Forex markets

International Finance


Global dimensions of
 Financial

markets  Institutions  Instruments and techniques  Public policy

Global Financial Markets

International Money Markets  International Capital markets  Eurocurrency Markets  Eurobond Markets  Global Derivatives Market


Global finance is an odd combination of

 World s

most perfect money and capital

markets
 The

Euromarkets and the free foreign exchange markets

 World s

most imperfect markets

 Domestic

capital markets whose development is stunted by restrictions and exchange controls

Foreign Exchange Market

A means by which payments are made across national boundaries, jurisdictions and currencies.  Sets price for one currency in terms of other


Eurocurrency Market


Market for bank time deposits and loans made outside the country of origin

ForexForex- Basic concepts

Exchange rate  Cash market, spot market and forward market  Quotation  Types of quotes  Spread/cost of transaction  Determinants of spread


Foreign exchange market

Forex market exists in network of information system.  Exchange rate: the rate at which one currency is traded for another. Foreign exchange can be in the form of cash, funds available on credit, debit cards, traveler s cheques, bank deposits


Major Forex markets

London 32%  New York 18%  Tokyo 8%  Singapore - 7%  Hong Kong  Paris  Frankfurt  Zurich


Characteristics of the Forex Market

World s largest and most liquid market  Vast geographical dispersion  Huge trading volumes three and half trillion dollars turnover per day  24 hour trading  Low margins  Network of international dealers  Quoted price changes as many as 18 times a minute and 18000 times a day


Segments
Over the counter (OTC) Composed of both commercial & investment banks (Bank of America, Merrill Lynch) It is where most of the foreign exchange activity takes place


Exchange Traded Market Composed of securities exchanges e.g. Chicago Mercantile Exchange, Philadelphia Stock Exchange - where certain types of foreign exchange instruments are traded e.g. exchange traded futures & options

There are seven major currencies that are most commonly traded. These include: EUR, USD, JPY, CHF, GBP, AUD, and CAD Currencies that are not on the top seven list are all considered minor currencies

Spot market
The market where the transactions are conducted for the spot delivery of currencies.  Spot delivery means delivery after 2 business days.  Spot rate determination: demand and supply of currency.


Quotations
The amount of currency necessary to buy or sell a unit of another currency.  Out right rates  Bid Rate: the rate at which the exchange Rate: dealer is ready to buy a currency.  Ask rate: the rate at which the dealer is rate: ready to sell the currency


Types of quotations
Direct quote: one unit of foreign currency quote: quoted in terms of domestic currency. Ex: Rs.43.50/$ (B) Rs.43.95/$ (A)  Indirect quote: one unit of domestic quote: currency is expressed in terms of foreign currency. Ex: GBP/Rs.85.03 (B) GBP/Rs.84.60 (A)


Practices of quotations
In terms of discounts and premiums Ex: 5% premium in 3 month forward market  In terms of basis points A basis point is one hundredth of one percent (0.0001) Ex: forward discount 60 basis points


(Contd)


In terms of a-b or a/b, where a and b aare numbers. Ex : S($/Rs) = Rs.44.55-75, 44.55/75 Rs.44.55-

Spread
Direct quote: quote: Spread = Ask Bid Ex: Rs.43.50/$ (B) Rs.43.95/$ (A) Spread: 43.95-43.50 = Rs. 0.45 43.95 Indirect quote: Spread = Bid Ask Ex: GBP/Rs.85.03 (B) GBP/Rs.84.60 Spread: 85.03-84.60 = Rs. 0.43 85.03

Determinants of spread
The currency being traded  The volume of currency being traded  The nature of the organization making quotes  Overall perception about the economy and the Forex market


Cross rate
Cross rate is a currency pair that does not include USD such as GBP/JPY Pairs that involve the EUR are called euro crosses, crosses, such as EUR/GBP All other currency pairs (those that don't involve USD or EUR) are generally referred to as cross rates

Forward market
Forward exchange rate : the exchange rates for delivery and payment at specified future dates.  Present contract for future delivery.  Forward exchange rate determination: determination: forward demand and forward supply of currencies.


Premium and Discount

Premium: Premium: a foreign currency is said to be at premium where forward price exceeds the present/spot price in terms of domestic currency.  Discount: a foreign currency is said to be Discount: at discount where forward price is lesser than the present/spot price in terms of domestic currency.


Participants in the forward market

Traders  Arbitrageurs  Hedgers  Speculators  Banks  Government


Traders


Traders use spot and forward markets to eliminate risk of loss of value of exports or import orders that are denominated in foreign currencies.

Arbitrageurs
 

Earn risk free profits by seeking advantage of differences in prices of Currencies (Spatial arbitrage) (a) Two currency arbitrage (b) Multicurrency arbitrage Interest rates (Interest rate arbitrage) (a) Covered interest arbitrage (b) Uncovered interest arbitrage

Hedgers
Hedgers enter into forward contracts to protect themselves against adverse exchange rate movements.  The purpose of hedging is minimization of loss and not profit maximization.


Speculators
Speculators actively expose themselves to currency risk and attempt to benefit from the exchange rate movements.  Weak currency speculation: Rule: Sell forward buy spot  Strong currency speculation: Rule: Buy cheap sell dear


Foreign Exchange Markets

London New York Tokyo Hong Kong Singapore

Foreign exchange turnover by currency

2001 (%) US Dollar Euro Japanese Yen Pound Sterling Swiss Franc Australian Dollar Canadian Dollar Swedish Krona Hong Kong Dollar Others 90.4 37.7 22.7 13.3. 6.1 4.2 4.5 4.5 2.2 14.4 2004 (%) 88.7 37.2 20.3 16.9 6.1 5.5 4.2 4.2 1.9 15 2007 (%) 86.3 37 16.5 15 6.8 6.7 4.2 4.2 2.8 20.5 2010 (%) 84.9 39.1 19 12.9 6.4 7.6 5.3 2.2 2.4 20.2

Note
Because 2 currencies are involved in each transaction, the sum of the percentage shares of individual currencies totals 200% instead of 100%.  Source : Bank of International Settlements

 Central

Bank Survey of Foreign Exchange Market Activity

Average Daily Turnover in Major Markets

US $ Billions

2001 1.UK 2.US 3.Japan 4.Singapo re 5.German y 6.Switzerl and 7.Hong Kong

2001 504 254 147 101 88 71 67

2004 UK US Japan

2004 753 461 199

2007 UK US

2007 1359 664

2010 UK US Japan Singapore

2010 1853 904.4 312.3 266

Switzerland 242 Japan Singapore Hong Kong Australia France Germany Denmark 238 231 175 170 120 99 86 3210

Singapo 125 re German y Hong Kong Australi a Switzerl and France Canada 118 102 81 79 64 54 1880

Switzerland
Hong Kong

263
237

Australia
France Denmark

192
151 120

8.Australia 52 9.France 48

10.Canada 42 Total 1200

Canada
Germany

62
109

London

London
Mother of all foreign exchange markets  World s largest foreign exchange market with 32% share  But pound is not the most widely traded currency  Advantage of proximity to Europe market, geographical location and time zone


History
Beginning of 20th century, London Forex Market (LFM) played a second fiddle. ( fiddle. More important were New York, Paris, Berlin). Berlin).  The World Wars worsened the situation. situation.  Declining interest in Pound Sterling and increasing importance of dollar


Key factors in development of LFM

LFM became the main European center for trading the US dollar. dollar.  US dollar emerged as a key international currency. currency.  More foreign exchange trading is done in dollars in London than in US  The post World War turmoil in central and east Europe helped LFM when trade at Berlin and Vienna were hindered. (The 2 hindered. main rivals)


Advantages of LFM
Concentration of financial institutions, fund management sector, investment banks & brokers. brokers.  Easy access to global market. market.  High quality of professional services. services.  Efficient telecom infrastructure. infrastructure.  Central geographical location.(Between US location. & Asia)  Use of English language. language.


Best time to trade in LFM



US trading session starts at 8:00 GMT and winds up at around 16:00 GMT. UK trading session starts at 13:00 GMT and winds up at around 22:00 GMT. Thus they overlap from 13:00 hrs GMT to 16:00 GMT. It is at this time when most of the trading takes place and the markets are the most liquid.

New York

Most widely traded currency

 Investment  Reserve  Transaction  Invoice  Intervention

Dollar the most widely traded currency

    

An investment currency in many capital markets A reserve currency held by many central banks A transaction currency in many international commodity markets An invoice currency in many contracts An intervention currency employed by monetary authorities in market operations to influence their own exchange rates Vehicle currency used for quotations

OVER-THEOVER-THE-COUNTER MARKET WITH AN EXCHANGEEXCHANGE-TRADED SEGMENT

Unregulated market No permission from SEC 90% of the trading Organized exchange Commodity Futures Trading Corporation (CFTC) Securities Exchange Commission

Tokyo

Tokyo Financial Exchange

Third largest market after US and UK till 2004 Established in 1989 due to a series of interest rate liberalization in Japan.  TFX has been challenging and realizing globallyglobally-standardized systems and schemes as a pioneering exchange in Japan.  It was established under financial futures trading law of Japan.


Features
Highly regulated  Dominated by few players  Trading the largest amounts for single transaction  Restricted to few currency pairs and few financial instruments  Participants are mostly Japanese  Majority of turnover comes from OTC products  Notorious for opacity in accounting practices


Hong Kong

Singapore

Singapore and Hong Kong



Often perceived as hub of most major multinational companies and important provision of financial services to international investors in South East Asia

History
After Second World War Singapore and Hong Kong had built up its reputation as a major commercial, manufacturing and shipping centre in the Far East  It was in late 1970s that they emerged as a financial centre  Became a hub for Asian Dollar market


Contd..
Turning point in 1978 after China s open door policy  This enhanced them as financial centre and gateway to China


Key factors for development

Both are situated at appropriate time zones which allow 24 hour trading when the two markets New York and London are closed.  Availability of Banking and financial facilities and infrastructure are identified as the two important factors in choosing these two places as financial hub for South East Asia Region


Contd..
Hong Kong is China Corporate Centre  Singapore is regional financial centre in the South East Asian Region  They do not have a Central Bank but only monetary authorities without currency issuing powers  Hong Kong Monetary Authority and Monetary Authority of Singapore