4. 4
PART I. INTRODUCTION
I. INTRODUCTION
A. The Market:
the place where money
denominated in one currency
is bought and sold with money
denominated in another
currency.
6. 6
INTRODUCTION
C. Location
1. OTC-type: no specific
location
2. Most trades by phone,
telex, or SWIFT*
*SWIFT: Society for Worldwide Interbank
Financial Telecommunications
7. 7
PART II.
ORGANIZATION OF THE FOREIGN
EXCHANGE MARKET
I . PARTICIPANTS IN THE
FOREIGN EXCHANGE MARKET
A. Participants at 2 Levels
1. Wholesale Level (95%)
- major banks
2. Retail Level
- banks deal with
business customers.
8. 8
ORGANIZATION OF THE FOREIGN
EXCHANGE MARKET
B. Two Types of Currency Markets
1. Spot Market:
- immediate transaction
- recorded by 2nd business
day
2. Forward Market:
- transactions take place at
a specified future date
9. 9
ORGANIZATION OF THE FOREIGN
EXCHANGE MARKET
C. Participants by Market
1. Spot Market
a. commercial banks
b. brokers
c. customers of commercial
and central banks
10. 10
ORGANIZATION OF THE FOREIGN
EXCHANGE MARKET
2. Forward Market
a. arbitrageurs
b. traders
c. hedgers
d. speculators
11. 11
ORGANIZATION OF THE FOREIGN
EXCHANGE MARKET
II. CLEARING SYSTEMS
A. Clearing House Interbank
Payments System ( CHIPS)
- used in U.S. for electronic
fund transfers.
B. FedWire
- operated by the Fed
- used for domestic transfers
12. 12
ORGANIZATION OF THE FOREIGN
EXCHANGE MARKET
III. ELECTRONIC TRADING
A. Automated Trading
- genuine screen-based
market
B. Results:
1. Reduces cost of trading
2. Threatens traders’
oligopoly of information
3. Provides liquidity
13. 13
ORGANIZATION OF THE FOREIGN
EXCHANGE MARKET
IV. SIZE OF THE MARKET
A. Largest in the world
1995: $1.2 trillion daily
B. Market Centers (1995):
London = $464 billion daily
New York= $244 billion daily
Tokyo = $161 billion daily
14. 14
PART III.
THE SPOT MARKET
I. SPOT QUOTATIONS
A. Sources
1. All major newspapers
2. Major currencies have
four different quotes:
a. spot price
b. 30-day
c. 90-day
d. 180-day
15. 15
THE SPOT MARKET
B. Method of Quotation
1. For interbank dollar
trades:
a. American terms
example: $.5838/dm
b. European terms
example: dm1.713/$
16. 16
THE SPOT MARKET
2. For nonbank
customers:
Direct quote
gives the home currency
price of one unit of
foreign currency.
EXAMPLE:
dm0.25/FF
17. 17
THE SPOT MARKET
C. Transactions Costs
1. Bid-Ask Spread
used to calculate the fee
charged by the bank
2. Bid = the price at which
the bank is willing to buy
3. Ask = the price it will sell
the currency
19. 19
THE SPOT MARKET
D. Cross Rates
1. The exchange rate
between 2 non-US$
currencies.
20. 20
THE SPOT MARKET
2. Calculating Cross Rates
When you want to know what
the dm/pound cross rate is, and you
know dm2/US$ and .55pounds/US$,
then
dm/pounds =
*dm2/US$ ÷ .55 pounds/US$
= dm3.60/ pound
*Hint: Keep the denominators alike. Convert to indirect
if necessary.
21. 21
THE SPOT MARKET
E. Currency Arbitrage
1. When cross rates differ from
one financial center to
another,
profit opportunities exist.
2. Buy cheap in one int’l market,
Sell at a higher price in
another
3. Role of Available Information
22. 22
THE SPOT MARKET
F. Settlement Date
Value Date:
1. Date monies are due
2. 2nd Working day after
date of original transaction.
23. 23
THE SPOT MARKET
G. Exchange Risk
1. Bankers = middlemen
a. Incurring risk of adverse
exchange rate moves.
b. Increased uncertainty
about future exchange
rate requires
25. 25
PART II.
MECHANICS OF SPOT
TRANSACTIONS
SPOT TRANSACTIONS: An
Example
Step 1. Currency transaction:
verbal agreement U.S.
Importer specifies
a. Account to debit (his acct)
b. Account to credit (exporter)
26. 26
MECHANICS OF SPOT
TRANSACTIONS
Step 2. Bank sends importer contract
note including:
- amount of foreign
currency
- agreed exchange rate
- confirmation of Step 1.
27. 27
MECHANICS OF SPOT
TRANSACTIONS
Step 3. Settlement
Correspondent bank in Hong
Kong transfers HK$ from
nostro account to exporter’s.
Value Date.
U.S. bank debits importer’s
account.
28. 28
PART III.
THE FORWARD MARKET
I. INTRODUCTION
A. Definition of a Forward Contract
an agreement between a bank and a
customer to deliver a specified amount
of currency against another currency
at a specified future date and at a fixed
exchange rate.
30. 30
THE FORWARD MARKET
B. Forward Rate Quotations
1. Two Methods:
a. Outright Rate: quoted to
commercial customers.
b. Swap Rate: quoted in the
interbank market as a
discount or premium.
31. 31
THE FORWARD MARKET
CALCULATING THE FORWARD
PREMIUM OR DISCOUNT
= F-S x 12 x 100
S n
where F = the forward rate of
exchange
S = the spot rate of exchange
n = the number of months in
the
forward contract
32. 32
THE FORWARD MARKET
C. Forward Contract
Maturities
1. Contract Terms
a. 30-day
b. 90-day
c. 180-day
d. 360-day
2. Longer-term Contracts
33. 33 28
PART I I I .
THE FORWARD MARKET
I . I NTRODUCTI ON
A. Definit ion of a Forward Cont ract
an agreem ent bet w een a bank and a
cust omer t o deliver a specified amount
of currency against anot her currency
at a specified fut ure date and at a fixed
exchange rate.
34. 3429
THE FORWARD MARKET
B. Forw ard Rate Quotations
1. Tw o Met hods:
a. Outright Rat e:
Pound 1.4326 1.4330
1 m f 1.4302 1.4309
b. Swap Rate: in t he interbank
market as a discount or prem ium.
Pound 26-30
1 m f 24-21
Rule if f b< fa --> premium , if fb> fa --> discount
35. 3530
THE FORWARD MARKET
CALCULATI NG THE FORWARD
PREMI UM OR DI SCOUNT
= F-S x 12 x 100
S n
w here F = the forw ard rate of exchange
S = the spot rate of exchange
n = the number of months in the
forw ard contract
36. 3631
THE FORWARD MARKET
C. Forw ard Contract
Mat urities
1. a. 30-day (1m)
b. 90-day (3m)
c. 180-day (6m)
2. 360-day (1yr) or longer-
term Contracts
