FINS1612 Lecture Notes - Lecture 8: Crawling Peg, Currency Basket, Hong Kong Dollar
Friday, 5 May 2017
Capital Markets & Institution
Foreign Exchange Markets
-Demand to buy & sell foreign currencies arises from:
•Financial flows associated with international trade in goods & services
•Cross-border capital transactions involving investment & borrowing of funds
•Speculative transactions aimed at profiting from favourable movements in future
exchange rates
•Central bank transactions within FX markets
-Bank for International Settlements (BIS): Central bank of central banks; conducts research &
makes recommendations relating to the supervision & stability of the international financial
system
-SWIFT: Electronic system operated by global financial institutions that facilitates international
financial transactions
-Each country or monetary union responsible for determining own exchange rate regime
-Exchange Rate: Value of one currency relative to another currency
•Major currencies like USD, GBP, JPY, EUR & AUD adopt floating exchange rate
•Currency determined by market forces of supply & demand (free float)
•Other types of exchange rate regimes:
-Managed float - held within defined band relative to other currency (ie Singapore, China)
-Crawling peg - allowed to appreciate in controlled steps over time (ie China - arguable)
-Linked exchange rate - tied to value of another currency/ basket of currencies (ie HKD)
-Global FX Markets:
•FX markets - markets that facilitate the buying & selling of foreign currencies
•FX dealers - institutions that quote buy (bid) & sell (offer) prices and act as principals in FX
markets
•Two-way prices - dealer quotes both a buy (bid) & sell (offer) price on a currency
•FX brokers - obtain best prices in global FX markets & match FX dealers’ buy & sell orders
for a fee
-Central Banks: Enter FX markets periodically for one of the following reasons
•To acquire foreign currency to pay for governments imports or to pay interest on, or
redeem, government’s overseas borrowings
•To change composition of holdings of foreign currencies as part of management of official
reserve assets - gold & international drawing rights
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Friday, 5 May 2017
•To influence floating exchange rate - particular in rapid appreciation or depreciation
-Clean float - when an exchange rate is determined by market forces without central
bank intervention
-Dirty float - central bank regularly intervenes in FX market to influence a floating
exchange rate
-Firms Conducting International Trade Transactions:
•Importers buy foreign currency to pay for imports
•Exporters often receive payment in foreign currency
-Investors & Borrowers in International Money Markets & Capital Markets:
•Commercial banks - borrow as part of active liability management strategies
•High credit rating required to borrow in international money & capital markets
•Fund managers purchase FX in order to acquire overseas investments
-Speculative Transactions:
•Long position - occurs when the underlying asset has been bought forward (buy)
•Short position - entering into forward contract to sell asset that is not held at that time (sell)
-Arbitrage Transactions:
•Arbitrage - simultaneously taking advantage of buy & sell price differences between
markets (only possible when differences occur between buy & sell prices in markets)
•Arbitrageur - party that simultaneously conducts buy & sell transactions in 2 or more
markets in order to take advantage of price differentials between markets
•Risk-free profits rare in an efficient market - FX markets deep & liquid
-Operation of FX Market:
•FX dealing room - physical location of FX dealers, usually within an institution’s treasury
operation
-Types of FX Transactions:
•Value date (of currency contract) - FX contract date at which delivery of currency &
financial settlement occur
-Two days after contract entered into = spot transactions
-More than two days after contract entered into = forward transactions
•Spot transaction (T + 2) - locks in an exchange rate today for settlement & delivery in 2
business days from date of transaction
•Forward transaction - locks in an exchange rate today for settlement & delivery at a
specified date beyond spot date
•Tod value transactions - FX contract settlement & delivery today
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find more resources at oneclass.com
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Document Summary
Bank for international settlements (bis): central bank of central banks; conducts research & makes recommendations relating to the supervision & stability of the international nancial system. Swift: electronic system operated by global nancial institutions that facilitates international. Each country or monetary union responsible for determining own exchange rate regime. Managed oat - held within de ned band relative to other currency (ie singapore, china) Crawling peg - allowed to appreciate in controlled steps over time (ie china - arguable) Linked exchange rate - tied to value of another currency/ basket of currencies (ie hkd) !1: to in uence oating exchange rate - particular in rapid appreciation or depreciation. Clean oat - when an exchange rate is determined by market forces without central bank intervention. Dirty oat - central bank regularly intervenes in fx market to in uence a oating. Firms conducting international trade transactions: importers buy foreign currency to pay for imports, exporters often receive payment in foreign currency.
