international business chapter 9

Copyright © 2011 Pearson Education, Inc. publishing as Prentice Hall

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International BusinessEnvironments and Operations

Part 4

World Financial Environment


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Chapter 9

Global Foreign Exchange Markets


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Chapter Objectives

• To learn the fundamentals of foreign exchange• To identify the major characteristics of the foreign-

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

• To describe how the foreign-exchange market works• To examine the different institutions that deal in

foreign exchange• To understand why companies deal in foreign

exchange


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What is Foreign Exchange?

• Money denominated in the currency of another nation or group of nations

• Can be in the form of cash, funds available on credit and debit cards, traveler’s checks, bank deposits, or other short-term claims

• An exchange rate is the price of a currency


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Players on the Foreign Exchange Market

The Bank for International Settlements (BIS)

divides the foreign-exchange market into

reporting dealers (also known as dealer

banks or money center banks), other

financial institutions, and non-financial

institutions.


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Aspects of the Foreign Exchange Market

• Over-the-counter (OTC) commercial and investment banks.

• Securities exchanges– CME, NASDAQ OMX, NYSE Liffe


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Traditional Foreign Exchange Instruments

• Spot Transactions• Outright Forward Transactions• FX Swap• Currency Swaps• Options• Futures Contract


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Size, Composition, and Location of the Foreign Exchange Market

• Size of the foreign-exchange market—$3.2 trillion daily

• The U.S. dollar is the most important currency on the foreign-exchange market

• Frequently Traded Currency Pairs– Top two pairs include EUR/USD and

USD/JPY


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Global Foreign Exchange: Currency Distribution


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Geographical Distribution of Foreign Exchange Markets


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Reasons Why Dollar isWidely Traded

1. It’s an investment currency in many capital markets.

2. It’s a reserve currency in many central banks.

3. It’s a transaction currency in many international commodity markets.

4. It’s an invoice currency in many contracts.

5. It’s an intervention currency employed by monetary authorities in market operations to influence their own exchange rates.


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The Spot MarketThe spot market is for foreign-exchange transactions that occur within

2 business days.

•Direct and Indirect QuotasA dealer (US based) quotes for the British pounds $1.6469/71; means: the dealer is willing to buy pounds at $1.6469 each and sell them for

$1.6471 each.

•Base and Term CurrenciesWhen dealers quote currencies to their customers, they always quote

the base currency (the denominator) first, followed by the terms currency (the numerator).

•Inter-bank TransactionsTransactions between banks.


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The Forward MarketThe forward rate is the rate quoted for transactions that call for

delivery after two business days.

•Forward Discounts-exist when the forward rate is less than the spot rate.•Forward Premiums-exist when the forward rate is greater than the spot rate.

Options •Option- is the right, but not the obligation, to trade (buy/sell) a foreign currency at a specific exchange rate.

Futures•Futures-specifies an exchange rate in advance of the actual exchange of currency.


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The Foreign Exchange Trading Process


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Banks and Exchanges

• The top banks in the inter-bank market in foreign exchange are so ranked because of their ability to

• 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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Foreign-Exchange Trades: Top Commercial and Investment Banks,

2009 as Ranked by Overall Market Share


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Top Exchanges for Trading Foreign Exchange

Firms can also use securities exchanges for derivatives trade in foreign exchange.

• CME Group• NASDAQ OMX• NYSE Liffe


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Future: Where are foreign exchange markets headed?

• Restrictions to the free flow of goods and services should diminish

• Technological developments cause foreign exchange trades to be executed more quickly and cheaply.

• Internet trade will increase currency price transparency and increase the ease of trading, thus allowing more investors into the market.


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How Companies Use Foreign Exchange

Business Purpose I• Cash Flow Aspects of Imports and Exports

– Commercial Bills of Exchange– Letters of Credit

Business Purpose II (sometimes companies deal in foreign exchange for profit!!)

• Other Financial Flows– Speculation Buying or selling of a commodity (in this case foreign

currency) that has both an element of risk and the chance of great profit.

– Arbitrage Purchase of foreign currency on one market for immediate resale on another market (in different country) to profit from price discrepancy.


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