Slides of Jeff medura's book

2.  The foreign exchange market enables the trade of one
currency for another.
 Commercial banks manage this market, maintaining
inventories of different currencies.
 Individuals use the foreign exchange market when
traveling internationally, converting their domestic
currency to the foreign one.
 U.S.-based Multinational corporations (MNCs) use it for
conducting international business, buying or selling
goods in foreign currencies.
 Exchange rates define how much of one currency is
needed for another, affecting the costs of foreign
goods or services.
 The method of determining exchange rates has

3. Golden Standard:
 Between 1876-1913, exchange rates were governed by the
gold standard; each currency was convertible into gold at a
specified rate.
 The gold standard was suspended with the onset of World
War I in 1914.
 Some countries attempted to return to the gold standard in
the 1920s, but abandoned it due to a banking panic during
the Great Depression.
 In the 1930s, attempts were made to peg currencies to the
dollar or the British pound, resulting in frequent revisions.
 Due to the instability in the foreign exchange market and
severe restrictions on international transactions,
international trade volume declined during this period.

4. Agreements on Fixed Exchange Rates:
 In 1944, the Bretton Woods Agreement established fixed
exchange rates, allowing only 1% fluctuation.
 This system ended in 1971 due to an overvaluation of the
U.S. dollar.
 The Smithsonian Agreement subsequently devalued the
dollar relative to other major currencies.
 It also widened exchange rate fluctuation boundaries to
2.25%, permitting rates to move more freely.

5. Floating Exchange Rate System:
 Post-Smithsonian Agreement, governments struggled to
maintain exchange rates within the widened boundaries.
 By March 1973, the official boundaries established by the
Smithsonian Agreement were removed.
 Widely traded currencies were then allowed to fluctuate
freely, driven by market forces.

6.  The foreign exchange market operates digitally, not in a
physical location, with transactions conducted over
telecommunications networks.
 Major trading centers include London, New York, and
Tokyo, contributing over half the global trading volume.
 Dealers like CitiFX, J.P. Morgan Chase, and Deutsche
Bank facilitate currency exchanges; some operate
exclusively online.
 Daily trading volume is around $4 trillion, with the U.S.
dollar in 40% of transactions.
 Many transactions between non-U.S. countries occur
without involving the U.S. dollar.

7. Spot Market:
 The most prevalent type of foreign exchange transaction
happens for immediate exchange, known as the spot
market.
 The rate at which one currency is traded for another in the
spot market is referred to as the spot rate.

8. Spot Market Structure:
 Commercial transactions in the spot market are typically
conducted electronically, with the exchange rate at the time
dictating the necessary funds for the transaction.
 In the case of a bank experiencing a shortage in a
particular foreign currency, it can purchase that currency
from other banks in the interbank market.
 Other financial institutions like securities firms can also
provide similar services.
 Most major airports worldwide and numerous city locations
have foreign exchange centers where individuals can
exchange currencies.

9. Use of the Dollar in the Spot Market:
 The U.S. dollar is widely accepted as a medium of
exchange in many countries, particularly in countries like
Bolivia, Indonesia, Russia, and Vietnam, where the local
currency may be weak or face foreign exchange
restrictions.
 Many merchants accept U.S. dollars as they can use them
to purchase goods from other countries.

10. Spot Market Time Zones:
 Foreign exchange trading is a continuous global process
due to varying business hours across time zones.
 Opening exchange rates in the U.S. are influenced by rates
from earlier-opening markets like London.
 Exchange rates can fluctuate based on changes in supply
and demand conditions before U.S. market opens.
 Many U.S. banks, including medium-sized ones, have set
up night trading desks to capitalize on nighttime exchange
rate movements and cater to corporate clients.

11. Spot Market Liquidity:
 Liquidity refers to the ease with which a currency can be
bought or sold.
 More liquid currencies are easier for MNCs to obtain or sell.
 Less liquid currencies can make it difficult for MNCs to
quickly purchase or sell them.

12. Attributes of the Banks that Provide Foreign Exchange:
 When choosing a bank for foreign exchange services, it is
important to consider the following factors:
 Competitive exchange rates
 Availability of hard-to-find currencies
 Speed of execution
 Market insights and forecasts
 Reputation and customer service
 By considering these factors, you can be sure to choose a
bank that will provide you with the best possible foreign
exchange services.

13. Foreign Exchange Quotations:
 Exchange rates between two currencies should be similar
across banks.
 If there is a large discrepancy, customers or other banks
will buy from the bank with the lower price and sell to the
bank with the higher price.
 This will cause the exchange rates to adjust until they are
similar across all banks.
 This process is called arbitrage and it helps to keep
exchange rates fair and competitive.

14. Foreign Exchange Quotations:
 Exchange rates between two currencies should be similar
across banks.
 If there is a large discrepancy, customers or other banks
will buy from the bank with the lower price and sell to the
bank with the higher price.
 This will cause the exchange rates to adjust until they are
similar across all banks.
 This process is called arbitrage and it helps to keep
exchange rates fair and competitive.

15. Bid/Ask Spread of Banks:
 Commercial banks charge a fee for exchanging currencies,
called the bid/ask spread.
 The bid/ask spread is the difference between the price that
a bank buys a currency for and the price that it sells the
currency for.
 The bid/ask spread can vary depending on the currency
pair and the time of day.
 It is important to be aware of the bid/ask spread when
exchanging currencies.

16. Comparison of Bid/Ask Spread Among Currencies:
 The bid/ask spread is the difference between the price a
bank buys and sells a currency for.
 It is typically larger for retail transactions and smaller for
wholesale transactions.
 It is normally larger for illiquid currencies.
 Bid/Ask Spread = (Ask Rate – Bid Rate)/Ask Rate

17. Factors That Affect the Spread:
 Spread = f (Order Cost, Inventory Cost, Competition,
Volume, Currency Risk)
 Order costs are the costs of processing orders, including
clearing costs and the costs of recording transactions.
 Inventory costs include storage, insurance, security,
depreciation, and interest. The higher the inventory costs,
the larger the spread between the buy and sell prices of a
currency.
 The more intense the competition, the smaller the spread
quoted by intermediaries. Competition is more intense for
the more widely traded currencies because there is more
business in those currencies.

18. Factors That Affect the Spread:
 Liquidity is a measure of how easily a currency can be
bought or sold. More liquid currencies are less likely to
experience sudden changes in price.
 Currency volatility is the degree to which the price of a
currency fluctuates over time. It can be caused by
economic or political factors. Volatile currencies are more
likely to experience sudden changes in price, which can
lead to large losses for investors.

19. The exchange rates of major currencies are published daily in
newspapers and online. Most countries have their own
currency, but some countries, such as those in the eurozone,
use a common currency. The eurozone is a group of 17
European countries that use the euro as their currency.

20. Direct Vs Indirect Quotations
The exchange rates of major currencies are published daily in
newspapers and online. Most countries have their own
currency, but some countries, such as those in the eurozone,
use a common currency. The eurozone is a group of 17
European countries that use the euro as their currency.

21. Interpreting Changes in Exchange Rates
 Exhibit 3.3 shows the relationship between direct and
indirect exchange rates.
 When the euro appreciates against the dollar, the indirect
exchange rate declines.
 When the euro depreciates against the dollar, the indirect
exchange rate rises.
 It is easier to compare currencies and determine whether a
currency is appreciating or depreciating if all exchange
rates are converted into direct quotations.
 For consistency, the examples in this text use direct
quotations unless an example can be clarified by the use of
indirect quotations.

22. Source of Exchange Rate Quotations
 Yahoo's website (http://finance.yahoo.com/currency)
provides updated currency quotations for major currencies.
 You can select any currency to get an exchange rate
quotation and view historical exchange rate trends.
 The trends show the direction, extent of change, and range
of exchange rates for different time periods.
 It's important to understand whether the quotation is direct
(in dollars) or indirect (currency per dollar) when
interpreting the trend.
 Other sources like www.federalreserve.gov/release and
www.oanda.com also provide exchange rate quotations.
 Be cautious of different sources using either direct or
indirect quotations for specific currencies.

23. Source of Exchange Rate Quotations
 Yahoo's website (http://finance.yahoo.com/currency)
provides updated currency quotations for major currencies.
 You can select any currency to get an exchange rate
quotation and view historical exchange rate trends.
 The trends show the direction, extent of change, and range
of exchange rates for different time periods.
 It's important to understand whether the quotation is direct
(in dollars) or indirect (currency per dollar) when
interpreting the trend.
 Other sources like www.federalreserve.gov/release and
www.oanda.com also provide exchange rate quotations.
 Be cautious of different sources using either direct or
indirect quotations for specific currencies.

24. Cross Exchange Rates
 Most exchange rate tables show how currencies compare
to the US dollar.
 Sometimes, companies are interested in the exchange rate
between two non-dollar currencies.
 For example, a Canadian company buying Mexican goods
wants to know the value of the Mexican peso compared to
the Canadian dollar.
 This type of rate is called a cross exchange rate, which
shows how much one foreign currency is worth in terms of
another foreign currency.
 Cross exchange rates can be easily calculated using
foreign exchange quotations by dividing the value of one
currency in dollars by the value of the other currency in doll

25. Source of Cross Exchange Rate Quotations
 Yahoo's website (http://finance.yahoo.com/currency-
investing) provides cross exchange rates for major
currencies.
 You can check the recent trend of a specific cross
exchange rate for different time periods.
 The trend shows how much the cross exchange rate has
changed over that period.
 When the euro and British pound have moved in a similar
direction against the US dollar and by similar degrees, the
exchange rate between the euro and British pound has
remained relatively stable over time.

26. Currency Derivative
 Forward contracts involve exchanging currencies at a
predetermined rate.
 Currency futures contracts allow buying or selling
currencies at a specified price in the future.
 Currency options contracts provide the right to buy or sell
currencies at a predetermined price within a specific time
period.

27. Forward Contracts
 Multinational corporations (MNCs) may want to secure a
future exchange rate and use forward contracts to achieve
this.
 Forward contracts are agreements between MNCs and
foreign exchange dealers, specifying the currencies,
exchange rate, and future transaction date.
 The forward rate is the specified exchange rate within the
contract for the future currency exchange.
 MNCs use forward contracts to hedge against currency
fluctuations for future payments or receipts in foreign
currencies.
 The forward market facilitates trading of these contracts,
mainly involving foreign exchange dealers and MNCs, with

28. Currency Futures Contracts
 Futures contracts, similar to forward contracts, are traded
on exchanges rather than over the counter.
 Currency futures contracts specify a standard volume of a
particular currency to be exchanged on a specific
settlement date.
 Some multinational corporations (MNCs) in international
trade use currency futures contracts to hedge their
positions.
 The futures rate in a futures contract represents the
exchange rate at which a specified currency can be bought
or sold on the settlement date, similar to the role of the
forward rate in a forward contract.

29. Currency Options Contracts
 Currency options are classified as calls or puts.
 Call options allow buying a currency at a specific price
within a set time period, used for hedging future payables.
 Put options allow selling a currency at a specific price
within a set time period, used for hedging future
receivables.
 Currency options offer flexibility as there is no obligation to
exercise the option, and they have gained popularity for
hedging purposes among multinational corporations.

31. International Money Market
 Local corporations and country governments often need
short-term funds, while a money market helps transfer
funds from surplus units to deficit units.
 Financial institutions like banks accept short-term deposits
and redirect funds to those in need, and
corporations/governments issue short-term securities
bought by local investors.
 In international business, corporations and governments
often require short-term funds in foreign currencies due to
reasons such as import payments, lower interest rates, or
potential currency depreciation.
 Some corporations and institutional investors choose to
invest in foreign currencies instead of their home currency

32. The international money market includes large banks in
countries around the world. Two other important components
of the international money market are the European money
market and the Asian money market.

33. European Money Market:
 The European money market evolved from the
Eurocurrency market, which emerged to meet the needs of
expanding multinational corporations.
 Eurodollars, U.S. dollars deposited in European banks,
played a crucial role in facilitating international trade with
European countries.
 Regulatory changes in the United States and the
involvement of OPEC contributed to the growth of the
Eurocurrency market by providing opportunities for foreign
lending and depositing oil revenues.
 While the term "Eurocurrency market" is not as commonly
used today, the European money market remains
significant within the network of international money

34. Asian Money Market:
 The Asian money market, initially known as the Asian dollar
market, developed to meet the needs of businesses using
the U.S. dollar for international trade.
 It is centered in Hong Kong and Singapore, where banks
accept deposits and provide loans in various foreign
currencies.
 Major sources of deposits in this market are multinational
corporations and government agencies, while
manufacturers are the primary borrowers.
 The Asian money market also facilitates interbank lending
and borrowing, where banks seek additional funds or lend
to each other. It often has connections with the European
market.

35.  Money market interest rates in a country are determined by
the balance between the demand for short-term funds from
borrowers and the supply of available funds from savers.
 Countries with high demand for short-term funds and
limited supply tend to have higher money market interest
rates, while those with low demand and ample supply have
lower rates.
 Developing countries generally have higher money market
rates due to their higher growth and the need for more
funds to finance that growth.
 Money market rates can vary significantly among
currencies depending on the total supply of funds and the
demand for borrowing in each country. Corporations
typically pay slightly higher rates than the government,
reflecting the risk of potential default on borrowed funds.

36. Global Integration of Money Market Interest Rates
 Money market interest rates among countries are closely
linked because economic conditions affect the demand and
supply of short-term funds globally.
 When the global economy weakens, corporations borrow
less, reducing the demand for funds and causing interest
rates to fall.
 Conversely, during economic upturns, corporations expand
and require more funds, increasing the demand and driving
interest rates higher.
 The correlation in money market rates reflects how
economic changes impact borrowing needs, leading to
similar rate movements across countries.

37. Risk of International Money Market Securities
 International money market securities are short-term debt
securities issued by MNCs and government agencies,
typically with a maturity of one year or less.
 These securities are considered safe, especially if they
have high ratings from credit agencies, and investors are
less concerned about the issuer's financial condition at
maturity.
 However, there is a possibility of default, so investors
should consider the credit risk associated with these
securities.
 Investors in international money market securities also face
exchange rate risk if the currency of the securities weakens
against their home currency, which can lead to investment

38. International Credit Market
 Multinational corporations and domestic firms have options
for obtaining medium-term funds through local financial
institutions or foreign banks in the form of Euro credit loans.
 Banks face challenges when their short-term deposits and
long-term loans have different maturities, so they use
floating rate loans tied to market interest rates like LIBOR
to manage risks.
 The international credit market is well-established in Asia
and emerging in South America, but participation in certain
markets may decrease during economic crises due to
increased credit risk.
 Funding tends to gravitate towards markets with robust
economic conditions and manageable credit risk, even

39. Regulations in the Credit Market
 Regulations influenced the credit market by imposing
limitations on certain local markets, prompting investors
and borrowers to find ways around these restrictions.
 Varied regulations among countries gave certain banks
advantages over others, but international banking
regulations have gradually become more standardized.
 Key regulatory events that fostered a more competitive
global banking environment include the Single European
Act, the Basel Accord, and the Basel II Accord.
 These regulatory measures aimed to enhance the
uniformity and efficiency of global banking practices,
facilitating increased competition and a more level playing
field.

40. Single European Act
 The Single European Act, implemented in 1992, had a
significant impact on international banking within the
European Union (EU).
 Key provisions of the act include the free movement of
capital throughout Europe, allowing banks to offer a wide
range of financial services across EU countries.
 The act also brought about similar regulations on
competition, mergers, and taxes across the EU, creating a
more harmonized banking environment.
 Banks established in one EU country gained the right to
expand into other EU countries, leading to increased
efficiency and easier cross-border operations. Similar
provisions apply to non-U.S. banks entering the United

41. Basel Accord
 Prior to 1987, banks had different capital standards
globally, giving some banks an advantage in lending to
multinational corporations (MNCs).
 To address this disparity, major countries proposed uniform
bank standards, resulting in the Basel Accord of 1988.
 The Basel Accord established guidelines requiring banks to
maintain a minimum capital ratio of 4 percent based on the
risk-weighted assets.
 These guidelines prevent banks from evading capital
requirements by considering both on-balance sheet and
off-balance sheet items.

42. Basel II Accord
 The Basel Committee is finalizing the Basel II Accord to
address inconsistencies in banking regulations and
improve risk management in banks.
 The accord aims to account for variations in collateral
requirements among banks and encourages them to
enhance their operational risk control measures.
 It also emphasizes the need for banks to provide more
detailed information about their exposure to different types
of risk to both existing and potential shareholders.

43. Basel III Accord
 The 2008-2009 financial crisis revealed the riskiness of
banks and their impact on economies, leading to the
development of "Basel III," a global agreement among
regulators to make banks safer.
 Basel III introduces higher capital requirements and new
methods to estimate risk, aiming to prevent future financial
crises by strengthening banks' financial positions.
 To avoid sudden disruptions, banks are given a long period
to comply with the new rules, but concerns remain that
another crisis could occur before banks fully meet the
required capital levels.