WEEK 1 - Foreign Exchange and the Foreign Exchange Market Flashcards
What exactly is foreign exchange?
Act of trading one country’s currency for another
What can drive FOREX?
Tourism and Illegal Activity -> Lead to movement of bank notes across national borders
What does the foreign exchange market consist of?
- Private Banks -> Bid for others or themselves
- Foreign Exchange Dealers and Brokers
- Central Banks -> Ownership of currencies (only ones that can issue the currency)
via which
-> Households, Firms and Govts (Customers) participate in FOREX
In 2016 what were the 3 most traded currencies?
2016 -> 5.088 Trillion traded
- USD/EUR -> 23% of total trading
- USD/YEN -> 17.7% of total trading
- USD/GBP -> 9.2%
Trading Volume:
UK -> 2,426 BN (37.1%)
US -> 1,272 BN (19.4%)
What make up most of transactions?
Interbank trading and speculation
How does interbank trading work and what is its benefit?
Trading among banks themselves
Only for banks
Positive:
- Allow banks to readjust position in foreign currency quickly at low cost
e. g. Citibank too much yen -> Can sell to other banks and buy dollars quickly
What does the overall forex market look like?
SEE GRAPH IN NOTES
What is an exchange rate and how is it expressed?
Price of one currency in terms of another:
e.g. $1.4 =£1
Expressed as $/£ = 1.4 (per £1 =$1.4)
How do we find the pound price of £1 (following $/£ = 1.4)
£/$ = 0.71 (1/1.4)
How do we calculate appreciation and depreciation?
e.g.
BEFORE: £/$ = 0.71
NOW: £/$ = 0.67
% CHANGE IN VALUE OF DOLLAR
% change £/$ = (NOW - BEFORE)/BEFORE = -.0.0563 = 5.63% Depreciation
What is a Spot Market?
Mkt of immediate sale or purchase of an asset
What is a Forward market?
Exchange of Currency at specified future date
What is the Bid/Offer Spread?
Bid Rate -> Rate at which currency is bought
Offer Rate -> Rate at which currency sold
Spread is difference between the two
-> Only shows last 3 digits of the rate
What is Arbitrage?
Creating position to realise riskless profit from mkt disequilibrium (BID/OFFER IN EACH MARKET)
What is Speculation?
Creating positions to realise profit from his/her expectations
- Risk taking position
- Betting on actual future price or expected future price
- Either gain or lose
How can Arbitrage firms make money? (2 point arbitrage)
SEE GRAPH IN NOTES FOR BETTER EXPLANATION
How can Arbitrage Firms make money? (3 point arbitrage)
SEE GRAPH IN NOTES FOR BETTER EXPLANATION
Why are there so many flucuations in SR?
- Inventory Control:
Effect of exchange rate when traders alter quotes to maintain balance between amount of currency bought and sold to ‘square off’ during the day - Asymmetric Info:
Changes due to trader fear that they quoting prices to someone who knows more about current conditions than they do
What are some of the causes of Asymmetric Info?
Order Flow: (Which Currency is requested becomes info)
e.g If people want to buy JPY from you 3 times in one day, something might be happening
Insider Info
What causes LR Fluctuations of exchange rate?
- Econ Factors:
Change in Demand for domestic goods relative to foreign goods causing more movement in exchange rates
What is the trade flow model?
Supply and Demand Model to explain LR movements of exchange rates
D of £
- US Importers want to buy UK goods, need to buy £
S of £
- UK Importers want to buy US goods, need to give up £ for $,
Equilibrium as S=D
SEE GRAPHS IN NOTES
What is a Exchange rate index?
Broad measure of avg value of currency relative to several other major currencies
e.g USD against avg value of 10 currencies
