International Business Environments Operations 15 e Daniels

Chapter 8 Global Foreign. Exchange Markets Copyright © 2015 Pearson Education, Inc. 8 -2

Learning Objectives p p p Learn the fundamentals of foreign exchange Identify the major characteristics of the foreignexchange market and how governments control the flow of currencies across national borders Describe how the foreign-exchange market works Examine the different institutions that deal in foreign exchange Understand why companies deal in foreign exchange Copyright © 2015 Pearson Education, Inc. 8 -3

What Is Foreign Exchange? Discussion of foreign exchange involves the currency, market, rate and players in the market. Each institution has a specific role. p p Foreign exchange currency: money denominated in the currency of another nation or group of nations Foreign exchange market: where foreign exchange transactions take place Exchange rate: the price of a currency Players in the foreign exchange market include n Reporting dealers n Financial institutions n Nonfinancial institutions Copyright © 2015 Pearson Education, Inc. 8 -4

Size, Composition, and Location of the Foreign Exchange Market p p p Market size is $4 trillion daily and the U. S. dollar is the most important currency on the foreign-exchange market The most commonly traded currency pairs are EUR/USD and USD/JPY London is the largest foreign exchange market (followed by New York, Tokyo, and Singapore) because of its strategic location between Asia and the Americas. Market activity first heightens when Europe and Asia are open and again when Europe and the United States are open. Electronic platforms made foreign currency transactions easier. Bank of International Settlements (BIS) plays a critical role in managing FX transactions worldwide Copyright © 2015 Pearson Education, Inc. 8 -5

The Circadian Rhythms of the Foreign Exchange Market 6

Size, Composition, and Location of the Foreign Exchange Markets: Average Daily Volume 1998 -2013

Size, Composition, and Location of the Foreign-Exchange Market Global Foreign Exchange: Currency Distribution Copyright

Size, Composition, and Location of the Foreign Exchange Markets: Geographic Distribution Copyright © 2015

Why U. S. Dollar is so widely traded p p p It is an investment currency in many capital markets It is a reserve currency held by many central banks It is a transaction currency in many international commodity markets It is an invoice currency in many contracts It is an intervention currency employed by monetary authorities in market operations to influence their own exchange rates 10

Global Over The Counter (OTC) Foreign Exchange Instruments p p p Spot transactions are for immediate delivery of the currency, within two days maximum. Forward transactions involve currency exchange beyond three days at a fixed rate, known as the forward rate. FX Swaps is exchange of currencies in the spot market with agreement to reverse the transaction in the future. It is a combination of spot and forward transaction at the same time. Options are contracts specifying the right to buy or sell foreign exchange within a specific period or on a specific date. Futures are contracts forward delivery of currency for specific amounts with specific maturity dates, not as flexible as a forward contract Copyright © 2015 Pearson Education, Inc. 8 -11

Global OTC Foreign Exchange Instruments Foreign Exchange Markets: Turnover by Instrument Copyright © 2015

FX Terms and Quotes p Foreign exchange dealers quote rates n n n p p Bid (buy) rate: the rate at which traders buy foreign exchange Offer (sell) rate: the rate at which traders sell foreign exchange Spread: the difference between bid and offer rates Direct quote (the number of dollars per unit of foreign currency) and Indirect Quote (the number of units of foreign currency per dollar) Cross rate determines the rate between two foreign currencies Copyright © 2015 Pearson Education, Inc. 8 -13

Banks And Exchanges p The top banks in the inter-bank market in foreign exchange can n n trade in specific market locations engage in major currencies and cross-trades deal in specific currencies handle derivatives p forwards, options, futures, swaps conduct key market research Copyright © 2015 Pearson Education, Inc. 8 -14

Banks And Exchanges Foreign Exchange Trades: Top Commercial Banks, 2012 Ranked by Overall Market

FX Fluctuation and Trade p p Assume that current U. S. Dollar and Japanese Yen exchange rate is $ 1 = ¥ 105. Japanese Yen appreciates against U. S. Dollar, and, the new market rate is to $ 1 = ¥ 95. How will this affect U. S. -Japan trade? n Japanese exports to U. S. …. Will it increase or decrease? n U. S. Exports to Japan…. Will it increase or decrease? Because Japanese can buy the same dollar with a smaller quantity of Yen (95 now, instead of 105 before) their purchasing power has increased against the Americans. To them, imports from USA is now cheaper. This means that they will import more from USA. In other words, U. S. exports to Japan will increase. On the contrary, Americans are getting less Yen for the same dollar, so they will buy less from Japan. Thus Japanese exports to the U. S. will decrease. Policy question: can a strong yen reduce the U. S. trade 16 deficit with Japan?

Future of FX Market p More efficient markets n n p create more opportunities foreign exchange trading lower costs Financial crisis in Europe n future of the euro Rise of the Chinese yaun and Brazilian real p Technology developments p n more electronic trades Copyright © 2015 Pearson Education, Inc. 8 -17

Chapter 8: Discussion Questions 1. 2. 3. 4. 5. What is a foreign exchange market? Explain the role each institution plays in the FX market. Why U. S. dollar is the most traded currency in the world? Define the following Global Over The Counter (OTC) Foreign Exchange Instruments: spot rate, forward rate, options, futures and swap. Define the following terms and distinguish their differences: bid, offer, spread, and cross rate. How does the fluctuation of exchange rate affect trade? For example, if Yen appreciates against Dollar, how will this affect U. S. -Japan trade? I can ask similar question with any currency.

All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America. Copyright © 2015 Pearson Education, Inc. 8 -19