International Financial Markets

Question 1

What is the foreign exchange market?

Answer 1

Allows for exchange of one currency for another to facilitate international trade or financial transactions. The exchange rate specifies the rate at which one currency can be exchanged for another.

Question 2

What is the OTC market

Answer 2

The OTC market is the telecommunications network where companies normally exchange one currency for another. Banks are the main provider of foreign currency.

Question 3

What is the spot market

Answer 3

A foreign exchange transaction for immediate exchange is said to trade in the spot market. The exchange rate in the spot market is the spot rate which is today’s price, immediate pricing. Us dollar is the most connoly accepted medium fo exchange.

Question 4

Talk about the spot market timings and liquidity

Answer 4

Foreign exchange trading is conducted only during normal business hours in a given location. Thus, at any given time on a weekday, somewhere around the world a bank is open and ready to accommodate foreign exchange requests.
Spot market liquidity: More buyers and sellers means more liquidity. Liquidity means ability to sell large quantities of assets without changing prices.

Question 5

Explain liquidity in the context of financial markets

Answer 5

ability to sell large quantities of assets without changing prices.

Question 6

What are the attributes of banks that provide foreign exchange?

Answer 6

Competitiveness of quote
Special relationship with the bank
Speed of execution
Advice about current market conditions
Forecasting advice

Question 7

Explain how banks make money from foreign exchange quotations

Answer 7

At any given point in time, a bank’s bid (buy) quote for a foreign currency will be less than its ask (sell) quote.
Bid/Ask spread of banks: The bid/ask spread covers the bank’s cost of conducting foreign exchange transactions

Question 8

Formula for bid ask spread

Answer 8

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

Question 9

What are the factors that affect the bid ask spread?

Answer 9

Order costs - processing, clearing and records
Inventory costs
Competition - more competition smaller spread quoted
volume - higher volume means lower spread (means more competitive)
currency risk

Question 10

What is a direct quotation structure for currency conversion?

Answer 10

Direct Quotation represents the value of a foreign currency in dollars (number of dollars per currency).
Example: $1.40 per Euro

Question 11

What is an indirect quotation structure for currency conversion?

Answer 11

Indirect quotation represents the number of units of a foreign currency per dollar. Indirect quotation = 1 / Direct quotation
Example: €0.7143 per Dollar

Question 12

What is a cross exchange rate?

Answer 12

Cross exchange rate is the amount of one foreign currency per unit of another foreign currency
Example:
Value of peso = $0.07
Value of Canadian dollar = $0.70
Value of peso in C$ = C$ 0.10

Question 13

What happens to exchange rates as currencies appreciate/depreciate?

Answer 13

When the euro is appreciating against the dollar (based on an upward movement of the direct exchange rate), the indirect exchange rate of the euro is declining.
When the euro is depreciating (based on a downward movement of the direct exchange rate) against the dollar, the indirect exchange rate is rising.

Question 14

What is a currency derivative

Answer 14

A contract with a price that is partially derived from the value of the underlying currency that it represents. There are unlimited combinations of derivatives available.

Question 15

What is a forward contract

Answer 15

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. They can be custom and traded OTC with bank.

Question 16

What are currency futures contracts

Answer 16

Currency futures contracts: similar to forward contracts but sold on an exchange. Contracts are standardised unlike forwards.
Specifies a standard volume of a particular currency tobe exchanged on a specific settlement date.

Question 17

What is the future spot rate

Answer 17

The future spot rate is the spot rate that will exist at a future point in time and is uncertain as of today.

Question 18

What is a currency call option

Answer 18

provides the right (but not the obligation) to buy currency as a specified strike price within a period of time

Question 19

What is a currency put option

Answer 19

provides the right (but not the obligation) to sell currency at a specified stock price within a specified period of time.

Question 20

What is the international money market composed of

Answer 20

Composed of several large banks that accept deposits and provide short-term loans in various currencies.This market is used primarily by governments and large corporations.

Question 21

International Money Market - why has it grown

Answer 21

Because firms:
May need to borrow to pay for imports denominated in a foreign currency.
May choose to borrow in a currency in which the interest rate is lower.
May choose to borrow in a currency that is expected to depreciate against their home currency

Question 22

Discuss the changes in money market interest rates among currencies

Answer 22

Money market rates vary due to differences in the interaction of the total supply of short-term funds available (bank deposits) in a specific country versus the total demand for short-term funds by borrowers in that country.
Rates tend to be highly correlated over time.
Economic conditions weaken - need for liquidity declines so corporations reduce short terms funds they wish to borrow. vice versa.

Question 23

Explain international money market securities

Answer 23

International Money Market Securities are debt securities issued by MNCs and government agencies with a short-term maturity - perceived to be safe from risk of default.- even if true they still have exchange rate risk.

Question 24

Explain Euro credits

Answer 24

Loans of 1 year or longer extended by banks to MNCs or government agencies in Europe are commonly called Eurocredits or Eurocredit loans.

Question 25

What is the general idea of syndicate loans in the credit market

Answer 25

A syndicate of banks can be formed to underwrite the loans and the lead bank is responsible for negotiating the terms with the borrower. - Usually banks from multiple countries

Question 26

What is the single European Act regulation?

Answer 26

Regulation in credit markets - capital can flow freely in Europe. Banks can offer a wide variety of lending, leasing, and securities activities in the EU.
Regulations regarding competition, mergers, and taxes are similar through the EU.
A bank established in any one of the EU countries has the right to expand into any or all of the other EU countries.

Question 27

Explain the Basel Accord

Answer 27

Issue 1 : Banks must maintain capital equal to at least 4 percent of their assets. For this purpose, banks’ assets are weighted by risk.
Issue 2: Many expansions and require banks to provide more information to existing and prospective shareholders about their exposure to risk.
Issue 3: New methods which require banks to maintain higher levels of capital.

Question 28

Explain definition of foreign bonds and international bond market

Answer 28

Foreign Bonds are denominated in the local currency of the country where the bond is issued, issued by a foreign borrower
The international bond markets facilitate international transfers of long-term credit, thereby enabling governments and large corporations to borrow funds from various countries.

Question 29

Explain features of eurobonds

Answer 29

Features of eurobonds: Bearer Bonds, annual coupon, convertible or callable.
For eurobonds the underwiritng process is done by multinational syndicate across many countries.

Question 30

Discuss bond market yields across countries and changes

Answer 30

Bond market yields among countries tend to be highly correlated over time.
When economic conditions weaken, aggregate demand for funds declines with the decline in corporate expansion and vice versa

Question 31

What are the risks associated with International Bonds

Answer 31

Interest rate risk
Exchange rate risk
Liquidity risk - perhaps not consistently active market for bonds
Credit risk

Question 32

Define the bond yield

Answer 32

Interest rate at which the PV of stream of payments is exactly equal to the current price.

Question 33

Describe how bonds are sensitive to interest rates in relation to time period and coupon rate.

Answer 33

Longer term bonds are more sensitive to interest rate changes than shorter term bonds - true for coupon bonds and zero coupon bonds.
Lower coupon bonds have higher sensitivity to interest rate changes for a given maturity.

Question 34

What is the formula for current yield

Answer 34

(Annual coupon payment/ Bond price) x 100

Question 35

What is ADR?

Answer 35

American Depository Receipts (ADR) - Certificates representing bundles of stock. ADR shares can be traded just like shares of a stock

ADR shares can be traded like shares of stock so the ADR price changes each day in response to supply and demand. Overtime however the value of an ADR should move in tandem with the value of the corresponding stock

Question 36

What is the price of an ADR

Answer 36

Price of an ADR is: P(ADR) = P(Foreign stock) x S where P is price and S is the spot rate of the foreign currency.

Question 37

What are the factors that influence stock market trading activity

Answer 37

Rights - vary by country
Legal protection of shareholders
Government enforcement of securities laws
Accounting laws

Question 38

Explain an integrated financial amrket

Answer 38

one where domestic investors can buy foreign assets and foreign investors can buy domestic assets.

Question 39

Explain an efficient capital market

Answer 39

An efficient capital market is one in which security prices adjust rapidly to the arrival of new information and therefore, the current prices of securities reflect all information about the security.

Question 40

Summarise different forms of EMH

Answer 40

Weak form - Stock prices reflect all security markets information
Semistrong form - security prices reflect all public information
Strong form - security prices reflect all public and private information