Power Points by J.Wiley & Sons Joseph F. Greco, Ph.D. California State University, Fullerton 1
CHAPTER 7 THE FOREIGN EXCHANGE MARKET
CHAPTER OVERVIEW I. INTRODUCTION II.ORGANIZATION OF THE FOREIGN EXCHANGE MARKET III. THE SPOT MARKET IV. THE FORWARD MARKET
PART I. INTRODUCTION I.
INTRODUCTION A. The Currency Market: where money denominated in one currency is bought and sold with money denominated in another currency.
INTRODUCTION B. International Trade and Capital Transactions: facilitated with the ability to transfer purchasing power between countries
Location 1. OTC-type: no specific location 2. Most trades by phone, telex, or SWIFT
SWIFT: Society for Worldwide Interbank Financial
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 banks 2. Retail Level - business customers
ORGANIZATION OF THE FOREIGN EXCHANGE MARKET B.
Two Types of Currency Markets
1. Spot Market: - immediate transaction - recorded by 2nd business day
ORGANIZATION OF THE FOREIGN EXCHANGE MARKET 2. Forward Market: - transactions take place at a specified future date
ORGANIZATION OF THE FOREIGN EXCHANGE MARKET C. Participants by Market 1. Spot Market a. commercial banks b. brokers c. customers of commercial and central banks 10
ORGANIZATION OF THE FOREIGN EXCHANGE MARKET 2. Forward Market a. arbitrageurs b. traders c. hedgers d. speculators 11
ORGANIZATION OF THE FOREIGN EXCHANGE MARKET II. CLEARING SYSTEMS A. Clearing House Interbank Payments System (CHIPS) - used in U.S. for electronic fund transfers. 12
ORGANIZATION OF THE FOREIGN EXCHANGE MARKET B. FedWire - operated by the Fed - used for domestic transfers 13
ORGANIZATION OF THE FOREIGN EXCHANGE MARKET III. ELECTRONIC TRADING A. Automated Trading - genuine screen-based market
ORGANIZATION OF THE FOREIGN EXCHANGE MARKET B. Results: 1.
Reduces cost of trading
Threatens traders’ oligopoly of information
Provides liquidity 15
ORGANIZATION OF THE FOREIGN EXCHANGE MARKET IV.
SIZE OF THE MARKET
A. Largest in the world 1999:
US$1.5 trillion daily or US$375 trillion a year
In 1999 the US GDP was US$9.1 trillion 16
ORGANIZATION OF THE FOREIGN EXCHANGE MARKET B. Market Centers (1998): #1: London = $637 billion daily #2: New York= $351 billion daily #3: Tokyo = $149 billion daily 17
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 18
THE SPOT MARKET B. Method of Quotation 1. For interbank dollar trades: a. American terms example: $.5838/dm
European terms example: Peso1.713/$ 19
THE SPOT MARKET 2. For nonbank customers: Direct quote gives the home currency price of one unit of foreign currency.
THE SPOT MARKET C. Transactions Costs 1. Bid-Ask Spread used to calculate the fee charged by the bank •
Bid = the price at which the bank is willing to buy • Ask = the price it will sell the currency 21
THE SPOT MARKET 4. Percent Spread Formula (PS):
Ask − Bid PS = x100 Ask 22
THE SPOT MARKET D. Cross Rates 1.
The exchange rate between 2 non - US$ currencies.
THE SPOT MARKET 2. Calculating Cross Rates When you want to know what the dm/ff cross rate is, and you know dm2/US$ and ff.55/US$ then dm/ff = dm2/US$ ÷ ff.55/US$ = dm3.636/ ff 24
THE SPOT MARKET E. Currency Arbitrage 1. If cross rates differ from one financial center to another, and profit opportunities exist.