Session 17 The Foreign Exchange Market

An Exchange Rate An exchange rate is the price of one nations in terms of another nations money. There are two basic types of exchange rate, depending on the timing of actual exchange of moneys. Spot exchange rate This is the price of immediate exchange. For standard large trades in the market, immediate for most currencies means exchange or delivery in two working days after the exchange is agreed. Forward exchange rate This is the price set now for an exchange that will take place sometime in the future such as 30, 90, or 180 days from now.

Foreign Exchange Market The foreign exchange market is the market in which national moneys are traded for other national moneys. The foreign exchange market is not a single gathering place where trades shout buy and sell orders at each other. Rather, banks and the traders who work at backs are at the center of the foreign exchange market.

Two Main Types of Foreign Exchange Market Retail Part of the Market The trading done with customer is called the retail part of the market. Interbank Part of the Market The trading done between the banks active in the market is called the interbank part of the market. The banks active in foreign exchange trading are located in countries around the world, so this is a 24-hours market. On working days, foreign exchange trading is always occurring somewhere in the world.

Half of foreign exchange trading involves banks in two location : London and New York

Retail Part Using the Foreign Exchange Market Individuals, businesses, other organizations Interbank Part Information

Demand and Supply for Foreign Exchange Individuals, businesses, other organizations U.S.U.K. Exporter Need to be paid by dollar Need to pay by pound Importer Create Demand for Dollar Create Supply for Pound Bank Pound Dollar Unless the U.K. importers have large holdings of dollars to spend

The Spot Exchange Market :Fixed Exchange Rates £1 = $ D£ S£ U.K. buy from U.S. U.S. buy from U.K. Excess Supply If the U.K. government want to keep the exchange rate at $1.98/ pound, it needs to buy £50 billions from the market. (This is done by selling $99 billion, equal to £50 times $1.98 per pound.) Equilibrium

Excess Demand If the Swiss government want to keep the exchange rate at $0.6/ franc, it needs to sell 100 francs the strong demand.

The Spot Exchange Market :Float Exchange Rates £1 = $