Multinational financial management 7th CH07

Multinational Financial
Management
Alan Shapiro

7th Edition

Power Points by
J.Wiley & Sons
Joseph F. Greco, Ph.D.
California State University, Fullerton
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CHAPTER 7
THE FOREIGN
EXCHANGE
MARKET

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CHAPTER OVERVIEW
I.
INTRODUCTION
II.ORGANIZATION OF THE
FOREIGN EXCHANGE
MARKET
III. THE SPOT MARKET
IV. THE FORWARD MARKET

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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.

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INTRODUCTION
B.
International Trade and Capital
Transactions:
facilitated with the ability
to transfer purchasing power
between countries

5


INTRODUCTION
C.

Location
1.
OTC-type: no specific
location
2.
Most trades by phone,
telex, or SWIFT

SWIFT: Society for Worldwide Interbank
Financial

Telecommunications
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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

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ORGANIZATION OF THE FOREIGN
EXCHANGE MARKET
B.

Two Types of Currency Markets

1. Spot Market:
- immediate transaction
- recorded by 2nd business day

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ORGANIZATION OF THE FOREIGN
EXCHANGE MARKET
2. Forward Market:
- transactions take place at a
specified future date

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ORGANIZATION OF THE FOREIGN
EXCHANGE MARKET
C. Participants by Market
1.
Spot Market
a. commercial banks
b. brokers
c. customers of commercial

and central banks
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ORGANIZATION OF THE FOREIGN
EXCHANGE MARKET
2. Forward Market
a. arbitrageurs
b. traders
c. hedgers
d. speculators
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ORGANIZATION OF THE FOREIGN
EXCHANGE MARKET
II. CLEARING SYSTEMS
A. Clearing House Interbank
Payments System
(CHIPS)
- used in U.S. for electronic
fund transfers.
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ORGANIZATION OF THE FOREIGN
EXCHANGE MARKET
B. FedWire
- operated by the Fed
- used for domestic

transfers
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ORGANIZATION OF THE FOREIGN
EXCHANGE MARKET
III. ELECTRONIC TRADING
A. Automated Trading
- genuine screen-based
market

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ORGANIZATION OF THE FOREIGN
EXCHANGE MARKET
B. Results:
1.

Reduces cost of trading

2.

Threatens traders’
oligopoly of information

3.

Provides liquidity
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ORGANIZATION OF THE FOREIGN
EXCHANGE MARKET
IV.

SIZE OF THE MARKET

A. Largest in the world
1999:

US$1.5 trillion daily
or
US$375 trillion a year

In 1999 the US GDP was US$9.1 trillion
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ORGANIZATION OF THE FOREIGN
EXCHANGE MARKET
B. Market Centers (1998):
#1: London = $637 billion
daily
#2: New York= $351 billion
daily
#3: Tokyo = $149 billion
daily
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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
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THE SPOT MARKET
B. Method of Quotation
1. For interbank dollar
trades:
a. American terms

example: $.5838/dm

b.

European terms
example: Peso1.713/$
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THE SPOT MARKET
2. For nonbank customers:
Direct quote
gives the home currency
price of one unit of foreign
currency.

EXAMPLE:

dm0.25/FF
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THE SPOT MARKET
C. Transactions Costs
1.
Bid-Ask Spread
used to calculate the fee
charged by the bank
•

Bid = the price at which the
bank is willing to buy
•
Ask = the price it will sell the
currency
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THE SPOT MARKET
4. Percent Spread Formula
(PS):

Ask − Bid
PS =
x100
Ask
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THE SPOT MARKET
D. Cross Rates
1.

The exchange rate
between 2 non - US$
currencies.

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THE SPOT MARKET
2. Calculating Cross Rates
When you want to know what
the dm/ff cross rate is, and you
know dm2/US$ and ff.55/US$
then dm/ff = dm2/US$ ÷
ff.55/US$
= dm3.636/ ff
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THE SPOT MARKET
E. Currency Arbitrage
1. If cross rates differ from
one financial center to
another, and profit
opportunities exist.

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