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International Finance > Chapter 3 > Flashcards

Chapter 3 Flashcards

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1
Q

FX Markets

A

allows for the exchange of on currency for another

Exchange rate specifies the ra at which one currency can be exchanged for another

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2
Q

History of FX Rate

A
  1. Gold Standard (1876 - 1913)
    ^Each currency was convertible into gold at a specified rate. When WW1 began in 1914, the gold standard was suspended
  2. Agreements on Fixed Exchange Rates
    ^Bretton Woods Agreement 1944 - 1971
    ^Smithsonian Agreement
    1971 - 1973
  3. Floating Exchange Rate System
    ^Widely traded currencies were allowed to fluctuate in accordance with market forces
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3
Q

Gold Standard

A

each currency was convertible into gold at a spec. rate
thus ER between 2 currencies was determined by their relative convertibility rates per ounce of gold
each country used gold to back its currency
min. government intervention
countries committed to maintaining the convertibility of their currency constant

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4
Q

Bretton Woods Agreement

Agreements on Fixed Exchange Rates

A

government intervention to prevent ER moving more than 1% from initial
they would operate as S&B to adjust the ER to make D/S go back again
-Open trade
-Limit capital flows
-The system eventually collapsed in 1971
–> US appeared to be overvalued (demand

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5
Q

Smithsonian Agreement

Agreements on Fixed Exchange Rates

A

Fix Exchange Rate allowing a 2.25% fluctuations
more flexible
US $ was devalued relative to the other major currencies
Eliminated - March 1973

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6
Q

Floating Exchange Rate System

A

widely traded currencies were allowed to fluctuate in accordance with market forces
official boundaries were eliminated

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7
Q

FX Transaction Types/Ways

A
  1. OTC
  2. FX Dealers
  3. Spot Market
  4. Interbank
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8
Q

OTC

A

telecommunications network where companies normally exchange one currency for another
Where currency options are offered by commercial banks and brokerage firms.
They are unlike the currency options traded on an exchange because they offer currency options that are tailored to the specific needs of the firm

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9
Q

FX Dealer

A

serve as intermediary in FX Market

E.g. Banks

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10
Q

Spot Market

A

FX transaction for IMMEDIATE exchange

  • US $ is commonly accepted medium of exchange
  • time zones ((24/7))
  • high liquidity &turnover
  • interbank market
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11
Q

Bid/Ask Quotes

A

commercial banks charge fees for conducting FX transactions
buy currencies from Customers slightly lower price (bid) and sell currency (ask)
B/A spread covers banks cost of conducting Fx transactions
Spread =
(Ask Rate - Bid Rate)/(Ask Rate)

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12
Q

B/A Spread

A

(Ask Rate - Bid Rate)/(Ask Rate)
represents discount in the bid rate as a % of Ask rate
measures the % markup of Ask over the Bid Rate

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13
Q

Factors affecting spread

A

Spread = f (Order costs [+], Inventory costs [+], Competition [-], Volume [-], Currency risk [+])

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14
Q

Factors affecting spread

1. Order costs (+)

A

cost of processing orders
clearing cost
cost of recording transactions

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15
Q

Factors affecting spread

2. Inventory costs (+)

A

cost of maintaining an inventory in a part. currency

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16
Q

Factors affecting spread

3. Competition (-)

A

the more intense competition

the smaller the spread by intermediaries

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17
Q

Factors affecting spread

4. Volume (-)

A

large trading volume
more liquidity
numerous buyers &sellers

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18
Q

Factors affecting spread

5. Currency risk (+)

A

economic &political conditions that cause the demand for &supply the currency to change abruptly

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19
Q

Direct Quotation

A

Represents the value of a foreign currency in dollars (number of dollars per currency)
Example: $1.12 per Euro

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20
Q

Indirect Quotation

A

Represents the number of units of a foreign currency per dollar
Example: 0.8929 Euro per Dollar

Indirect quotation = 1/Direct quotation

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21
Q

Arbitrage Profit

A

(There may exist arbitrage profit in cross exchange rate,) Is defined as the simultaneous purchase and sale of an asset in order to profit from a difference in the price

Profit with zero cost

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22
Q

Forward Contracts

A

Agreements between a foreign exchange dealer and an MNC that specifies the currencies to be exchanged, the exchange rate, and the date at which the transaction will occur
^The Forward Rate is the exchange rate specified by the forward contract
^The Forward Market is the over-the-counter market where forward contracts are traded

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23
Q

Future Contracts

A

Similar to forward contracts but sold on an exchange

-Specifies a standard volume of a particular currency to be exchanged on a specific settlement date

-The Future Rate
^is the exchange rate at which one can purchase or sell a specified currency on the specified settlement date

-The future Spot Rate
^is the spot rate that will exist at a future point in time and is uncertain as of today

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24
Q

Currency Options Contracts

A

A. Currency Call Option:
^provides the right to buy currency at a specified strike price within a specified period of time

B. Currency Put Option:
^provides the right to sell currency at specified strike price within a specified period of time

25
Q

International Money Market

A

Corporations or governments need short-term funds denominated in a currency different from their home currency

26
Q

The international money market has grown because firms:

A

A. May need to borrow funds to pay for imports denominated in a foreign currency
B. need funds to support local operations - may consider borrowing in a currency with lower IR (take advantage) - spec. desirable if it will have receivable denominated in that currency in the future
C. May choose to borrow in a currency that is expected to depreciate against their home currency
D. Investors? (Interest rate and value of foreign currency)

27
Q

International Money Market

A) European M. Market

A

dollars deposits in banks in Europe &other countries
Eurodollars/Eurocurrency market
“$”deposits in banks can then be use to lend to corp. customers based in Europe

28
Q

International Money Market

B) Asian M. Market

A

centeres in HK, Singapore
originated as a market involving mostly dollar-denominated deposits
originally known as the Asian Dollar Market
why? businesses could not rely on banks in Europe (distance &time zones)

29
Q

Money Market

C) IR

A

rates depend on
a) supply of ST funds available (bank deposits)
b) total demand for St funds by borrowers
Low IR: large supply of savings
high IR: strong demand to borrow that currency
rates tend to be higher in developing countries
normally rates paid by corporations who borrow ST funds in a particular country is slightly higher than rate paid by national government within same country

30
Q

Money Market

D) global integration of MM rates

A
  • rates among countries tend to be highly correlated over time
  • weak eco. conditions –> corp. will reduce the amount of ST funds they wish to borrow
    corp. need for liquidity declines
  • strong eco. conditions –>
    increase in corp. expansion
    corp. need additional liquidity to support expansion
31
Q

International Money Market

Securities

A

debt securities issued by MNCs &government agencies with ST maturity (< 1yr)
perceived as very safe (default risk) - spec. for high rated securities
bad credit risk still exists
but they are more exposed to exchange rate risk when the currency denominating the securities differ from the home currency of the investors

32
Q

Gold Standard

Advantage

A

restricted supply of gold - counties cannot have high inflation
any BOP disequilibrium can be corrected automatically via cross-borders of gold

33
Q

Gold Standard

Disadvantages

A

world economy can be subject to deflationary pressure due to supply of gold
it has no mechanism itself to enforce the rules on the game
as a result - countries may pursue economic policies which are incompatible with the GS

34
Q

Flexible Exchange Rate

A

automatic achievement of BOP Equilibrium

maintenance of national policy autonomy

35
Q

Flexible Vs Fixed Exchange Rate System

A

random fluctuations may discourage international trade &encourage market segmentation
–> suboptimal allocation of resources
–> increases uncertainty/risk related to int. trade &investment
keeping a fixed exchange rate however is restricting I.T
People can use hedging strategies against future currency volatility

36
Q

Fixed Exchange Rates

Advantages

A
  1. elimination of uncertainty in risk (stable rate)/fluctuation in the currency
  2. greater confidence to invest
    attract investors due to stable currency system
    e.g. known cost of imports
    no speculation possible
    sense of confidence that payments can me made safely without danger of losses
  3. prevention of depreciation of currency
  4. adoption of responsible macro-eco. policies
  5. anti-inflationary
  6. Current Account (rapid appreciation can badly affect exports)
37
Q

Fixed Exchange Rates

Disadvantages

A

1a) conflict with other macro-economic objectives
1.b) Speculation encourage (if its fundamentally misvalued)
–> currency is underpressure &keeps falling (country then has buy convert foreign currency or increase IR to reduce inflationary pressure
but if economy is growing slowly this could lead to recession due to decrease of aggregate demand
2. adequacy of FX reserves (poor developing countries find it hard to maintain an adequate Volume of FX reserves)
3. International competitive environment does not get reflected
4. expensive to maintain - as it has to have enough FX reserves to manage its currency´s value
5. less flexible
6. hard to know the exact rate as to join in

38
Q

International Financial Market

A
  1. FX Market
  2. International Money Market
  3. International Credit Market
  4. International Bond Market
  5. International Stock Market
39
Q

Interbank Market

A

banks obtain quotes, contact brokers matching one bank desiring to sell with another bank desire to buy
e.g LIBOR

40
Q

Attributes of Banks that provide Foreign Exchange

A 
Competitiveness of Quotes
Special relationship with bank
Speed of Executions
Advice about current market conditions
Foreign Advice
41
Q

International Money Market

Domestic Market

A

a) indv./local inst. investors provide funds through ST deposits at commercial banks
b) corp./governments issue ST securities which are purchased by local investors
transfer of St funds from savers to borrowers
Borrowers = firms (support operations) &government (finance their budget deficit)

42
Q

D. Investors? (Interest rate and value of foreign currency)

A
  • IR that they receive from local currency is less than what they would receive on foreign
  • consider to invest in currency which could appreciate in future (and convert it later into home so as to receive more)
    more favourable exchange rate at the end of the period
    diversify credit risk (not expose to eco. condition in a single country)
43
Q

Asian Market

Main Players

A

a) mayor sources of deposits =international firms with excess cash&gov. agencies)
b) mayor borrowers = manufacturers
c) another function = interbank lending&borrowing –> banks with more qualified loan applicants that they can accommodate use interbank market to obtain add. funding
d) banks in AMM commonly borrow from or led to EM

44
Q

International Money Market

E) Standardising Global Bank Regulation

A

differences in regulations –> comparative advantages of banks
regulations (i,e restriction in local markets) –> allowed for a more competitive global banking

45
Q

E) Standardising Global Bank Regulation

1. Single European Act (1992)

A

capital can flow freely throughout Europe
banks can offer wide range of lending, leasing, securities in EU
regulations regarding competitions, mergers, taxes are similar through EU
bank established in EU has the right to expand into any or all other Eu states
–> efficiency of European banking system

46
Q

E) Standardising Global Bank Regulation

2. Basel Accord (1987)

A

Problem - variation in capital standard imposed on banks
–> US were allowed to maintain more capital
mayor industrialised countries propose uniform banking standard guidelines
–> bank must maintain capital equal to 4% of their assets (assets are weighted my risk

47
Q

E) Standardising Global Bank Regulation

3. Basel Accord

A

Requirements for better collaterals to back up the loans
new accord account for ope. risk
–> prevent risk losses resulting from inadequate or failed internal process or system
–> encourage banks to improve their techniques for controlling operational risk to reduce failures in bank system
–> banks were required to offer more information to existing&prospective investors about exposure to diff. risk

48
Q

International Credit Market

A

Medium-ST Loans via issuance of notes

Eurocredits or EC Loans

49
Q

International Credit Market

Asset-Liability Mismatch

A

affects performance of banks

  • -> locked in rates on LT loan whilst St deposits rates rise over time
  • -> avoid using floating rates (e.g LIBOR)
  • -> premium paid above Spread will depend on credit risk of borrower
50
Q

International Credit Market

Syndicated Loans

A

single bank is unwilling or unable to lend alone the amount to firm/government

  • -> lead bank organises group of banks to underwrite the loan
  • -> borrowers is required to pay interest + front-end management fee + commitment fee
51
Q

International Credit Market
Syndicated Loans
Interest Rates

A

depends on
currency, maturity, creditworthiness
IR adjustable to interbank lending rate (6m)

52
Q

International Credit Market
Syndicated Loans
Advantages

A

reduce default risk or large loan to the degree for each indv. bank
–> increase prob. of prompr repayment
add extra incentive for the borrower to repay the loan (reputation)

53
Q

International Bond Market

Issuer

A

LT Debt
attract stronger demand than home country
international firm prefer to finance spec. foreign project using spec. currency
financing foreign currency with lower IR which reduce cost of financing

54
Q

International Bond Market

Investor

A

Mutual funds, commercial banks, insurance companies, pension funds

  • -> earn higher Ir on bonds denominated in foreign currency
    a) foreign bonds (issued by borrower foreign to the country where bond is placed)
    b) Eurobond (issued in the country other than country the currency denominating the bond)
55
Q

International Stock Market

Issuance

A

stock offering may be easier digested if its issued in several markets
enhance global image/reputation
increase efficiency of new issue
locations to place its stock (maybe there where future CF is likely to be higher)

56
Q

International Stock Market

Investor

A

easier access (non us investors easy access to US stocks)
investors of foreign countries are willing to purchase if hey can easily sell their holdings in 2nd market
or sock is denominated in currency where it is placed
invest in stocks which they expect to strengthen
mean of diversifying Pf
eco. condition will be more favourable in a spec. country

57
Q

International Stock Market

Comparison of Stock Market

A

large MCNs have begun to float new stocks issues simultaneously in various countries (through syndication)
global distribution of stocks can be issued much larger market
–> greater quantity of stocks at given price
–> makes it easier to trade all stocks in just one single market
recent years = increase of emerging markets which enables US firms to raise funds by issuing stocks there & listing stock on local stock exchanges

58
Q

Important Characteristics

BANKS

A

(1) competitiveness of the quote,
(2) the firm’s relationship with the bank,
(3) speed of execution,
(4) advice about current market conditions, and (5)forecasting advice

International Finance (9 decks)

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