FINC 327 Chapter 3: International Finc markets

Question 1

foreign exchange market

Answer 1

exchange of one currency for another

Question 2

Foreign exchange dealers serve

Answer 2

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

Question 3

interbank market

Answer 3

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

Question 4

Spot Market Liquidity

Answer 4

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.

Question 5

bid price

Answer 5

bank buying currency at low

Question 6

ask price

Answer 6

bank selling currency at high

Question 7

bid/ask spread

Answer 7

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.

Question 8

spread equation

Answer 8

Spread= (Ask rate - Bid rate) / Ask rate

Question 9

The spread is normally larger for

Answer 9

illiquid currencies that are less frequently traded.

Question 10

Order costs.

Answer 10

Order costs are the costs of processing orders; these costs include clearing costs and the costs of recording transactions.
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Question 11

Inventory costs.

Answer 11

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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Question 12

Competition.

Answer 12

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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Question 13

Volume.

Question 14

Currency risk.

Answer 14

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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Question 15

eurozone

Answer 15

The area containing the countries that have adopted the euro is referred to as the eurozone. Currently, the eurozone encompasses 17 European countries.

Question 16

direct quotations

Answer 16

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

Question 17

indirect quotations

Answer 17

quotations that report the number of units of a foreign currency per dollar

Question 18

if a currency’s direct exchange rate is rising over time, then its indirect exchange rate

Answer 18

must be declining over time (and vice versa).

Question 19

cross exchange rate

Answer 19

reflects the amount of one foreign currency per unit of another foreign currency

Question 20

forward contract

Answer 20

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.

Question 21

forward rate

Answer 21

exchange rate, specified in the forward contract, at which the currencies will be exchanged

Question 22

Eurodollars

Answer 22

dollar deposits in banks in Europe/ foreign countries

Question 23

eurosterling

Answer 23

UK pound deposits in banks in foreign countries

Question 24

EuroEuro

Answer 24

Euro deposits in banks in foreign countries

Question 25

EuroYen

Answer 25

Yen deposits in banks in foreign countries

Question 26

LIBOR

Answer 26

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

Question 27

money market interest rates

Answer 27

– 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

Question 28

international money market securities

Answer 28

When MNCs and government agencies issue debt securities with a short-term maturity (one year or less) in the international money market

Question 29

Eurocredits or Eurocredit loans

Answer 29

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

Question 30

A loan denominated in the currency of a country with very low inflation

Answer 30

normally has a relatively low interest rate

Question 31

Mismatch seen in international credit market

Answer 31

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

Question 32

syndicate

Answer 32

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.

Question 33

Why would MNCs choose to issue bonds in international bond market?

Answer 33

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

Question 34

A foreign bond

Answer 34

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.

Question 35

Eurobonds

Answer 35

Eurobonds are bonds that are sold in countries other than the country whose currency is used to denominate the bonds.

Question 36

Yankee stock offerings

Answer 36

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.

Question 37

American depository receipts (ADRs),

Answer 37

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.

Question 38

arbitrage with American depository receipts (ADRs),

Answer 38

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.