Financial Markets and Institutions Week 6: Lecture 2 - Introduction to Foreign Exchange Markets

Question 1

Why Study Financial Markets?

Answer 1

Financial markets are crucial in our economy.
1. Channel funds from savers to investors, promoting
economic efficiency.
2. Market activity affects personal wealth, business firms,
and economy.
3. Well functioning financial markets are key factors in producing high economic growth.

Question 2

What’s the foreign exchange market?

Answer 2

Where individuals, firms and banks buy and sell
foreign currencies or foreign exchange

Question 3

What’s the volume of the ‘foreign exchange market’?

Answer 3

$5 trillion

Question 4

What are ‘financial institutions’?

Answer 4

The corporations, organizations, and networks that
operate the so-called “marketplaces.”

Question 5

Describe & explain the functions of the Foreign Exchange Markets

Answer 5

1. Transfer purchasing power from one nation and
   currency to another.
   ◼ Demand for currency arises when:
   ◼ Tourists visit another country
   ◼ Domestic firm wants to import from other countries
   ◼ Individual wants to invest abroad
   ◼ Supply of currency arises from:
   ◼ Foreign tourist expenditures
   ◼ Export earnings
   ◼ Receiving foreign investments
2. Provide credit for foreign transactions
   ◼ Credit is needed when goods are in transit, and to allow
   the buyer time to resell the goods to make the payment.
3. Provide the facilities for hedging and speculation.
   ◼ About 90% of foreign exchange trading reflects purely
   financial transactions, and only about 10% trade
   financing.

Question 6

Describe the participants in foreign exchange markets

Answer 6

◼ Those needing currency to fund transactions
◼ Tourists, importers, exporters, investors, etc.
◼ Commercial banks
◼ Serve as the clearinghouses for currency exchange
◼ Foreign exchange brokers
◼ Clearinghouse for surpluses and shortages between the commercial banks
◼ Central banks
◼ Buyer or seller of last resort in the foreign exchange market