FOREIGN EXCHANGE AND INTERNATIONAL FINANCIAL MARKE.docx

1、FOREIGN EXCHANGE AND INTERNATIONAL FINANCIAL MARKECHAPTER 7Foreign Exchange and International Financial MarketsOBJECTIVESAfter studying this chapter, students should be able to:Describe how demand and supply determine the price of foreign exchange. Discuss the role of international banks in the fore

2、ign-exchange market.Assess the different ways that firms can use the spot and forward markets to settle international transactions.Summarize the role of arbitrage in the foreign-exchange market.Discuss the important aspects of the international capital market.LECTURE OUTLINE OPENING CASE: Dollar Mak

3、es Canada a Land of the SpreeThis case discusses the impact the weak Canadian dollar has had on cross-border business between the US and Canada. As the Canadian dollar has dropped in value against the US currency, Americans have been able to buy more and more Canadian goods for the same amount of US

4、 dollars.Key PointsThe Canadian dollar (known as the loonie) has been declining in value against the US dollar for several years, recently trading at less than 70 cents US per Canadian dollar.Though the US dollar has been gaining value against several currencies, Canadas proximity makes it an attrac

5、tive shopping destination for Americans. American companies are able to acquire Canadian firms at better prices.Mail order and Internet shopping let Americans shop for Canadian bargains without even leaving home.The weak Canadian dollar is good for Canadian exporters, who find it easier to sell thei

6、r goods.Canadian consumers are the losers, as American imports and trips abroad have become increasingly more expensive.CHAPTER SUMMARYChapter Seven introduces the student to the practical aspects of the foreign-exchange market. The chapter discusses how currency prices are determined, the role and

7、activities of international banks in the foreign-exchange markets, how the spot and forward markets are used in international trade transactions, arbitrage in the foreign-exchange markets, and issues relating to the international capital markets. I. THE ECONOMICS OF FOREIGN EXCHANGEForeign exchange

8、can be defined as currencies issued by another country. The price of different currencies in the flexible exchange-rate system is determined by supply and demand. Demand for a currency occurs when the residents of a country buy foreign products, services, and assets. Discuss Figure 7.1 here. In orde

9、r to pay for the foreign products, residents must sell their own currency and buy the other countrys currency. In doing so, they increase the supply of their own currency. Discuss Figure 7.2 here. Teaching Note:Instructors may find it worthwhile to create a scenario in which students are asked to ob

10、tain a particular currency from another student to see the supply and demand process in action.The exchange rate is the price of one currency in terms of another, at the equilibrium price of the foreign currency. Discuss Figure 7.3 here. A direct quote is the price of the foreign currency in terms o

11、f the home currency, while an indirect quote is the price of the home currency in terms of the foreign currency. Discuss Figure 7.4 here. Discuss Venturing Abroad: A Brief HintThis Going Global Box helps the student better understand exchange rates by using “laymens terms” to discuss the prices of c

12、urrencies. Specifically, the Box links the price of currencies with the price of bread. The Box fits in well with a preliminary discussion of exchange rates.II. THE STRUCTURE OF THE FOREIGN EXCHANGE MARKETThe foreign-exchange market consists of buyers and sellers of currencies, including internation

13、al banks, central banks, brokers, businesses and speculators. Foreign exchange is traded every minute of the day, in a volume of $1.2 trillion. The majority (83%) of transactions involve the U.S. dollar, and it is therefore known as the primary transaction currency. Discuss Map 7.1 and Figure 7.5. T

14、he Role of BanksThe foreign exchange departments of large international banks play a dominant role in the foreign exchange market.Discuss Wiring the World: The Biggest Online MarketThe foreign exchange market does $1.5 trillion worth of business a day. It is the worlds single biggest market and is m

15、oving online to take advantage of speed and lower cost.International banks operate in both the wholesale and retail markets as they trade for their own accounts and those of customers. Commercial customers are involved in the foreign-exchange market through their normal commercial activities. Specul

16、ators take positions in currencies as they try to predict the direction of currency fluctuations. In doing so, speculators deliberately assume exchange-rate risk. Arbitrageurs try to make risk-free profits as they capitalize on the differences in currency prices between markets. Central banks interv

17、ene in the market under fixed exchange-rate systems to maintain par values, but may allow currencies to float freely under flexible exchange-rate systems. Not all currencies can be traded in the foreign-exchange market. Those that are tradable are call convertible or hard currencies, those that are

18、not are called inconvertible or soft currencies. Spot and Forward MarketsCurrencies can be traded in the spot market or in the forward market. Spot transactions are delivered in two business days, while forward transactions are delivered at the specified forward date of 30, 90, or 180 days. Most tra

19、nsactions in the forward market are swap transactions in which the trader simultaneously buys and sells the same currency with different delivery dates.Currency futures are used to obtain foreign exchange, however, unlike forward contracts, they are designed with standard amounts for standard delive

20、ry dates. Currency can also be obtained through currency options. A call option allows the holder to purchase a specified quantity of foreign-exchange at a specified price by a specified date, while a put option allows a holder to sell a specified quantity of foreign-exchange at a specified price by

21、 a specified date. Options do not have to be exercised. Figure 7.6, listing some options available on the Chicago Mercantile Exchange, should be discussed here. Hedging is used by firms to reduce their foreign-exchange risk. If the forward price and the spot price of a particular currency are differ

22、ent, then the currency is said to be selling at a forward discount (forward price is lower than the spot price) or forward premium (forward price is higher than the spot price.)Arbitrage and the Currency MarketArbitrage is the riskless purchase of a product in one market for immediate resale in a se

23、cond market in order to profit from a price discrepancy.Arbitrage of Goods-Purchasing Power Parity. The law of one price suggests that arbitrage activities will continue until the price of the good in question is equal in both markets. The theory of purchasing-power parity (PPP) states that the pric

24、es of tradable goods, when expressed in a common currency, will tend to equalize across countries as a result of exchange-rate changes. In other words, arbitrage activities affect the demand, and therefore the price, of currencies. The theory of PPP is used by international economists as they compar

25、e living standards across countries, and by foreign-exchange analysts when they forecast long-term exchange rate changes.Discuss Bringing the World into Focus: Big Mac CurrenciesThis Going Global Box illustrates the concept of purchasing power parity by considering the price of Big Macs around the w

26、orld. The Box is a useful one because most students can relate to the product in question, and may have even purchased Big Macs in other countries. The Box fits in well with a discussion of PPP.Arbitrage of Money. In the financial markets, arbitrageurs attempt to make risk-free profits by trading in

27、 foreign exchange. Two point arbitrage (also known as geographic arbitrage) allows a trader to capitalize on differences between currency prices in two foreign-exchange markets. Three point arbitrage involves buying and selling three different currencies to make a risk-free profit. A currencys cross

28、-rate can be calculated through the use of a third currency. Discuss Figure 7.7 here. Covered interest arbitrage enables a trader to capitalize on geographic interest rate differentials, but avoid risk by covering exchange-rate exposure in the forward market. Interest rates differ among countries as

29、 a result of the international Fisher effect which suggests that national differences in expected inflation rates yield differences in nominal interest rates among countries.III. THE INTERNATIONAL CAPITAL MARKET Major International BanksInternational banks play an important role in assisting compani

30、es with their international transactions. International banks act both as commercial bankers and as investment bankers. Their operations can take various forms. Discuss Table 7.1 here. Correspondent banking relationships involve setting up a reciprocal relationship with a bank in another country. Un

31、der the agreement, each bank will then act as the local bank for foreign customers. For example, a British bank may set up a correspondent relationship with a Swiss bank in which the British bank acts as the Swiss banks correspondent in Britain and the Swiss bank acts as the British banks coresponde

32、nt in Switzerland.Banks that have more extensive international operations may have a subsidiary bank, a branch bank, or an affiliated bank. A subsidiary bank is an operation that is incorporated separately from the parent, while a branch bank is not. An affiliated bank involves taking an ownership position in an operation in conjunction with a partner.Commercial Banking Services. Commercial banks provide short-term financing of international transactions, international electronic funds transfers, transactions in