The Foreign Exchange Market International Finance (MB 74)
The Foreign Exchange Market What is a foreign Exchange Market? A market where purchasing power in one currency can be converted into purchasing power into another currency. Rationale/Significance of the Foreign Exchange Market Characteristics 24 Hour Global OTC Market Principal Centers TokyoLondonNew York
The Foreign Exchange Market Contd… Volume: $1.3 trillion daily, up from $100 billion in the 1980s Main Participants Users Market Makers
Participants Users Multinationals Institutional Investors SpeculatorsTrading Companies Individuals Market Makers Commercial Banks Investment Banks Central Banks Exchanges —92% of the daily market activity driven by speculation
Major Trading Centers Percentage of Market London32% New York18% Tokyo 8% Singapore 7% Europe55% Asia26% North America19%
Currency Composition
Types of Instruments in the FX Market
Currency Prices BidOffer Yen per US $ TraderBuys US $ Sells US $ ClientSells US $Buys US $ £/$ TraderBuys US $ Sells US $ ClientSells US $Buys US $
Currency Prices BidOffer U.S. Dollar/¥ TraderBuys ¥ Sells ¥ ClientSells ¥Buys ¥ U.S. Dollar/£ TraderBuys £ Sells £ ClientSells £Buys £
How FX Traders Profit? Bid-Ask Spread Anticipation and speculation in exchange rate movement As a foreign exchange trader if you anticipate appreciation of Yen, what should you do As a foreign exchange trader if you anticipate depreciation of British pound, what should you do?
Foreign Exchange Markets Spot Market Forward Market Swap Market Eurocurrency Markets Eurodollar Market Eurobond Market
Spot Market The Standard Trade For delivery of currency bought and sold two business days from the trade date
Spot Market Quotations “Direct,” “American,” or “Normal Quotations ¥1 = $ THB1 = $ £1 = $ Price of domestic currency per unit of foreign currency “Indirect,” “European,” “Reciprocal”, or “Volume” Quoatations $1 = ¥ $1= THB44.15 $1 = £ Effectively quotes the volume of foreign currency purchased by fixed quantity of domestic currency
Cross Rate of Exchange An Exchange Rate between two currencies that is derived from the exchange rates of those currencies with a third currency. Value of Currency A Value of Currency A per unit of Currency B Per unit of Currency C = Value of Currency C per unit of Currency B
The Forward Market Forward Trade For delivery of both currencies more than two business days from trade date Forward Contracts and Hedging/Speculation Forward Rate Quotations Forward Premium/Discount
Swap Market Meaning of Swap Trade Simultaneous buying and selling of a currency with different maturities (usually from spot to a forward date)
Eurocurrency Markets Meaning of Eurocurrency market Eurodollar Market Reasons for growth of Eurodollar Market Eurobond Market Reasons for growth of Eurobond Market
Arbitrage in Currency Markets Locational Arbitrage Triangular Arbitrage