Chapter 3 Flashcards
What is the Foreign exchange market?
Market composed primarily of banks, serving firms and consumers who wish to buy or sell various currencies.
History of Foreign Exchange
Gold Standard (1876-1913): Exchange rates were based on gold convertibility.
Bretton Woods Agreement (1944-1971): Established fixed exchange rates within narrow boundaries.
Smithsonian Agreement (1971): Allowed for devaluation of the dollar and widened boundaries for exchange rates.
Floating Exchange Rate System - rates move according to market forces (w some central bank intervention)
What is the Spot Market? Spot rate?
Market in which exchange transactions occur for immediate exchange.
Current exchange rate of a currency
Bid/Ask Spread: **
The difference between the bid price (buy) and ask price (sell) of a currency.
= (Ask rate - Bid rate)/ Ask rate
Bid/Ask Spread is
___ for currencies of less value
___ for illiquid currencies
SMALLER (actual # not %)
Larger
Factors that impact the Spread: **
Order Costs +
Inventory Costs +
Competition -
Volume -
Currency risks +
Direct VS Indirect Quotation **
Direct = ___ USD = 1 foreign
Indirect = $1 USD = ___ foreign
Indirect = 1/Direct Quote
Direct = 1/Indirect Quote
If direct is rising, indirect is
declining
Cross Exchange Rates *
The exchange rate between two currencies based on their values against a third currency.
Use indirect
EXAMPLE: Value of euro in terms of pesos = Value of euro in $$ / Value of peso in $
Derivative Contracts (3)
Forward Contracts: Agreements to buy/sell currency at a future date at a specified rate.
Currency Futures: Standardized contracts traded on exchanges.
Currency Options: Provide the right, but not the obligation, to buy or sell currency at a specified price.
(call/buy or put/sell)
International Money Market - Purpose + Incentive
Purpose: Accommodate MNCs’ short-term funding needs in various currencies.
Incentives for Foreign Investment: Higher interest rates in foreign markets attract investors.
Dollar Dominated Bank Accounts
Used by foreign countries as medium for international trade
Eurodollars: dollar deposits in banks in Europe
Asian market intergrated w Europe
Money Market Rates
Low demand + large supply = low rates
High Demand + small supply = high rates
London Interbank Offer Rate (LIBOR)
the rate most often charged for very short-term loans (such as for one day) between banks.
Influence market - when raise, market raise
Risks in International Money Market
MNCs pay higher rate than local gov
Exchange rate risk - when foreign weakens vs home = less return
International Credit Market
Medium term funds sources: financial institutions,
Banks in foreign markets
What is a Syndicated Loan?
A syndicate of banks can be formed to underwrite the loans and the lead bank is responsible for negotiating the terms with the borrower.
if single bank unwilling or can’t lend amount needed
Regulations in Credit Market
Single European Act
Basel Accord
Basel 2 Accord
Basel 3 Accord **
International Bond Market Types
Foreign bonds: issued by foreign
Parrallel bonds: bonds placed in different countries and denominated in the respective currencies of the countries where they are placed.
Eurobonds: bonds that are sold in countries other than the country whose currency is used to denominate the bonds.
Features of Eurobonds
Bearer form: no records of ownership
Yearly coupon payments
Covertibility clause (stock)
Advantage to issues: few protective covenants
Bond Markets relationships
When economic conditions weaken, aggregate demand for funds declines with the decline in corporate expansion.
When economic conditions strengthen, aggregate demand for funds increases with the increase in corporate expansion.
Risks of International bonds
Interest rate risk
Exchange rate
Liquidity
Credit
International Stock Market - Issuance in US
Yankee stock offering: offerings of stock by non-U.S. firms in the U.S. markets.
American Depository Receipts (ADRs): certificates representing ownership of foreign stocks, which are traded on stock exchanges in the United States.
Factors that influence trading activity (stock)
Rights vary by country
Legal protection of shareholders
Government enforcement of securities laws
Accounting laws
(International Accounting Standards Board)
How the Financial Markets Serve MNCs
Foreign trade with business clients.
Direct foreign investment, or the acquisition of foreign real assets.
Short-term investment or financing in foreign securities.
Longer-term financing in the international bond or stock markets.
