Network of financial institutions and brokers in which individuals, businesses, banks, and governments buy and sell the currencies of different countries

The liquidity of the market provides businesses with access to international markets for goods and services by providing foreign currency necessary for transactions worldwide

Foreign Exchange (FX) Market

The bid price is the price at which the market is willing to buy a particular currency

The ask price is the price at which the market is willing to sell a particular currency

Bid/Ask Price for a Currency

Convert From/To Dollar Pound FFranc DMark Yen

Dollar 1 0.591 5.385 1.594 116.3

Pound 1.665 1 9.12 2.607 193.1

FFranc 0.1823 0.1095 1 0.2965 21.11

DMark 0.6149 0.3694 3.351 1 72.14

Yen 0.00847 0.005093 0.0465 0.01379 1

1. Direct quote:$.6149/DM

2. Indirect quote (reciprocal rate):DM1.6263/$ = 1/.6149

3. Bid rate = $.6149/DM (price bid by broker to purchase DM)

Ask rate = $.6273/DM =1/1.594 (price asked by broker to sell DM)

Spread = $.0124 = transaction cost

Meaning of foreign exchange quote

Objectives◦ Minimize cost of funds◦ Improve liquidity◦ Reduce risks◦ Improve return on investment

Cash inflows and outflows Beginning cash balance Collections Disbursements Ending cash balance Investing surplus cash Covering cash shortage Ending cash required

International cash management

Compare direct rates to cross rates to identify attractive exchange opportunities:

◦ Direct rate to convert £ to DM = DM2.607/£

◦ Cross rate DM/£ using $:

Convert £ to $ ($1.665/£) and then convert $ to DM (DM1.594/$):

($1.665/£) * (DM1.594/$ )= DM2.654/£

◦ This particular cross rate of £ to $ to DM is more attractive than converting £ directly to DM.

Cross Rates

Bilateral arbitrage opportunity:

Assume you can convert your $ into € 0.7431 with a broker in New York and then convert each € with a broker in Frankfurt for $1.346:

New York Frankfurt

$1.3457 / € € 0.7429/$ € 0.7431 /$ $1.346/ € _____

$1 € 0.7431 * $1.346/ € $1.0002

Comparing quotes from different traders

New York Frankfurt Zurich € 0.7431 /$ CHF1.326/€ $1.016/CHF

$1 € 0.7431 * CHF1.326/€ CHF.9854 * $1.016/CHF

$1.0011

Foreign exchange market efficiency – Foreign exchange rates reflect all publicly available

information

Trilateral arbitrage