6: Week International financial markets
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Fundamentals of international financial market
-- foreign exchange
-- exchange rate
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Players on the foreign exchange market:
Bank for International Settlements (BIS): based
in Basel, Switzerland, a central banking institution
owned and controlled by 55 central banks, divides
the market into three major categories: reporting
dealers, financial institutions, and non-financial
institutions.
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-- reporting dealers, known as money center banks,
include 10 largest foreign exchange traders: Deutsche Bank, UBS,
Barclays, RBS, Citi, JP Morgan, HSBC, Goldman Sachs, Credit
Suisse, BoA.
-- other financial institutions: commercial banks other
than those money center banks; hedge funds, pension
funds, money market funds, currency funds, mutual
funds, specialized foreign exchange traders, and so on.
-- non-financial institutions: governments and MNEs.
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Electronic services:
-- Reuters
-- EBS
-- Bloomberg
Services: Link to the trading system, market data, news,
quotes, statistics.
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Foreign exchange markets,
Over-the-counter market (OTC): commercial
banks, investment banks, other financial institutions
Exchange traded market: security exchanges, e.g.,
the CME (Chicago Mercantile Exchange), NASDAQ
OMX and NYSE Liffe (London International Financial
Futures and Options Exchange)
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The biggest markets:
London
New York
Tokyo
Singapore
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Foreign exchange instruments:
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Spot transactions: spot rate; second date settlement
Outright forward transactions: settle at a later date at
a pre-agreed rate (catering to firm needs, e.g., time,
amount)
FX swap: swapped on one date and swapped back on a
future date
Currency swaps: deal with interest-bearing financial
instruments (e.g. bond)
Options: the right but not obligation to trade in the
future
Futures contract: buy or sell at a particular price and
amount on a particular future date. (less flexible than
forward transactions)
330G financial markets
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Derivatives,
Outright forward transactions
Foreign exchange swaps
Currency swaps
options
Futures
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Size of the market and major currencies
around $ 5 trillion traded everyday
US dollar accounts for 86.3% of all transactions (one
side, buy or sell, 2007 data). Five reasons for its
popularity:
its 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 to influence exchange
rates
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A typical spot market transaction:
Bid (buy)---------------<Spread>------------offer (sell)
Direct quote (or American term): USD/ unit of foreign
currency
Indirect quote (or European term): foreign currency/ US
dollar
Base currency/ term currency: e.g., USA/ Euro
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Singapore-based trader Nick Leeson, who in February 1995 brought
down the centuries-old Barings merchant bank after it was discovered
he had lost $1.4bn in unauthorized derivatives trades.
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Rogue equity trades cost the Swiss bank $2.3 billion
Kweku M. Adoboli of UBS was charged on Friday in
London with one count of fraud and two counts of false
accounting.
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Foreign exchange trading process:
US firm A
Bank A
Broker
Euros
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330G financial markets
Money
center bank
Options/futures
exchange
Bank B
US firm B
Broker
Dollars
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How firms use foreign exchange:
domestic setting: commercial bill of exchange or
draft, sight draft (immediate payment) and time
draft (later payment)
import and export: letter of credit (L/C);
confirmed letter of credit (guarantee of an
additional bank)
Speculation: arbitrage (buying in one market and
immediate sale in another market); interest
arbitrage (invest in debt instruments to earn
interest)
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The International Monetary Fund
The Bretton Woods System: 1944, Bretton,
New Hampshire, > International Monetary Fund, 1945/47
Member countries currencies gold US dollar
Objectives:
1.Ensure stability in the international monetary system
2.Promote cooperation and exchange rate stability
3.Facilitate balanced growth of international trade
4.Provide resources to help members in balance-ofpayments difficulties or assist with poverty reduction
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Tristane Banon
Dominique Strauss-Kahn, former head of
the International Monetary Fund
Nafissatou Diallo
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Head of the International Monetary Fund,
Christine Lagarde
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SDRs (Special Drawing Rights) and the quota system
-- the unit of account used by IMF
Weighted average of 4 currencies:
USD: 44%; euro: 34%; Japanese yen: 11%; British pound: 11%.
SDR 325 billion (USD 503 billion) by 2009
The US: 17.19%
Japan: 6.13%
Germany: 5.99%
France: 4.94%
UK: 4.94%
The rest of the world, each country holds a small percentage
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Exchange rate arrangements:
Dollarization: no separate legal tender, e.g., El
Salvador, Ecuador, Panama
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Exchange rate arrangements:
Dollarization: no separate legal tender, e.g., El
Salvador, Ecuador, Panama
Pegged arrangements: peg a currency with another
currency, the e.g., dollar, or a basket of currencies
and float with it.
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Exchange rate arrangements:
Dollarization: no separate legal tender, e.g., El
Salvador, Ecuador, Panama
Pegged arrangements: peg a currency with another
currency, e.g., the dollar, or a basket of currencies
and float with it.
Independent floating: the dollar, euro, the Swiss
franc, Japanese yen, and British pound
-- some other countries like Brazil, Mexico, and
Chile also allow currency to float with market forces
without government intervention
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The euro: requirements for applicants
-- annual government deficit not exceeding 3%
of GDP
-- total gov. debt not exceeding 60% of GDP
-- inflation rate within 1.5% of the 3 bestperforming members
-- average long-term interest rate within 2% of
the average of the 3 best performers
-- exchange rate: keep within the normal floating
margin for at least 2 years
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The Chinese yuan (Ren Min Bi, RMB)
-- pegged with the dollar, euro, yen, and
won, but IMF classifies it as a single peg
against the dollar.
http://www.boc.cn/sourcedb/whpj/enindex.html
http://www.youtube.com/watch?v=WQQtreKkljg
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The Chinese yuan (Ren Min Bi, RMB)
The question: is revaluation of the yuan
good to the U.S.?
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How governments control exchange rate?
-- licenses
-- multiple exchange rates
-- import deposits
-- quantity control
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How can exchange rate affect business?
-- marketing
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How can exchange rate affect business?
-- marketing
-- production
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How can exchange rate affect business?
-- marketing
-- production
-- financial decisions
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What factors to monitor in predicting the
trend of exchange rate?
-- institutional setting: intervention vs. floating
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330G financial markets
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What factors to monitor in predicting the
trend of exchange rate?
-- institutional setting: intervention vs. floating
-- basic analyses: economic figures, e.g., ppp,
balance of payments, forex reserve,
unemployment rate, savings, inflation, growth,
gov. policy
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330G financial markets
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What factors to monitor in predicting the
trend of exchange rate?
-- institutional setting: intervention vs. floating
-- basic analyses: economic figures, e.g., ppp,
balance of payments, forex reserve,
unemployment rate, savings, inflation, growth,
gov. policy
-- confidence factors: consumer confidence
index, market views and expectations
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330G financial markets
12/05/11
What factors to monitor in predicting the
trend of exchange rate?
-- institutional setting: intervention vs. floating
-- basic analyses: economic figures, e.g., ppp,
balance of payments, forex reserve,
unemployment rate, savings, inflation, growth,
gov. policy
-- confidence factors: consumer confidence
index, market views and expectations
-- shocks: natural, political, social, economic
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330G financial markets
12/05/11
What factors to monitor in predicting the
trend of exchange rate?
-- institutional setting: intervention vs. floating
-- basic analyses: economic figures, e.g., ppp,
balance of payments, forex reserve,
unemployment rate, savings, inflation, growth,
gov. policy
-- confidence factors: consumer confidence
index, market views and expectations
-- shocks: natural, political, social, economic
-- technical analyses: charts, transaction volume
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Case analysis:
Sony (p. 382-386)
Questions 1, 2, 3, 4.
http://www.youtube.com/watch?v=g2vMRjO1oXY
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1. Why did the contraction of the U.S. and Japanese
economies and the rise in the value of the yen hurt Sonys
exports from Japan?
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2. In what other ways has the strong yen affected Sonys
bottom line?
What would be the effect of a weak yen?
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3. Given the instability in the currency markets, why do you
think it is important for Sony to manufacture more products in
the U.S. and Europe and to also buy more from suppliers in
other countries in Asia?
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4. What are the major forces that affected the Japanese yen
prior to the global financial crisis in the fourth quarter of 2008?
What has had the greatest impact on the yen since then, and
where do you forecast the future value of the yen?
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MGMT 330G Assignment: Mid-Term Summary
To demonstrate your understanding of the contents we have covered in the first half of this term, please 1) summarize what you have
learnt in not more than 500 words; and 2) write a short explanation to each of the key terms listed below. You can find answers to
these terms in the first ten chapters of the text. This assignment will be used as a factor to count towards your participation score. Your
answers should be submitted in print during the class time on Tuesday, Oct. 25, 2011.
Key terms:
International business
Off-shoring
Multinational enterprise (MNE)
Cultural difference
Individualism vs. collectivism
Intellectual property rights (IPR)
Gross domestic product (GDP)
Command economy
Market economy
Comparative advantage
Product life cycle theory (PLC)
Trade surplus
Dumping
Quota
Subsidy
Trade war
WTO
Exchange rate
Letter of credit
Black market
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330G Mid-Term Summary
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Next week:
Text Chapter 11/12.
Prepare case: Burger King
Case questions: 1, 2, 3, 4, 5, 6.
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