UNIVERSITY OF LJUBLJANA
FACULTY OF ECONOMICS
CONTENTS ENDwww.StudsPlanet.com Page 1
UNIVERSITY OF LJUBLJANA
FACULTY OF ECONOMICS
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1. Definition and Organization of the ...
UNIVERSITY OF LJUBLJANA
FACULTY OF ECONOMICS
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1. Definition and Organization of the ...
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Clearing of currencies:
 service of ...
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FACULTY OF ECONOMICS
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Foreign Exchange Market and Insurance ...
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Foreign Exchange Markets and Conscious...
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3. Foreign Exchange Market Participant...
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Economic Agents and Types of Activitie...
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Economic Agents and Types of Activitie...
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Economic Agents and Motivation for th...
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Economic Agents and Motivation for th...
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4. Size and Structure of Foreign Exch...
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5. Types of Foreign Exchange Market T...
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Swap Transactions
simultaneous purch...
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Futures
basic characteristics of fut...
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 similarities and differences betwee...
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Characteristic Futures Outright Forwa...
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Options
basic characteristics of opt...
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Options
types of options trading:
 ...
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Usage of options:
 when the economi...
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Profit/
loss
Limited
loss
Unlimited
p...
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6. Quotations of Currencies on Foreig...
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Currency Quotations in Spot Foreign
E...
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Currency Quotations in Spot Foreign
E...
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Currency Quotations in Spot Foreign
E...
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Currency Quotations in Forward Foreig...
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Financial Times
Wall Street Journal...
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Forex markets

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  • Forex markets

    1. 1. UNIVERSITY OF LJUBLJANA FACULTY OF ECONOMICS CONTENTS ENDwww.StudsPlanet.com Page 1
    2. 2. UNIVERSITY OF LJUBLJANA FACULTY OF ECONOMICS CONTENTS ENDwww.StudsPlanet.com Page 2 1. Definition and Organization of the Foreign Exchange Markets 2. Foreign Exchange Market Functions 3. Foreign Exchange Market Participants 4. Size and Structure of Foreign Exchange Market Transactions 5. Types of Foreign Exchange Market Transactions 6. Quotations of Currencies on Foreign Exchange Markets CONTENTS AND PURPOSE  purpose:  enhance theoretical knowledge from the first two chapters with practical issues of foreign exchange markets functioning  principles for the analysis of the international business finance problems
    3. 3. UNIVERSITY OF LJUBLJANA FACULTY OF ECONOMICS CONTENTS ENDwww.StudsPlanet.com Page 3 1. Definition and Organization of the Foreign Exchange Markets foreign exchange markets are markets on which individuals, firms and banks buy and sell foreign currencies:  foreign exchange trading occurs with the help of the telecommunication net between buyers and sellers of foreign exchange that are located all over the world  can actually talk about a single international foreign exchange market for every single currency  foreign exchange trading takes place at least in some of the world financial centers in every moment interbank-markets client markets
    4. 4. UNIVERSITY OF LJUBLJANA FACULTY OF ECONOMICS CONTENTS ENDwww.StudsPlanet.com Page 4 Clearing of currencies:  service of exchanging one currency for another Provision of Credit:  trader that bought a certain good from the manufacturer, needs time to sell this good to the final customer and to pay the manufacturer with the money he received from the customer 2. Foreign Exchange Market Functions Clearing of Currencies and Provision of Credit
    5. 5. UNIVERSITY OF LJUBLJANA FACULTY OF ECONOMICS CONTENTS ENDwww.StudsPlanet.com Page 5 Foreign Exchange Market and Insurance Against Foreign Exchange Risk hedging:  activities with which the foreign exchange market participants avoid exchange rate risk or activities with which they are closing their open foreign exchange position  closed foreign exchange position:  size of the assets in a certain currency is equal to the size of the liabilities in the same currency  full insurance against exchange rate risk with respect to this currency  open foreign exchange position:  long: net assets in a certain currency  short: net liabilities in a certain currency  in the spot or forward foreign exchange market  standardized forward contracts and options
    6. 6. UNIVERSITY OF LJUBLJANA FACULTY OF ECONOMICS CONTENTS ENDwww.StudsPlanet.com Page 6 Foreign Exchange Markets and Conscious Foreign Exchange Risk Acceptance activities in which economic agents consciously open their foreign exchange positions – long or short – hoping to get profits in all foreign exchange market segments
    7. 7. UNIVERSITY OF LJUBLJANA FACULTY OF ECONOMICS CONTENTS ENDwww.StudsPlanet.com Page 7 3. Foreign Exchange Market Participants Economic Agents and Types of Activities on Foreign Exchange Markets Client buys $ with € Local bank Main banks’ interbank market Local bank Client buys € with $ Purchases and sales of big multinational companies Brokers
    8. 8. UNIVERSITY OF LJUBLJANA FACULTY OF ECONOMICS CONTENTS ENDwww.StudsPlanet.com Page 8 Economic Agents and Types of Activities on Foreign Exchange Markets bank clients (individuals, firms, non-banking financial institutions):  all those groups of legal and physical persons that need foreign currency in doing their commercial or investment business commercial banks:  the most important group of foreign exchange market participants  they buy and sell foreign currencies for their clients and trade for themselves
    9. 9. UNIVERSITY OF LJUBLJANA FACULTY OF ECONOMICS CONTENTS ENDwww.StudsPlanet.com Page 9 Economic Agents and Types of Activities on Foreign Exchange Markets brokers:  agents that connects dealers interested in buying and selling foreign exchange, but does not become an active client in the transaction  they provide their client, the bank, with the information about the exchange rates at which banks are willing to buy or sell a particular currency central banks:  foreign exchange market interventions are meant to influence the exchange rate of the domestic currency in a way that is beneficial for the domestic economy and, consequently, for the country  it does not necessarily have a profit, it can also have a loss
    10. 10. UNIVERSITY OF LJUBLJANA FACULTY OF ECONOMICS CONTENTS ENDwww.StudsPlanet.com Page 10 Economic Agents and Motivation for the Foreign Exchange Market Participation arbitragers:  they want to earn a profit without taking any kind of risk (usually commercial banks):  try to profit from simultaneous exchange rate differences in different markets  making use of the interest rate differences that exist in national financial markets of two countries along with transactions on spot and forward foreign exchange market at the same time (covered interest parity)
    11. 11. UNIVERSITY OF LJUBLJANA FACULTY OF ECONOMICS CONTENTS ENDwww.StudsPlanet.com Page 11 Economic Agents and Motivation for the Foreign Exchange Market Participation hedgers and speculators:  hedgers do not want to take risk while participating in the market, they want to insure themselves against the exchange rate changes  speculators think they know what the future exchange rate of a particular currency will be, and they are willing to accept exchange rate risk with the goal of making profit  every foreign exchange market participant can behave either as a hedger or as a speculator in the context of a particular transaction
    12. 12. UNIVERSITY OF LJUBLJANA FACULTY OF ECONOMICS CONTENTS ENDwww.StudsPlanet.com Page 12 4. Size and Structure of Foreign Exchange Market Transactions Table 4.1: Size and Structure of Transactions in the Foreign Exchange Markets, 1989 – 1998 (mia $) 1989 1992 1995 1998 Traditional foreign exchange transactions 590 820 1190 1490 • Spot market transactions 350 400 520 590 • Forward market transactions 240 420 670 900 Untraditional foreign exchange transactions - - 45 97 Source: Roberts, 1999, p. 33. the biggest share of all financial markets in the world Currency Percentage $ 87 DEM 30 ¥ 21 £ 11 FRF 5 CHF 7 Other 39 All currencies 200,00
    13. 13. UNIVERSITY OF LJUBLJANA FACULTY OF ECONOMICS CONTENTS ENDwww.StudsPlanet.com Page 13 5. Types of Foreign Exchange Market Transactions Spot Foreign Exchange Transactions almost immediate delivery of foreign exchange buyer and seller establish the exchange rate at the time of the agreement, payment and delivery are not required until maturity forward exchange rates:  1, 3, 6, 9 months, one year Outright Forward Transactions
    14. 14. UNIVERSITY OF LJUBLJANA FACULTY OF ECONOMICS CONTENTS ENDwww.StudsPlanet.com Page 14 Swap Transactions simultaneous purchase and sale of a given amount of foreign exchange for two different value dates:  “spot against forward” swaps: d c b a *= a – annual swap rate (%), b – premium/discount during the time of the currency swap, c – spot exchange rate, and d - 1/part of the year, for which the currency swap is agreed upon (if the contract is valid for a three-month period, then this is one quarter of a year)  “forward-forward” swaps
    15. 15. UNIVERSITY OF LJUBLJANA FACULTY OF ECONOMICS CONTENTS ENDwww.StudsPlanet.com Page 15 Futures basic characteristics of futures:  the amount of the currency that is being traded  type of currency quotation  contract expiration  last day of trading with the contract  settlement day  margin requirements information about futures trading futures usage:  arbitrage between outright forward contract and futures  rarely used as an insurance instrument (rigidity!)
    16. 16. UNIVERSITY OF LJUBLJANA FACULTY OF ECONOMICS CONTENTS ENDwww.StudsPlanet.com Page 16  similarities and differences between outright forward contract and futures:  both need to be executed unconditionally  they are usually established for at most one year Characteristic Futures Outright Forward Contract Size of the contracts standardized for a given currency depends on the individual needs of the client Location and trade activity at the stock exchange or at a given location; actively traded in an organized market with the provision of agents, connected among each other with the help of telecommunications; not traded in an organized market Duration of the contract standardized, but at most a year depends on the individual needs of the client , but not more than a year Contract has to be executed yes yes Insurance and Security of doing Business with the Instrument insurance explicitly required (margin requirements); high security of doing business with the instrument insurance not required explicitly (implicit insurance are affiliations of two partners up till now); lower security than futures Trade regulation regulated with the stock exchange rules regulation not explicitly determined
    17. 17. UNIVERSITY OF LJUBLJANA FACULTY OF ECONOMICS CONTENTS ENDwww.StudsPlanet.com Page 17 Characteristic Futures Outright Forward Contract Contract partners not in direct contact in direct contact Price determination based on supply and demand based on quotations Determination of the dayof the settlement standardized depends on the individual needs of the client Accesibility of the contract for non- bank agents accessible to anyone in practice accessible to big clients with good ratings Liquidity of the instrument and the contract amounts high liquidity; small contract amounts and small size of transactions low liquidity; high contract amounts and large size of transactions compared to the size of futures Costs of the instrument based on costs that the broker zaračuna for the purchase of the instrument and its sale later on higher than for futures; based on the difference in offer and bid price of the currency that the bank offers the client Currency quotation number of units of $ for one unit of a foreign currency (American quotation) number of domestic currency units for one unit of a foreign currency (European quotation) Riskiness of the instrument very limited; stock exchange enters the contract, explicitly required insurance higher than for futures; for this reason, business is done only with credible partners Profit yield/loss payment daily once; at contract execution or when the contract expires
    18. 18. UNIVERSITY OF LJUBLJANA FACULTY OF ECONOMICS CONTENTS ENDwww.StudsPlanet.com Page 18 Options basic characteristics of options:  financial instrument that gives the buyer the right, but not the obligation, to buy or sell a standardized amount of a foreign currency, that is traded, at a fixed price at a particular time, or until a particular time in the future  call option and put option  American and European options  three different prices:  exercise/strike price  cost, price or value of the option  underlying or actual spot exchange rate “at-the- money” “in-the- money” “out-of- money”
    19. 19. UNIVERSITY OF LJUBLJANA FACULTY OF ECONOMICS CONTENTS ENDwww.StudsPlanet.com Page 19 Options types of options trading:  in organized markets:  standardized contracts with given strike prices, standardized durations (1, 3, 6, 9, 12 months) and expirations  only certain currencies, contract amounts are standardized  over-the-counter trading:  expiration date, strike price and contract amount depend on the individual needs of the client  counterparty risk!  retail and interbank market information about options trading
    20. 20. UNIVERSITY OF LJUBLJANA FACULTY OF ECONOMICS CONTENTS ENDwww.StudsPlanet.com Page 20 Usage of options:  when the economic agent expects that the exchange rate trend of a particular currency could change drastically  when the economic agent does not know for sure that a certain foreign exchange flow will occur in the future  advantages:  fixed option costs  options do not need to be executed Options
    21. 21. UNIVERSITY OF LJUBLJANA FACULTY OF ECONOMICS CONTENTS ENDwww.StudsPlanet.com Page 21 Profit/ loss Limited loss Unlimited profit A. Buyer of a call option Profit/ loss Limited loss Unlimited profit C. Buyer of a put option Profit/ loss Limited profit Unlimited loss B. Seller of a call option Profit/ loss Unlimited loss Limited profit D. Seller of a put option
    22. 22. UNIVERSITY OF LJUBLJANA FACULTY OF ECONOMICS CONTENTS ENDwww.StudsPlanet.com Page 22 6. Quotations of Currencies on Foreign Exchange Markets quotation of a currency tells us at what price is a financial mediator willing to buy or sell a certain currency Currency Quotations in Spot Foreign Exchange Markets European and American quotation direct and indirect quotation (which currency is regarded as a domestic/basis currency) 100* 0 0 s ss s t − =∆ 100*0 t t s ss s − =∆
    23. 23. UNIVERSITY OF LJUBLJANA FACULTY OF ECONOMICS CONTENTS ENDwww.StudsPlanet.com Page 23 Currency Quotations in Spot Foreign Exchange Markets American quotation European quotation Definition: number of units of $ needed to buy a unit of a foreign currency Definition: number of units of a foreign currency needed to buy $1 Direct quotation in the USA: number of units of a domestic currency ($) needed to buy a unit of foreign currency Direct quotation outside the USA: number of units of a domestic currency needed to buy a unit of a foreign currency ($) Indirect quotation outside the USA: number of units of a foreign currency ($) needed to buy a unit of a domestic currency Indirect quotation in the USA : number of units of a foreign currency needed to buy a unit of a domestic currency ($)
    24. 24. UNIVERSITY OF LJUBLJANA FACULTY OF ECONOMICS CONTENTS ENDwww.StudsPlanet.com Page 24 Currency Quotations in Spot Foreign Exchange Markets bid price and offer/sell price quotation:  bid price is the exchange rate at which a bank is willing to buy another currency  offer/sell price is the exchange rate at which the same bank is willing to sell the currency in question transaction costs:  banks usually do not charge provision  difference between the bid and offer/sell price represents the bank’s profit and is called a margin or spread priceoffer/sell pricebid-priceoffer/sell margin =
    25. 25. UNIVERSITY OF LJUBLJANA FACULTY OF ECONOMICS CONTENTS ENDwww.StudsPlanet.com Page 25 Currency Quotations in Spot Foreign Exchange Markets cross exchange rate:  can be calculated with the help of the relationship of two currencies with a third currency triangular currency arbitrage:  it enables profit earning because of inconsistency between currency quotations in different financial centers  buying a particular currency in one financial center and selling it in another financial center
    26. 26. UNIVERSITY OF LJUBLJANA FACULTY OF ECONOMICS CONTENTS ENDwww.StudsPlanet.com Page 26 Currency Quotations in Forward Foreign Exchange Markets  outright quotation  točkovna quotation, forward premium/discount:  forward discount:  when a currency is worth less (is cheaper relative to another currency) in the forward foreign exchange market than in the spot foreign exchange market  forward premium:  when a currency is worth more (is more expensive relative to another currency) in the forward foreign exchange rate market than in the spot foreign exchange market  annual forward premium and discount 100* 360 * ns sf fUSD − = 100* 360 * nf fs fUSD − =
    27. 27. UNIVERSITY OF LJUBLJANA FACULTY OF ECONOMICS CONTENTS ENDwww.StudsPlanet.com Page 27 Financial Times Wall Street Journal Publishing the Currency Quotations in the Leading World Financial Newspapers

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