10 Pages
Unlock Document

Michael H O

ECO365 Summer 2011 Chapter 14 Problem Set 1. Who are the participants in the foreign exchange market? Why buying and selling in the foreign exchange market are dominated by commercial banks? What are the wholesale and retail rates? Exchange rates are determined by the interaction of the households, firms, and financial institutions that buy and sell foreign currencies to make international payments. The market in which international currency trades take place is called the foreign exchange market. Individuals may also participate in the foreign exchange market, but such cash transactions are an insignificant fraction of total foreign exchange trading. Banks routinely enter the foreign exchange market to meet the needs of their customers primarily corporations. In addition, a bank will also quote to other banks exchange rates at which it is willing to buy currencies from them and sell currencies to them. Over the years, deregulation of financial markets in the United States, Japan, and other countries has encouraged nonbank financial institutions to offer their customers a broader range of services, many of them indistinguishable from those offered by banks. Among these have been services involving foreign exchange transactions. Institutional investors, such as pension funds, often trade foreign currencies. Corporations with operations in several countries frequently make or receive payments in currencies other than that of the country in which they are headquartered. Central banks sometimes intervene in foreign exchange markets. While the volume of central bank transactions is typically not large, the impact of these transactions may be great. The reason for this impact is that participants in the foreign exchange market watch central bank actions closely for clues about future macroeconomic policies that may affect exchange rates. Government agencies other than central banks may also trade in the foreign exchange market, but central banks are the most regular official participants. Because their international operations are so extensive, large commercial banks are well suited to bring buyers and sellers of currencies together. A bank can economize on these search costs. Foreign currency trading among banks is called interbank trading, which accounts for most of the activity in the foreign exchange market. Interbank rates the rates banks charge to each other. No amount less than ,I million is traded at those rates. %K07,908,;,LO,-O094.47547,90.:8942078.,OO0709,LO7,908,70:8:,OOO0881,;47,-O09K,39K0ZK4O08,O0 interbank rates because it is cheaper to carry out a $1million foreign exchange transaction than IH transactions with each worth ,IHHHHH %K0L110703.0-09Z0039K0709,LO,3ZK4O08,O07,908L89K0-,3N8.425038,9L43 for doing the business. 2. If ,( L II in New York (which is different from London where ,(L IJ), then explain how the difference in exchange rates will be eliminated by investors who seek arbitrage profits by buying the euro in New York and sell it in London, or buying the dollar in London and sell it in New York. How long does it take to equalize the exchange rates between these two foreign exchange centers? How can the foreign exchange market work around the clock? Comparing ,(L II (every euro can buy II dollar) in New York and ,( L IJ (every euro can buy IJ dollar) in London, dollar is relatively expensive in New York (euro is relatively cheaper in New York) and euro is relatively more expensive in London (dollar is relatively cheaper in London). According to the principle of buy low and sell high (aarbitrage the process of buying a currency cheap and selling it dear), investors can Michael Ho Page 1 of 10
More Less

Related notes for ECO365H5

Log In


Join OneClass

Access over 10 million pages of study
documents for 1.3 million courses.

Sign up

Join to view


By registering, I agree to the Terms and Privacy Policies
Already have an account?
Just a few more details

So we can recommend you notes for your school.

Reset Password

Please enter below the email address you registered with and we will send you a link to reset your password.

Add your courses

Get notes from the top students in your class.