International Financial Markets Flashcards by Sarah Oliver

What is the foreign exchange market?

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.

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What is the OTC market

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

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What is the spot market

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.

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Talk about the spot market timings and liquidity

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.

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Explain liquidity in the context of financial markets

ability to sell large quantities of assets without changing prices.

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What are the attributes of banks that provide foreign exchange?

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

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Explain how banks make money from foreign exchange quotations

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

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Formula for bid ask spread

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

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What are the factors that affect the bid ask spread?

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

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What is a direct quotation structure for currency conversion?

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

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What is an indirect quotation structure for currency conversion?

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

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What is a cross exchange rate?

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

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What happens to exchange rates as currencies appreciate/depreciate?

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.

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What is a currency derivative

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.

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What is a forward contract

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.

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What are currency futures contracts

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.

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What is the future spot rate

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

What is a currency call option

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

What is a currency put option

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

What is the international money market composed of

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.

International Money Market - why has it grown

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

Discuss the changes in money market interest rates among currencies

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.

Explain international money market securities

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.

Explain Euro credits

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

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

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

What is the single European Act regulation?

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.

Explain the Basel Accord

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.

Explain definition of foreign bonds and international bond market

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.

Explain features of eurobonds

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

Discuss bond market yields across countries and changes

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

What are the risks associated with International Bonds

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

Define the bond yield

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

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

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.

What is the formula for current yield

(Annual coupon payment/ Bond price) x 100

What is ADR?

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

What is the price of an ADR

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.

What are the factors that influence stock market trading activity

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

Explain an integrated financial amrket

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

Explain an efficient capital market

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.

Summarise different forms of EMH

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