Chapter 3

Question 1

What is the Foreign exchange market?

Answer 1

Market composed primarily of banks, serving firms and consumers who wish to buy or sell various currencies.

Question 2

History of Foreign Exchange

Answer 2

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)

Question 3

What is the Spot Market? Spot rate?

Answer 3

Market in which exchange transactions occur for immediate exchange.

Current exchange rate of a currency

Question 4

Bid/Ask Spread: **

Answer 4

The difference between the bid price (buy) and ask price (sell) of a currency.

= (Ask rate - Bid rate)/ Ask rate

Question 5

Bid/Ask Spread is

___ for currencies of less value

___ for illiquid currencies

Answer 5

SMALLER (actual # not %)

Larger

Question 6

Factors that impact the Spread: **

Answer 6

Order Costs +
Inventory Costs +
Competition -
Volume -
Currency risks +

Question 7

Direct VS Indirect Quotation **

Answer 7

Direct = ___ USD = 1 foreign
Indirect = $1 USD = ___ foreign

Indirect = 1/Direct Quote
Direct = 1/Indirect Quote

Question 8

If direct is rising, indirect is

Answer 8

declining

Question 9

Cross Exchange Rates *

Answer 9

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 $

Question 10

Derivative Contracts (3)

Answer 10

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)

Question 11

International Money Market - Purpose + Incentive

Answer 11

Purpose: Accommodate MNCs’ short-term funding needs in various currencies.

Incentives for Foreign Investment: Higher interest rates in foreign markets attract investors.

Question 12

Dollar Dominated Bank Accounts

Answer 12

Used by foreign countries as medium for international trade

Eurodollars: dollar deposits in banks in Europe

Asian market intergrated w Europe

Question 13

Money Market Rates

Answer 13

Low demand + large supply = low rates
High Demand + small supply = high rates

Question 14

London Interbank Offer Rate (LIBOR)

Answer 14

the rate most often charged for very short-term loans (such as for one day) between banks.

Influence market - when raise, market raise

Question 15

Risks in International Money Market

Answer 15

MNCs pay higher rate than local gov

Exchange rate risk - when foreign weakens vs home = less return

Question 16

International Credit Market

Answer 16

Medium term funds sources: financial institutions,
Banks in foreign markets

Question 17

What is a Syndicated Loan?

Answer 17

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

Question 18

Regulations in Credit Market

Answer 18

Single European Act

Basel Accord

Basel 2 Accord

Basel 3 Accord **

Question 19

International Bond Market Types

Answer 19

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.

Question 20

Features of Eurobonds

Answer 20

Bearer form: no records of ownership
Yearly coupon payments
Covertibility clause (stock)

Advantage to issues: few protective covenants

Question 21

Bond Markets relationships

Answer 21

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.

Question 22

Risks of International bonds

Answer 22

Interest rate risk
Exchange rate
Liquidity
Credit

Question 23

International Stock Market - Issuance in US

Answer 23

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.

Question 24

Factors that influence trading activity (stock)

Answer 24

Rights vary by country
Legal protection of shareholders
Government enforcement of securities laws
Accounting laws
(International Accounting Standards Board)

Question 25

How the Financial Markets Serve MNCs

Answer 25

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.