Foreign Exchange Market (12) Flashcards
What can you say about international transactions ?
Trade between countries involves the mutual exchange of different currencies.
Transactions conducted in the Foreign Exchange Market determine the rates at which currencies are exchanged, which in turn determine the cost of purchasing foreign goods/financial assets.
ER shapes international transactions
- shortfall FEX // nat currency devaluates
- surplus FEX // nat currency revaluates
FOREIGN EXCHANGE MARKET
- over-the-counter market
- thousands of dealers (mostly banks)
- buy/sell deposits denominated in foreign currencies
- very competitive
- colossal volumes
- functions are no different from a centralised market
FOREIGN CURRENCY
legal tender and any means of payment denominated in a currency other that the domestic currency
CONVERTIBLE CURRENCY
a currency whose P is determined by the market, since there is a free exchange for another currency
(liquid instrument, ≠ currencies tightly controlled by CB or other authority)
CROSS RATES
two currencies are quoted using a third currency as a go-between (traditionally the dollar plays this role).
we avoid the info overload of quoting all ≠ currencies between each directly, as well as a lack of liquidity and enormous costs.
FUNCTIONS OF CURRENCY MARKETS
- Establish P and ER
- Transfer purchasing power in international markets
- Provide instruments/mechanisms to finance international trade
- Offer facilities for managing risks and speculation
CHARACTERISTICS OF CURRENCY MARKETS
- global
- continuous
- decentralised
- depth
- electronic
- non-organised (OTC market)
ORGANISATION OF CURRENCY MARKETS
most transactions channel using electronic platforms between banks (Reuters, Bloomberg…)
STRUCTURE OF FOREIGN EXCHANGE MARKETS
Participants…
- NON-FINANCIAL COMPANIES
exporters, importers, investors, tourists…
- FOREX BROKERS
agents used by Commercial Banks to influence in banking activities - MULTINATIONAL COMPANIES
carry out transactions in terms of vehicle currency (US $) - COMMERCIAL BANKS
intermediaries between offerers and demanders of foreign currencies - CENTRAL BANKS
determine the ER and ER system
(pre-determine ER, modify revenues in dollars and convert them into the national currency)
THEORIES FOR DETERMINING ER
THE LAW OF ONE P
ER is determined by the interaction of supplying demand. The starting point of “law of one P” is that two countries that produce identical goods, same tc and with low/no trade barriers, should have the same P for such goods.
PURCHASING POWER PARITY
ER between any two countries will adjust to reflect changes in the P levels of the two countries.
Is just an application of PPP to the national level, identical goods should be sold at identical P. On a global scale this means that the same goods should cost the same in all markets if we express them in the same currency.
FACTORS THAT AFFECT ER IN THE LN
- relative P levels, tariffs, preferences for domestic versus foreign goods and productivity.
(anything that increases domestic D for foreign goods relative to domestic goods depreciates domestic currency and viceversa)
Why is ER a two-way?
buyer’s position (BID): P payed to buy the offer
seller’s position (OFFER): P it will cost us to buy this currency
BID P < OFFER P
SECTIONS OF THE CURRENCY MARKET
SPOT FOREIGN EXCHANGE MARKET
market where the P of a currency is for immediate delivery (2 days). S&D main driver = financial transactions
FORWARD MARKET the transaction (volume, P, ER) is agreed today but, to be carried out and settled at a future pre-agreed rate. (Hedging strategies)
CURRENCY SWAPS
contracts in which you commit to an exchange of interest payments in different currencies for an agreed period of time at a pre-agreed ER.
OTC OPTIONS
right to sell/buy a currency with another currency at a specified ER during a specified period.
FOREIGN EXCHANGE SWAPS
transactions involving the actual exchange of two currencies (principal + interest) on a specific date at a rate agreed at the time of the conclusion of the contract (the short leg), and a reverse exchange of the same two currencies at a date further in the future at a rate agreed at the time of the contract (the long leg)
DATA AND STATISTICS
Trading in FOREX markets reached $2.4 trillion per day in April 2016
- US $ vehicle currency
- rise in the share of the Yuan
- share of trading between reporting dealers has increased too
