Lecture 1 Flashcards
What is the purpose of the foreign exchange market?
To facilitate international trade or financial transactions through currency exchange.
What are the three systems for exchanging foreign currencies?
- Gold standard
- Fixed exchange rates
- Floating rate system
What is the market for immediate exchange called?
Spot market
What role do brokers play in the interbank market?
Brokers act as intermediaries in trading between banks.
What does the forward market enable MNCs to do?
Lock in the exchange rate for future currency transactions.
What are customers concerned with when seeking foreign exchange?
- Quote competitiveness
- Special banking relationship
- Speed of execution
- Advice about current market conditions
- Forecasting advice
How do banks typically charge for foreign exchange services?
By having a bid (buy) quote that is less than the ask (sell) quote.
What is the formula for calculating the bid/ask spread?
Bid/ask spread = ask rate – bid rate
If the bid price for £ is $1.52 and the ask price is $1.60, what is the spread?
5%
What factors positively influence the spread on currency quotations?
- Order costs
- Inventory costs
- Currency risk
What factors negatively influence the spread on currency quotations?
- Competition
- Volume
What do direct quotations represent?
The value of a foreign currency in terms of the home currency.
What do indirect quotations represent?
The number of units of a foreign currency per unit of home currency.
How can the quotation ‘$1.6 to the £1’ be expressed?
$1.6/£ or $1.6:£1
What is a cross-exchange rate?
The amount of one foreign currency per unit of another foreign currency.
What do currency futures contracts specify?
A standard volume of a particular currency to be exchanged on a specific settlement date.
What is the difference between currency futures and forward contracts?
Futures are sold on exchanges, while forward contracts are not.
What do currency call options provide?
The right to buy a specific currency at a specific price within a specific period.
What do currency put options provide?
The right to sell a specific currency at a specific price within a specific period.
What functions do financial institutions serve in the international money market?
- Accepting deposits
- Offering loans in various currencies
What market developed during the 1960s and 1970s?
The Eurocurrency market.
What are Eurocredit loans?
Loans of one year or longer extended by banks in Europe to foreign MNCs or government agencies.
What is a common type of loan in the international credit market?
Floating rate loans based on LIBOR.
What is a syndicate of banks?
A group of banks that organize to underwrite a loan for a borrower.
What are foreign bonds?
Bonds denominated in the currency of the country where they are placed but issued by foreign borrowers.
What are Eurobonds?
Bonds sold in countries other than the country of the currency denominating the bonds.
What percentage of Eurobonds are denominated in U.S. dollars?
70 to 75%
What is one advantage of issuing stock in international markets for MNCs?
Enhances firms’ image and diversifies their shareholder base.
What are the four classifications of foreign cash flow movements for an MNC?
- Foreign trade (exports and imports)
- Direct foreign investment (DFI)
- Short-term investment or financing in foreign securities
- Longer-term financing in international bond or stock markets
How can MNCs use international financial markets to affect their cost of capital?
By reducing their cost of capital due to varying interest rates among countries.
