Transcript Chapter 9:The Foreign Exchange Market Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment by John Gionea Slides prepared by.

Chapter 9:The Foreign Exchange Market
Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/a
International Trade and Investment by John Gionea
Slides prepared by John Gionea
Lecture Plan:
• Determination of exchange rates
• Foreign exchange quotations
– Spot and forward rates
• Structure and size of the foreign exchange
market
• Economic theories of exchange rate
determination
• Case: The Fall of the Baht
Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/a
International Trade and Investment by John Gionea
Slides prepared by John Gionea
FOREIGN EXCHANGE
TRANSACTIONS
the
price of one currency
expressed in terms of
another currency!
• the foreign exchange rate is
• Appreciation
• Depreciation
1A$=US$ 0.55
1A$= US$ 0.60
1A$= US$ 0.50
Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/a
International Trade and Investment by John Gionea
Slides prepared by John Gionea
Determination of the
exchange rates
Price
$A1
in $US
0.55
S
E
D
Quantity of $A
Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/a
International Trade and Investment by John Gionea
Slides prepared by John Gionea
Floating Currencies:
Demand for the National Currency
• Nation’s exporters paid in other hard currencies
• Foreign companies undertaking direct
and portfolio investment in the nation’s economy
• "Bull" speculators in the nation’s currency
• Nation’s Central Bank(RBA) selling US$ and
other hard currencies for the nation’s currency
• Foreign tourists visiting your country.
Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/a
International Trade and Investment by John Gionea
Slides prepared by John Gionea
Floating Currencies:Supply of the
National Currency
•
•
•
•
•
Nation’s importers paying in US $, Yen etc.
Domestic firms investing abroad
"Bear" speculators in the national currency
Nation’s central bank buying US $, Yen etc.
Individual residents travelling overseas
Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/a
International Trade and Investment by John Gionea
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The EURO
• Benefits:
– significant savings for businesses and individuals
– easier comparability of prices; more competition
– boost to the development of a highly liquid panEuropean capital market
– more investment options
• Drawbacks:
– national authorities lose control over monetary
policy
– EU is not an “optimal currency area”
Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/a
International Trade and Investment by John Gionea
Slides prepared by John Gionea
SPOT TRANSACTIONS
• Spot transaction:is the purchase of FX with
delivery and payment (referred to as
settlement,on the following business day.
• The foreign exchange traders always quote:
– a bid (buy) and offer (sell) rate
• The SPREAD is the difference between the
bid and offer rates and is the margin on
which the trader earns a profit
Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/a
International Trade and Investment by John Gionea
Slides prepared by John Gionea
Market Quotations
• Dealers always “buy low” and
“sell high”
• Selling rates and Buying rates are always
from the perspective of the dealer/bank
Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/a
International Trade and Investment by John Gionea
Slides prepared by John Gionea
FORWARD TRANSACTIONS
• A FORWARD RATE is the price agreed on
today for purchase or sale of foreign
exchange at a future date.
• Usually agreed for less than 1 year
• Premiums and Discounts: Forward
quotations are either at a
– PREMIUM: forward >spot
– DISCOUNT:forward< spot
Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/a
International Trade and Investment by John Gionea
Slides prepared by John Gionea
Structure of the FX Market
• Large commercial banks deal at two levels:
– Retail:with bank customers
– Interbank(wholesale):with other domestic and
foreign banks
– A third market, the FX futures/options market came
into existence in the 1970’s with the inauguration
of trading in foreign exchange futures and options
by certain commodity and stock exchanges in the
US,subsequently adopted by other financial centres
Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/a
International Trade and Investment by John Gionea
Slides prepared by John Gionea
Functions of the Foreign
Exchange Market
• Currency conversion
• Reduction of foreign exchange risk
Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/a
International Trade and Investment by John Gionea
Slides prepared by John Gionea
Structure of the FX Market
• Large commercial banks deal at two levels:
– Retail:with bank customers
– Interbank(wholesale):with other domestic and
foreign banks
– A third market, the FX futures/options market came
into existence in the 1970’s with the inauguration
of trading in foreign exchange futures and options
by certain commodity and stock exchanges in the
US,subsequently adopted by other financial centres
Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/a
International Trade and Investment by John Gionea
Slides prepared by John Gionea
Geographical distribution of global reported
foreign exchange market turnover, %
France
Australia
Hong Kong
Switzerland
Germany
Singapore
Japan
United States
United Kingdom
3
3.2
4.1
4.4
5.4
6.2
9.1
FOREX %
15.7
31.1
Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/a
International Trade and Investment by John Gionea
Slides prepared by John Gionea
Share of traditional foreign exchange
transactions in the total turnover, %.
% of total T/O
60.0
50.0
40.0
Spot
30.0
Outright forwards
20.0
FX Swaps
10.0
0.0
1989
1992
1995
1998
2001
Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/a
International Trade and Investment by John Gionea
Slides prepared by John Gionea
Economic theories of exchange rate
determination
• Prices and Exchange rates
– The Law of one price
– The Purchasing Power parity(PPP)
• Money supply and price inflation
• Interest rates and exchange rates
• Investor psychology and band wagon
effects
Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/a
International Trade and Investment by John Gionea
Slides prepared by John Gionea
affecting the Australian
dollar exchange rate
Factors
•
•
•
•
•
Relative interest rates
Commodity prices and terms of trade
Relative inflation rates
The external account
The role of the Central Bank
– The Fall of the Baht
Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/a
International Trade and Investment by John Gionea
Slides prepared by John Gionea