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Ch07[1]
This document provides an overview of Chapter 7 from the 7th edition of the textbook "Multinational Financial Management" by Alan Shapiro. It discusses the foreign exchange market, including the spot market and forward market. The key points are: 1) The foreign exchange market facilitates international trade and capital flows by allowing currency to be exchanged. Major participants include commercial banks and customers. 2) There are two main parts - the spot market for immediate exchanges recorded within 2 business days, and the forward market for exchanges at a specified future date. 3) The daily foreign exchange market volume was $1.5 trillion in 1999, with London, New York, and Tokyo being the major centers. The market allows
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Ch07[1]
- 1. 1 Multinational Financial Management Alan Shapiro 7th Edition J.Wiley& Sons Power Points by Joseph F. Greco, Ph.D. California State University, Fullerton
- 2.
- 3. 3 CHAPTER OVERVIEW I. INTRODUCTION II.ORGANIZATIONOF THE FOREIGN EXCHANGE MARKET III. THE SPOT MARKET IV. THE FORWARD MARKET
- 4. 4 PART I. INTRODUCTION I.INTRODUCTION A. The Currency Market: where money denominated in one currency is bought and sold with money denominated in another currency.
- 5. 5 INTRODUCTION B. International Tradeand Capital Transactions: facilitated with the ability to transfer purchasing power between countries
- 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 OFTHE FOREIGN EXCHANGE MARKET I . PARTICIPANTS IN THE FOREIGN EXCHANGE MARKET A. Participants at 2 Levels 1. Wholesale Level (95%) - major banks 2. Retail Level - business customers
- 8. 8 ORGANIZATION OF THEFOREIGN EXCHANGE MARKET B. Two Types of Currency Markets 1. Spot Market: - immediate transaction - recorded by 2nd business day
- 9. 9 ORGANIZATION OF THEFOREIGN EXCHANGE MARKET 2. Forward Market: - transactions take place at a specified future date
- 10. 10 ORGANIZATION OF THEFOREIGN EXCHANGE MARKET C. Participants by Market 1. Spot Market a. commercial banks b. brokers c. customers of commercial and central banks
- 11. 11 ORGANIZATION OF THEFOREIGN EXCHANGE MARKET 2. Forward Market a. arbitrageurs b. traders c. hedgers d. speculators
- 12. 12 ORGANIZATION OF THEFOREIGN EXCHANGE MARKET II. CLEARING SYSTEMS A. Clearing House Interbank Payments System (CHIPS) - used in U.S. for electronic fund transfers.
- 13. 13 ORGANIZATION OF THEFOREIGN EXCHANGE MARKET B. FedWire - operated by the Fed - used for domestic transfers
- 14. 14 ORGANIZATION OF THEFOREIGN EXCHANGE MARKET III. ELECTRONIC TRADING A. Automated Trading - genuine screen-based market
- 15. 15 ORGANIZATION OF THEFOREIGN EXCHANGE MARKET B. Results: 1. Reduces cost of trading 2. Threatens traders’ oligopoly of information 3. Provides liquidity
- 16. 16 ORGANIZATION OF THEFOREIGN EXCHANGE MARKET IV. SIZE OF THE MARKET A. Largest in the world 1999: US$1.5 trillion daily or US$375 trillion a year In 1999 the US GDP was US$9.1 trillion
- 17. 17 ORGANIZATION OF THEFOREIGN EXCHANGE MARKET B. Market Centers (1998): #1: London = $637 billion daily #2: New York= $351 billion daily #3: Tokyo = $149 billion daily
- 18. 18 PART III. THE SPOTMARKET 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
- 19. 19 THE SPOT MARKET B.Method of Quotation 1. For interbank dollar trades: a. American terms example: $.5838/dm b. European terms example: Peso1.713/$
- 20. 20 THE SPOT MARKET 2.For nonbank customers: Direct quote gives the home currency price of one unit of foreign currency. EXAMPLE: dm0.25/FF
- 21. 21 THE SPOT MARKET C.Transactions Costs 1. Bid-Ask Spread used to calculate the fee charged by the bank • Bid = the price at which the bank is willing to buy • Ask = the price it will sell the currency
- 22. 22 THE SPOT MARKET 4.Percent Spread Formula (PS): 100x Ask BidAsk PS − =
- 23. 23 THE SPOT MARKET D.Cross Rates 1. The exchange rate between 2 non - US$ currencies.
- 24. 24 THE SPOT MARKET 2.Calculating Cross Rates When you want to know what the dm/ff cross rate is, and you know dm2/US$ and ff.55/US$ then dm/ff = dm2/US$ ÷ ff.55/US$ = dm3.636/ ff
- 25. 25 THE SPOT MARKET E.Currency Arbitrage 1. If cross rates differ from one financial center to another, and profit opportunities exist.
- 26. 26 THE SPOT MARKET 2.Buy cheap in one int’l market, sell at a higher price in another 3. Role of Available Information
- 27. 27 THE SPOT MARKET F.Settlement Date Value Date: 1. Date monies are due 2. 2nd Working day after date of original transaction.
- 28. 28 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
- 29. 29 THE SPOT MARKET 1.)Demand for higher risk premium 2.) Bankers widen bid-ask spread
- 30. 30 MECHANICS OF SPOT TRANSACTIONS SPOTTRANSACTIONS: An Example Step 1. Currency transaction: verbal agreement, U.S. importer specifies: a. Account to debit (his acct) b. Account to credit (exporter)
- 31. 31 MECHANICS OF SPOT TRANSACTIONS Step2. Bank sends importer contract note including: - amount of foreign currency - agreed exchange rate - confirmation of Step 1.
- 32. 32 MECHANICS OF SPOT TRANSACTIONS Step3. Settlement Correspondent bank in Hong Kong transfers HK$ from nostro account to exporter’s. Value Date. U.S. bank debits importer’s account.
- 33. 33 PART IV. THE FORWARDMARKET 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.
- 34. 34 THE FORWARD MARKET 2.Purpose of a Forward: Hedging the act of reducing exchange rate risk.
- 35. 35 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.
- 36. 36 THE FORWARD MARKET CALCULATINGTHE 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