FNCE 404 Midterm: Chapter 5

44 views20 pages
9 Aug 2016
Department
Course
Professor
Chapter 5: Financial Goals and Corporate Governance
Functions of the Foreign Exchange Market (FOREX)
The FOREX is the mechanism by which participants
oTransfer purchasing power between countries
oObtain/provide credit for international trade transactions
oMinimize exposure to the risks of exchange rate changes  HEDGE
RISKS
Structure of the FOREX
There are four main dimensions of the FOREX:
oStructure
oTransactions
oSize
oMethods of stating exchange rates, quotations, and changes in
exchange rates
Geographically, the FOREX spans the globe with prices moving and
currencies trading every hour of every business day
Major world trading starts each morning in Sydney and Tokyo
Then moves west to Hong Kong and Singapore
Continuing to Europe and finishing on the West Coast of the U.S.
The FOREX consists of two tiers
oThe interbank or wholesale market, and
oThe client or retail market
Five broad categories of participants operate within these two tiers
oBank and nonbank foreign exchange dealers
oIndividuals and firms conducting commercial or investment
transactions
oSpeculators and arbitragers **LIQUIDITY IS KEY**
oCentral banks and treasuries
oForeign exchange brokers
▽▽▽
Bank and Nonbank Dealers
They profit from buying foreign exchange at a “bid” price and reselling it at a
slightly higher “offer” or “ask” price
Large international banks often function as “market makers
These dealers stand willing at all times to buy and sell those currencies in
which they specialize and thus maintain an “inventory” position in those
currencies
Individuals and Firms
Individuals (such as tourists) and firms (such as importers, exporters and
MNEs) conduct commercial and investment transactions in the FOREX
find more resources at oneclass.com
find more resources at oneclass.com
Unlock document

This preview shows pages 1-3 of the document.
Unlock all 20 pages and 3 million more documents.

Already have an account? Log in
Their use of the FOREX is necessary but nevertheless incidental to their
underlying commercial or investment purpose.
Some of the participants use the market to “hedge” foreign exchange risk
Speculators and Arbitragers
Speculators and arbitragers operate for their own interest
Speculators seek all their profit from exchange rate changes
Arbitragers try to profit from simultaneous differences in exchange rates in
different markets
A large proportion of speculation and arbitrage is conducted by major banks
Central Banks and Treasuries
Use the market to acquire or spend their country’s currency reserves as well
as to influence the price at which their own currency trades
Support the value of their currency because of their government’s policies or
obligations
Their motive is not to profit but rather influence the foreign exchange value
Foreign Exchange Brokers
Agents who facilitate trading between dealers without themselves becoming
principals in the transaction
Dealers use brokers to expedite the transaction and to remain anonymous,
since the identity of participants may influence short-term quotes
Continuous Linked Settlement
Continuous Linked Settlement (CLS) system (since 2002) eliminates losses if
either party is unable to settle
CLS links real time settlement systems in different currencies
Eventually same-day settlements instead of the current lag of two days
The U.S. Commodity Futures Trading Commission (CFTC) regulates foreign
exchange trading
Transactions in the FOREX
Foreign exchange operations are defined by timing—the future date—set for
delivery
Transactions within this market can be executed on a spot (which may be
overnight), forward (including outright forward), or swap basis
A spot transaction in the interbank market is the purchase of foreign
exchange, with delivery and payment between banks to take place, normally,
on the second following business day
oThe settlement date is often referred to as the value date
An outright forward transaction requires delivery at a future value date of a
specified amount of one currency for a specified amount of another currency
oExchange rate agreed at the time of the transaction
find more resources at oneclass.com
find more resources at oneclass.com
Unlock document

This preview shows pages 1-3 of the document.
Unlock all 20 pages and 3 million more documents.

Already have an account? Log in
oBut payment and delivery not required until maturity
oMaturities: 1, 2, 3, 6, and 12 months
A swap transaction in the interbank market is the simultaneous and sale of
given amount of foreign exchange for two different value dates
oBoth purchase and sale are conducted with the same counterparty
oSome different types of swaps are: spot against forward, forward-
forward, and nondeliverable forwards (NDF)
Size of the FOREX
The Bank for International Settlements (BIS) estimates that daily global net
turnover in the FOREX to be USD 5.7 trillion in April 2013
The UK (London) and the US (New york) make up roughly 60% of the FOREX
Asian markets growing more rapidly than European markets
Foreign Exchange Rates & Quotations
A foreign exchange rate is the price of one currency expressed in terms of
another currency
A foreign exchange quotation (or quote) is a statement of willingness to buy
or sell at an announced rate
Professional dealers and brokers may state foreign exchange
quotations in one of two ways:
oThe foreign currency price of one dollar
oThe dollar price of a unit of foreign currency
Most foreign currencies in the world are stated in terms of the number of
units of foreign currency needed to buy one dollar
For example:
oThe exchange rate between US dollars and the Swiss franc is normally
stated: SF 1.6000/$ (European terms)
oThis rate can also be stated as: $0.6250/SF (American terms)
Excluding two important exceptions (euro and UK pound sterling), most
interbank quotations around the world are stated in European terms
find more resources at oneclass.com
find more resources at oneclass.com
Unlock document

This preview shows pages 1-3 of the document.
Unlock all 20 pages and 3 million more documents.

Already have an account? Log in

Get access

Grade+
$10 USD/m
Billed $120 USD annually
Homework Help
Class Notes
Textbook Notes
40 Verified Answers
Study Guides
1 Booster Class