THE FOREIGN
EXCHANGE
MARKET
CHAPTER OVERVIEW
I. INTRODUCTION
II. ORGANIZATION OF THE
FOREIGN EXCHANGE
MARKET
III. THE SPOT MARKET
IV. THE FORWARD MARKET
V. INTEREST RATE PARITY
THEORY
PART I. INTRODUCTION
I.
INTRODUCTION
A.The Currency Market:
where money
denominated in one
currency is bought and
sold with money
denominated in another
currency.
INTRODUCTION
B. International Trade and
Capital Transactions:
- facilitated with the ability
to transfer purchasing power
between countries
INTRODUCTION
C. Location
1. OTC-type: no specific
location
2. Most trades by phone,
telex, or SWIFT
SWIFT: Society for Worldwide
Interbank Financial
Telecommunications
PART II.
ORGANIZATION OF THE FOREIGN
EXCHANGE MARKET
I . PARTICIPANTS IN THE
FOREIGN EXCHANGE
MARKET
A.Participants at 2 Levels
1. Wholesale Level (95%)
- major banks
2. Retail Level
- business
customers.
PART III.
THE SPOT MARKET
I.
SPOT QUOTATIONS
A.Sources
1. All major newspapers
2. Major currencies have
four different quotes:
a. spot price
b. 30-day
c. 90-day
d. 180-day
b. European terms
example: dm1.713/$
EXAMPLE: dm0.25/FF
the
Ask Bid
PS
x100
Ask
MECHANICS OF SPOT
TRANSACTIONS
SPOT TRANSACTIONS: An
Example
Step 1. Currency transaction:
verbal agreement, U.S.
importer specifies:
a. Account to debit (his acct)
b. Account to credit
(exporter)
MECHANICS OF SPOT
TRANSACTIONS
Step 2. Bank sends importer
contract note including:
- amount of foreign
currency
- agreed exchange rate
- confirmation of Step 1.
MECHANICS OF SPOT
TRANSACTIONS
Step 3. Settlement
Correspondent bank in Hong
Kong transfers HK$ from
nostro account to exporters.
Value Date.
U.S. bank debits importers
account.
PART III.
THE FORWARD MARKET
I. INTRODUCTION
A. Definition of a Forward
Contract
an agreement between a bank and a
customer to deliver a specified
amount of currency against
another currency at a specified
future date and at a fixed exchange
rate.
PART IV.
INTEREST RATE PARITY THEORY
I. INTRODUCTION
A. The Theory states:
the forward rate (F) differs
from the spot rate (S) at
equilibrium by an amount
equal to the interest
differential (rh - rf) between
two countries.