1 / 28

Foreign Exchange Markets: An Introduction to Trading and Currency Exchange

Discover the organization, size, and intricacies of the foreign exchange market, including spot quotations, transactions costs, cross rates, currency arbitrage, and forward contracts. Learn about market participants, different market types, and calculating forward premiums or discounts.

keaton-austin
Download Presentation

Foreign Exchange Markets: An Introduction to Trading and Currency Exchange

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. The Foreign Exchange Market Chapter 7

  2. The Foreign Exchange Markets • I. INTRODUCTION • A. The Market: • the place where money denominated in one currency is bought and sold with money denominated in another currency.

  3. INTRODUCTION • B. International Trade and Capital Transactions: • - facilitated with the ability to transfer purchasing power • between countries

  4. INTRODUCTION • C. Location • 1. OTC-type: no specific location • 2. Most trades by phone or SWIFT* • *SWIFT: Society for Worldwide Interbank Financial Telecommunications

  5. PART II. ORGANIZATION OF THE FOREIGN EXCHANGE MARKET • I . PARTICIPANTS IN THE FOREIGN EXCHANGE MARKET • A. Participants at 2 Levels • 1. Wholesale Level (95%) • - major commercial banks • 2. Retail Level • - banks dealing for business customers.

  6. ORGANIZATION OF THE FOREIGN EXCHANGE MARKET • B. Two Types of Currency Markets • 1. Spot Market: • - immediate transaction • - recorded by 2nd business day • 2. Forward Market: • - transactions take place at a specified future date

  7. ORGANIZATION OF THE FOREIGN EXCHANGE MARKET • C. Participants by Market • 1. Spot Market • a. Commercial banks • b. Brokers • c. Customers of commercial banks • d. Central banks

  8. ORGANIZATION OF THE FOREIGN EXCHANGE MARKET • 2. Forward Market • a. Arbitrageurs • (holds currency) • b. Speculators • c. Hedgers

  9. ORGANIZATION OF THE FOREIGN EXCHANGE MARKET • II. SIZE OF THE CURRENCY MARKET • A. Largest in the world (1999): • $1.5 trillion daily • B. Market Centers (1998): • London = $637 billion daily • New York= $351 billion daily • Tokyo = $149 billion daily • C. Benchmark: • 1999 USGDP = $9.1 trillion

  10. PART III. THE SPOT MARKET • I. SPOT QUOTATIONS • A. Sources • 1. All major newspapers • 2. Major currencies have four different quotes: • a. spot price • b. 30-day • c. 90-day • d. 180-day

  11. THE SPOT MARKET • B. For nonbank customers: • Direct quote • gives the home currency price of one unit of foreign currency. • EXAMPLE in France : €.80/US$ • Indirect quote is the reciprocal

  12. THE SPOT MARKET • C. Transactions Costs • 1. Bid-Ask Spread • used to calculate the fee • charged by the bank • 2. Bid = the price at which the bank is willing to buy 3. Ask = the price it will sell the currency

  13. THE SPOT MARKET • 4. Percent Spread Formula: • Percent Spread = (Ask-Bid)/Ask x 100

  14. Sample Problem • Suppose the spot quote for the Swedish Krona is $.1395-99, what is the percent spread? • PS = Ask –Bid x 100 • Ask • = .1399 - .1395 x 100 • .1399 • = .29% or 29 basis points

  15. THE SPOT MARKET • D. Cross Rates • 1. The exchange rate between 2 non-US$ currencies. • 2. Purpose: to identify arbitrage opportunities

  16. Sample Problem • Suppose the spot quote for the Swedish • Krona and the French franc are $.1395/kr and $.1133/FF, what is the quote for the krona in Paris? • $.1133 • FF = _FF_ = 8.826 x US$ = 8.826 • kr $.1395 US$ 7.168 7.168 • kr • = FF1.23/kr

  17. THE SPOT MARKET • E. Currency Arbitrage • 1. When cross rates differ from • one financial center to another, • profit opportunities exist. • 2. Buy cheap in one int’l market, • sell at a higher price in another • 3. Importance of Arbitrage

  18. Sample Problem • Suppose the euro is quoted in London at £.6064-80 and the £ is quoted in Frankfurt at € 1.6244-59. Is there a profitable arbitrage situation?

  19. Sample Problem • LondonFrankfurt • £.6064-80/€€1.6244-59/£ • Bid Ask Bid Ask • .6064 .6080 .6150 .6156

  20. Sample Problem • 1. Buy euros for £ .6080 / € in London. • Use them in Frankfurt to buy pounds at €1.6259 (same as selling euros at £.6150). • This is a net profit is • .6150-.6080= £.0070 per euros • 4. A yield of 1.16% (.0070/.6080)

  21. Compute the percent spread • Pound spread = (1.6259-1.6244)/1.6259 = .09% • Euro spread = (.6080-.6064)/.6080 = .26%

  22. CURRENCY ARBITRAGE • What is The Critical Role of Arbitrage in the Global Financial Markets?

  23. PART III. THE FORWARD MARKET • I. INTRODUCTION • A. Definition of a Forward Contract • an agreement between a bank and a • customer to deliver a specified amount • of currency against another currency • at a specified future date and at a fixed • exchange rate.

  24. THE FORWARD MARKET • 2. Purpose of a Forward: • Hedging • the act of reducing exchange rate risk.

  25. THE FORWARD MARKET • C. Forward Contract Maturities • 1. Contract Terms • a. 30-day • b. 90-day • c. 180-day • d. 360-day • 2. Longer-term Contracts • 3. Require performance

  26. THE FORWARD MARKET • CALCULATING THE FORWARD PREMIUM OR DISCOUNT • = F-S x 12 x 100 • S n • where F = the forward rate of exchange • S = the spot rate of exchange • n = the number of months in the • forward contract

  27. Sample Problem • What is the forward discount or premium if the 30 day forward rate is $1.4498/£ and the spot is $1.4487?

  28. Sample Problem • What is the forward discount or premium if the 3 month forward rate is $1.4511/£ and the spot is $1.4487?

More Related