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International Business

Environments & Operations

15e

Daniels ● Radebaugh ● Sullivan

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Chapter 8

Global Foreign-Exchange Markets

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Learning Objectives Learn the fundamentals of foreign exchange Identify the major characteristics of the foreign-

exchange market and how governments control the flow of currencies across national borders

Describe how the foreign-exchange market works Examine the different institutions that deal in

foreign exchange Understand why companies deal in foreign

exchange

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What Is Foreign Exchange?Discussion of foreign exchange involves the currency, market, rate and players in the market. Each institution has a specific role.

Foreign exchange currency: money denominated in the currency of another nation or group of nations

Foreign exchange market: where foreign exchange transactions take place

Exchange rate: the price of a currency Players in the foreign exchange market include

Reporting dealers Financial institutions Nonfinancial institutions

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Size, Composition, and Location of the Foreign

Exchange Market Market size is $4 trillion daily and the U.S. dollar is the most

important currency on the foreign-exchange market The most commonly traded currency pairs are EUR/USD

and USD/JPY London is the largest foreign exchange market (followed by

New York, Tokyo, and Singapore) because of its strategic location between Asia and the Americas.

Market activity first heightens when Europe and Asia are open and again when Europe and the United States are open.

Electronic platforms made foreign currency transactions easier.

Bank of International Settlements (BIS) plays a critical role in managing FX transactions worldwide

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The Circadian Rhythms of the Foreign Exchange Market

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Size, Composition, and Location of the Foreign

Exchange MarketForeign Exchange Markets: Average Daily Volume 1998-2013

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Size, Composition, and Location of the Foreign-

Exchange MarketGlobal Foreign Exchange: Currency Distribution

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Size, Composition, and Location of the Foreign

Exchange MarketForeign Exchange Markets: Geographic Distribution

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Why U.S. Dollar is so widely traded

It is an investment currency in many capital markets

It is a reserve currency held by many central banks

It is a transaction currency in many international commodity markets

It is an invoice currency in many contracts It is an intervention currency employed by

monetary authorities in market operations to influence their own exchange rates

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Global Over The Counter (OTC)

Foreign Exchange Instruments Spot transactions are for immediate delivery of the

currency, within two days maximum. Forward transactions involve currency exchange beyond

three days at a fixed rate, known as the forward rate. FX Swaps is exchange of currencies in the spot market with

agreement to reverse the transaction in the future. It is a combination of spot and forward transaction at the same time.

Options are contracts specifying the right to buy or sell foreign exchange within a specific period or on a specific date.

Futures are contracts for forward delivery of currency for specific amounts with specific maturity dates, not as flexible as a forward contract

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Global OTC Foreign Exchange

InstrumentsForeign Exchange Markets: Turnover by Instrument

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FX Terms and Quotes Foreign exchange dealers quote rates

Bid (buy) rate: the rate at which traders buy foreign exchange

Offer (sell) rate: the rate at which traders sell foreign exchange

Spread: the difference between bid and offer rates Direct quote (the number of dollars per unit of

foreign currency) and Indirect Quote (the number of units of foreign currency per dollar)

Cross rate determines the rate between two foreign currencies

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Banks And Exchanges The top banks in the inter-bank market in

foreign exchange can trade in specific market locations engage in major currencies and cross-trades deal in specific currencies handle derivatives

forwards, options, futures, swaps conduct key market research

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Banks And ExchangesForeign Exchange Trades: Top Commercial Banks, 2012

Ranked by Overall Market Share

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FX Fluctuation and Trade

Assume that current U.S. Dollar and Japanese Yen exchange rate is $ 1 = ¥ 105. Japanese Yen appreciates against U.S. Dollar, and, the new market rate is to $ 1 = ¥ 95. How will this affect U.S.-Japan trade? Japanese exports to U.S. …. Will it increase or decrease? U.S. Exports to Japan…. Will it increase or decrease?

Because Japanese can buy the same dollar with a smaller quantity of Yen (95 now, instead of 105 before) their purchasing power has increased against the Americans. To them, imports from USA is now cheaper. This means that they will import more from USA. In other words, U.S. exports to Japan will increase.

On the contrary, Americans are getting less Yen for the same dollar, so they will buy less from Japan. Thus Japanese exports to the U.S. will decrease.

Policy question: can a strong yen reduce the U.S. trade deficit with Japan?

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Future of FX Market More efficient markets

create more opportunities for foreign exchange trading

lower costs Financial crisis in Europe

future of the euro Rise of the Chinese yaun and Brazilian real Technology developments

more electronic trades

Chapter 8: Discussion Questions1. What is a foreign exchange market? Explain the

role each institution plays in the FX market. 2. Why U.S. dollar is the most traded currency in

the world? 3. Define the following Global Over The Counter

(OTC) Foreign Exchange Instruments: spot rate, forward rate, options, futures and swap.

4. Define the following terms and distinguish their differences: bid, offer, spread, and cross rate.

5. How does the fluctuation of exchange rate affect trade? For example, if Yen appreciates against Dollar, how will this affect U.S.-Japan trade? I can ask similar question with any currency.

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