IEU - Lecture 3 - Foreign Exchange Market

IEU - Lecture 3 - Foreign Exchange Market - Izmir...

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Unformatted text preview: Izmir University of Economics ECON 306 INTERNATIONAL ECONOMICS Lecture 3 The Foreign Exchange Market Foreign Exchange and Exchange Rates The foreign exchange market is the market in which national moneys are traded for other national moneys. In this market an exchange rate is the price of one currency in terms of another currency. Two currencies involved Timing of delivery The spot exchange rate is the price for "immediate" exchange. The forward exchange rate is the price agreed to today for exchanges that will take place in the future. Figure 1 Exchange Rate Quotations, September 27, 2005 The basics of currency trading The foreign exchange market is not a single gathering place where traders shout buy and sell orders at each other. Rather, banks and traders who work at banks are at the center of foreign exchange market. The trading done with customers is called the retail part of the market. Some of this is trading with individuals in small amounts. The trading done between the banks active in the market is called the inter-bank part of the market. Nearly half of foreign exchange trading involves banks in two locations: London and New York. Foreign exchange trading in 2004 has been estimated at about $1.9 trillion per day. The basics of currency trading Trillion of US Dollar in 2004 11,4 41,7 693,5 0,0 100,0 200,0 300,0 400,0 500,0 600,0 700,0 800,0 World Exports World GDP Exchange trade Demand and Supply for Foreign Exchange Exports of goods and services and capital inflows (as well as income received from foreign sources) create a supply of foreign currency. Imports of goods and services and capital outflows (as well as income payments to foreigners) create a demand of foreign currency. Supply and demand for foreign exchange Supply Foreign demand for domestic goods & services (exports of goods & services) Foreign demand for domestic financial assets (capital inflows) Use of reserves by the central bank Demand Domestic demand for foreign goods & services (imports of goods & services) Domestic demand for foreign financial assets (capital outflows) Build up of reserves by the central bank Figure 2 The Spot Exchange Market: Floating and Fixed Exchange Rates...
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IEU - Lecture 3 - Foreign Exchange Market - Izmir...

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