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Foreign Exchange. Business and Financial Reporting (JMSC6004) March 18, 2002. Intl Monetary System. Bretton Woods, July 1944 US$ became primary medium of intl exchange Exchange rate fixed, plus/minus one pct. Gold fixed at $35/oz Smithsonian Agreement, Dec 1971

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foreign exchange

Foreign Exchange

Business and Financial Reporting (JMSC6004)

March 18, 2002

intl monetary system
Intl Monetary System
  • Bretton Woods, July 1944
    • US$ became primary medium of intl exchange
    • Exchange rate fixed, plus/minus one pct.
    • Gold fixed at $35/oz
  • Smithsonian Agreement, Dec 1971
    • gold fixed at $38/oz, fluctuation band 2.25 pct
  • Floating exchange rate, 1973
european development
European Development
  • Treaty of Rome, 1957, called for the creation of the Euopean Economic Community (EEC)
    • Common Market
    • European Monetary System (EMS)
    • ECU, a GDP weighted average of the EMS currencies, individual currencies fluctuating in a band of 2.25 pct.
slide4
G-7
  • G-5: U.S., Japan, Germany, UK, France, later adding Italy and Canada.
    • Economic ministers meet regularly
    • Goals change with economic conditions and the political agenda.
  • Plaza Agreement, Sept 1985
    • G-5 agreed to coordinated intervention to lower the value of the dollar; $ fell 4 pct in 24 hrs.
intervention
Intervention
  • Finance Ministers often believe that their currency is mispriced by the mkt
  • Struggle between govts and mkts
    • Contest of will
  • Central Bank “vigilantes”
forex dealing
Forex Dealing
  • Customer order facilitation
    • normally no commission, only bid/ask spread
    • handled on agency basis, back-to-back trade
    • in some cases, may take a counterparty position to accommodate a cutomer’s buy/sell order
  • Proprietary trading
    • using own capital trading for profit
quotation conventions
Quotation Conventions
  • “American”
    • the number of US dlrs that are equivalent to one unit of foreign currency, Br Pound = $1.47; A$ = $0.51.
    • British pound, Irish punt, Aussie dlr, NZ dlr.
  • “European”
    • the number of units of foreign currency per one U,S. dlr. E.g. $= 120 yen; US$=HK$7.8
varieties of fx
Varieties of Fx
  • Spot
    • settled in two business days
  • Forward
    • to be settled in one- three-, six- 12 mths
  • Cross Rate
    • exchange rate in which neither currency is the US dlr, e.g. DM = 57 yen.
pricing of a currency
Pricing of a currency
  • Purchasing Power Parity (PPP)
    • “Big Mac” index
  • Interest Parity Theorem
    • If the interest rate on a foreign ccy is different from that of the domestic ccy, the forward exchange rate will have to trade away from spot exchange rate by a sufficient amount to make profitable arbitrage impossible.
hedging currency risks
Hedging Currency Risks
  • Forward
  • Futures
  • Options
hard vs soft currencies
Hard vs Soft currencies
  • Convertibility
  • Is the capital account open or closed?
the almighty dollar
The Almighty Dollar
  • Dollarization
  • Currency Peg
  • Currency Board