Chapter 06 The Foreign Exchange Market 1 The

Transcript:Chapter 06 The Foreign Exchange Market 1 The:
Chapter 06 The Foreign Exchange Market 1 The Foreign Exchange Market Characteristics of the FOREX market Geographic extent of the foreign exchange (FOREX) market Functions of the FOREX market Market participants Foreign exchange transactions – spot, forward, and swaps Review of currency quotations used by currency dealers, financial institutions, and agents Cross exchange rates and opportunities arising from inter-market arbitrage 2 Characteristics of the FOREX Market The FOREX market provides the physical and institutional structure through which currencies are exchanged A foreign exchange transaction is an agreement between a buyer and a seller that a fixed amount of one currency will be delivered for some other currency at a specified rate 3 Geographic Extent of the Market Geographically, the FOREX market spans the globe with prices moving and currencies trading on a 24 hour basis Major exchanges are located in Singapore, Hong Kong, and Tokyo in the East Then it moves to Bahrain, and London for the European area And on to New York, San Francisco, and Sydney 4 Geographic Extent of the Market Source: Federal Reserve Bank of New York, “The Foreign Exchange Market in the United States,” 2001, www.ny.frb.org. 5 Functions of the FOREX Market The FOREX market functions to transfer purchasing power between countries, obtain or provide credit for international trade, and manage the exchange rate risk Transferring purchasing power – allow trade partners to convert foreign currency revenues into their own currency Credit for trade – the movement of goods between countries takes time which requires financing for products in transit (letters of credit) Managing FX exposure – the FOREX market provides “hedging” instruments to transfer exchange rate risk to someone else who is more willing to take that risk 6 Market Participants The FOREX market has two parts, the interbank or wholesale market, and the client or retail market Five broad categories of participants operate within these two parts Bank and non-bank foreign exchange dealers Individuals and firms Speculators and arbitragers Central banks and treasuries 7 Market Participants: Bank and Non-bank Dealers These participants profit from buying currencies at a bid price and then reselling them at an offer or ask price Competition among dealers narrows the spread between the bid and offer rate contributing to the market’s efficiency – lower the spread lower the costs of trading Dealers at large international banks often act as market makers – willing to buy or sell these