foreign exchange with other domestic and foreign banks,
and brokers will receive commissions for their services.
II. The Functions of Foreign
Exchange Market
A. Currency Conversion
• The payments a company receives for its exports and income it
receives from foreign investments may be in foreign currencies. To
use those funds in its home country, the company must convert
them to its home country’s currency;
• International businesses use foreign exchange markets when they
must pay a foreign company for its products or services in that
country’s currency;
• International businesses use foreign exchange markets when they
have spare cash that they wish to invest for short-terms in money
market. E.g. A US firm has $10 m and wants to invest it for 3
months. The interest rate in US is 8%, while the interest rate is
12% in France. Hence, the company may change its $ 10 m into
francs for investments to earn more interests of another 4% .
A. Currency Conversion
• Currency speculation (short-term movements of funds from one
currency to another one in the hopes of profiting from the
fluctuations in exchange rates) is another use of foreign
exchange markets. E.g. A US company has $ 10 m to invest for
3 months. Suppose the company suspects that US dollar is
overvalued against franc. That is the company expects the value
of the dollar to depreciate against franc. The current
dollar/franc exchange rate is $1=FFr 6, the company exchange
its $ 10 m into francs and receive FFr 6o m. In 3 months,
$1=FFr 5 (dollar depreciate against franc), then the company
exchange its FFr 60 m into $ 12 m. Thus, the company gets
profits = $12 m-$10 m = $ 2 m.
B. Insuring Against Foreign Exchange Risk
• The second function of the foreign exchange market is to
provide insurance to protect against the possible adverse
consequences of unpredictable change in exchange rates.
Through forward and future contracts (to fix future delivery
exchange rate), the foreign exchange market provides a
means of removing the foreign exchange risk.
III. Characteristics of Foreign
Exchange Market
• The foreign exchange market is a global single market of banks,
brokers, and foreign exchange dealers in many locations
connected by electronic communication systems, such as
telephone, fax and computer.
• The foreign exchange market has been growing at a rapid pace,
which reflects a general growth in the volume of cross-border
trade and investment.
• The foreign exchange market never sleeps, and it provides 24hour trading, because of the development of Internet technology.
• Most foreign exchange transactions involve dollars. Dealers may
trade one country’s currency for another one’s with the dollars as
intermediary, because the volume of international transactions
involving dollars is great. It is not hard to find dealers who wish
to trade dollars for other currencies.
•
Euro
US dollars
Japanese Yen
•
trading cost is bigger