The Foreign Exchange Market B 645

Outline Meaning of the Foreign Exchange Market Rationale for the Foreign Exchange Market Characteristics of the Foreign Exchange Market Price Quotation in the Foreign Exchange Market Types of Trade in the Foreign Exchange Market

Meaning A place where purchasing power in one currency can be converted into purchasing power into another currency A place where units of one currency can be exchanged for units of another currency

Rationale Growth of Global Commerce Guarantee to the participants that cash flows can be converted into the currency of their desire

The Foreign Exchange Market 24 Hour Global OTC Market Principal Centers LondonNew YorkTokyo Volume: $1.3 trillion daily, up from $100 billion in the 1980s Main Participants Users Market Makers

Participants Users Multinationals Institutional Investors Trading Companies Individuals Speculators 92% of the daily market activity driven by speculation Market Makers Commercial Banks Investment Banks Central Banks Exchanges

Major Trading Centers Percentage of Market London32% New York18% Tokyo 8% Singapore 7% Europe55% Asia26% North America19%

Types of Trade Spot Trade Forward Trade

Types of Foreign Exchange Trades Spot Trade--The Standard Trade For delivery of currency bought and sold two business days from trade date Also know as cash market

Exchange Rate Quotations “Direct,” “American,” or “Normal Quotations ¥1 = $ THB1 = $ Price of domestic currency per unit of foreign currency “Indirect,” “European,” “Reciprocal”, or “Volume” Quoatations $1 = ¥ $1= THB44.15 Effectively quotes the volume of foreign currency purchased by fixed quantity of domestic currency

Currency Prices Spot Agree on price today, settle two business days later BidOffer Yen per US $ TraderBuys US $ Sells US $ ClientSells US $Buys US $ Thai Baht/$ TraderBuys US $ Sells US $ ClientSells US $Buys US $

Currency Prices BidOffer U.S. Dollar/¥ TraderBuys ¥ Sells ¥ ClientSells ¥Buys ¥ U.S. Dollar/THB TraderBuys THB Sells THB ClientSells THBBuys THB

Forward Trade For delivery of both currencies more than two business days from trade date Used for hedging of exchange rate risk If you have foreign currency cash inflows, hedge by selling that currency in the forward market If you have foreign currency cash outflows, hedge by buying that currency in the forward market

Forward Trade Forward Premiums/Discount Forward rate may be more or less than the spot rate If forward rate is higher than the spot rate, the currency is trading at a forward premium in the foreign exchange market If forward rate is lower than the spot rate, the currency is trading at a forward discount in the foreign exchange market Annualized forward premium/discount