FINC 327 Chapter 3: International Finc markets Flashcards
foreign exchange market
exchange of one currency for another
Foreign exchange dealers serve
intermediaries in the foreign exchange market by exchanging currencies desired by MNCs or individuals Large foreign exchange dealers include CitiFX (a subsidiary of Citigroup), JPMorgan Chase
interbank market
If a bank begins to experience a shortage of a particular foreign currency, it can purchase that currency from other banks.
This is trading between banks
Spot Market Liquidity
The more buyers and sellers there are, the more liquid a market is. The spot markets for heavily traded currencies such as the euro, the pound, and the yen are extremely liquid.
If a currency is illiquid, then the number of willing buyers and sellers is limited and so an MNC may be unable to purchase or sell that currency in a timely fashion and at a reasonable
exchange rate.
bid price
bank buying currency at low
ask price
bank selling currency at high
bid/ask spread
The difference between the bid and ask prices is known as the bid/ask spread, which is meant to cover the costs associated with fulfilling requests to exchange currencies. The bid/ask
spread is normally expressed as a percentage of the ask quote.
spread equation
Spread= (Ask rate - Bid rate) / Ask rate
The spread is normally larger for
illiquid currencies that are less frequently traded.
Order costs.
Order costs are the costs of processing orders; these costs include clearing costs and the costs of recording transactions.
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Inventory costs.
Inventory costs are the costs of maintaining an inventory of a particular currency. Holding an inventory involves an opportunity cost because the funds could have been used for some other purpose.
If interest rates are relatively high, then the opportunity cost of holding an inventory should be relatively high.
The higher the inventory costs, the larger the spread that will be established to cover these costs.
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Competition.
The more intense the competition, the smaller the spread quoted by intermediaries.
it has forced dealers to reduce their spread in order to remain competitive.
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Volume.
Currency risk.
Some currencies exhibit more volatility than others because of economic or political conditions that cause the demand for and supply of the currency to change abruptly. For example, currencies in countries that have frequent political
crises are subject to sudden price movements. Intermediaries that are willing to buy or sell these currencies could incur large losses due to such changes in their value.
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eurozone
The area containing the countries that have adopted the euro is referred to as the eurozone. Currently, the eurozone encompasses 17 European countries.
direct quotations
Quotations that report the value of a foreign currency in dollars (number of dollars per unit of other currency)
in terms of your home currency
indirect quotations
quotations that report the number of units of a foreign currency per dollar
if a currency’s direct exchange rate is rising over time, then its indirect exchange rate
must be declining over time (and vice versa).
cross exchange rate
reflects the amount of one foreign currency per unit of another foreign currency
forward contract
an agreement between an MNC and a foreign exchange dealer that specifies the currencies to be exchanged, the exchange rate, and the date at which the transaction will occur.
forward rate
exchange rate, specified in the forward contract, at which the currencies will be exchanged
Eurodollars
dollar deposits in banks in Europe/ foreign countries
eurosterling
UK pound deposits in banks in foreign countries
EuroEuro
Euro deposits in banks in foreign countries
EuroYen
Yen deposits in banks in foreign countries
LIBOR
LIBOR (London interbank offer rate) is the rate of interest at which banks in Europe lend to each other. It is used as a base from which loan rates on other loans are determined in the Eurocredit market.
The London Interbank Offer Rate (LIBOR) is the rate most often charged for very short-term loans (such as for one day) between banks.
As the supply and demand for funds changes, so does the LIBOR
money market interest rates
– depend on the demand for short-term funds by borrowers relative to the supply of short-term funds
–a country that experiences both a high demand for and a small supply of short-term funds will have relatively high money market interest rates
—Money market rates tend to be higher in developing
countries because they experience higher rates of growth and so more funds are needed (relative to the available supply) to finance that growth
international money market securities
When MNCs and government agencies issue debt securities with a short-term maturity (one year or less) in the international money market
Eurocredits or Eurocredit loans
Loans of one year or longer that are extended by banks to MNCs or government agencies in Europe are commonly called Eurocredits or Eurocredit loans
A loan denominated in the currency of a country with very low inflation
normally has a relatively low interest rate
Mismatch seen in international credit market
banks accept short-term deposits and sometimes provide longer-term loans, their asset and liability maturities do not match
In order to avoid this risk, banks commonly use floating rate loans
syndicate
Sometimes a single bank is unwilling or unable to lend the amount needed by a particular corporation or government agency. In this case, a syndicate of banks may be organized.
Each bank within the syndicate participates in the lending. A lead bank is responsible for negotiating terms with the borrower, after which this bank organizes a group of banks to
underwrite the loans.
Why would MNCs choose to issue bonds in international bond market?
First, issuers recognize that they may be able to attract a stronger demand by issuing their bonds in a
particular foreign country rather than in their home country.
Second, MNCs may prefer to finance a specific foreign project in a particular currency and thus may seek funds where that currency is widely used.
Third, an MNC might attempt to finance projects in a foreign currency with a lower interest rate in order to reduce its cost of financing, although doing so would increase its exposure to exchange rate risk
A foreign bond
A foreign bond is issued by a borrower foreign to the country where the bond is placed.
For example, a U.S. corporation may issue a bond denominated in Japanese yen that is sold to investors in Japan.
Eurobonds
Eurobonds are bonds that are sold in countries other than the country whose currency is used to denominate the bonds.
Yankee stock offerings
Non-U.S. corporations that need large amounts of funds sometimes issue stock in the United States (these are called Yankee stock offerings) because the U.S. new-issues market is so liquid.
American depository receipts (ADRs),
are certificates representing bundles of the firm’s stock
Non-U.S. firms also obtain equity financing by issuing
Price of ADR = Price of FS X S
If there is a difference between the ADR price and the price of the foreign stock (after adjusting for the exchange rate), then investors can use arbitrage to capitalize on this discrepancy.
arbitrage with American depository receipts (ADRs),
If P ADR < ( PFS X S)
then ADR shares will flow back to France; they will be converted to shares of the French stock and
then traded in the French market. Investors can engage in arbitrage by buying the ADR shares
in the United States, converting them to shares of the French stock, and then selling those shares on
the French stock exchange where the stock is listed.
The arbitrage will (1) reduce the supply of ADRs traded in the U.S. market, putting upward
pressure on the ADR price, and (2) increase the supply of the French shares traded in the French
market, putting downward pressure on the stock price in France. The arbitrage will continue until
the discrepancy in prices disappears.
