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Unformatted text preview: Chapter 16
1 Bank Foreign Exchange (FX) Bank Risk Management Risk
x Commercial banks may conduct international finance Commercial operations in several ways: operations
– Contract with domestic customers to create assets, Contract liabilities, & off-balance sheet contingency items (letters of credits) denominated in foreign currency. credits) – Contract with foreign customers to create assets, liabilities, Contract and off-balance sheet contingency items in either foreign currency or dollars. currency – Purchase & sell foreign currencies for customers & offer Purchase hedging services to customers with exposures in foreign currencies. currencies. – Trade foreign currencies on their own account. + 2 Foreign Exchange Rates
x x x x Foreign exchange rate is simply the price of one Foreign country’s currency relative to another country’s currency. currency. Foreign exchange rates are set by supply & Foreign demand, when there are no restrictions on currency trading. currency Price relationship between major currencies Price changes from minute to minute. changes Indirect rate is exchange rate expressed in units of Indirect home currency to foreign currency, the direct rate. +
3 Spot Market & Forward Market
x Two types of foreign exchange markets Two distinguished by the dimension of time. distinguished
– Spot market deals in currencies bought & sold for Spot essentially immediate settlement on delivery & take place at the spot-exchange rate & are cleared (payment made) on the so called value date, normally two days after the buyer and seller agree on the transaction. buyer – Participants in forward market buy & sell currencies for Participants future delivery at the forward-exchange rate. Contract maturities in the forward market range from several days to months and, in the case of so-called hard currencies, even years. + even 4 5 Types of Organization
x Edge Act
– Allows banks to conduct international business Allows from offices outside home state. from – Chartered under Sec. 25(a) of Federal Reserve Chartered Act & not subject to state banking laws. Act – Capitalized with at least $2 million. – Conduct international operations abroad Conduct through domestic offices. + through
6 Types of Organization (Continued)
x Shell branches & representative offices.
– Located overseas for booking Eurocurrency Located liabilities or issuing foreign loans. liabilities – Located in financially obscure places (like Located Bahamas) where they avoid local taxes. Bahamas) – Don’t conduct local business. – Act like domestic LPOs--don’t take deposits. x Full service foreign branches.
– Act as extension of main bank. – Conduct wholesale banking business. +
7 Types of Organization (Continued)
x Merchant banks.
– Investment banking subsidary. – Conduct Glass-Steagall prohibited activities. x Consortium banks.
– U.S. & foreign banks form consortium. – Able to fund loan syndications. – Able to get into Eurofinancings +
8 Types of Organization Types (Continued) (Continued)
x International banking facilities.
– IBFs authorized in 1981 by Fed to let banks do IBFs what they were allowed to do overseas. what – IBF’s relatively unregulated & able to compete IBF’s for deposits without reserve requirements. + for 9 Foreign Exchange Market
x Spot market & forward market.
– Spot market deals in currencies bought & sold for Spot immediate settlement on delivery immediate – Forward market deals in currencies bought & sold Forward for future delivery at an agreed exchange rate. for x Foreign exchange quotations.
– Direct rate is home currency to foreign currency Direct which is indirect rate. which x Interest arbitrage.
– Riskless on currency with difference prices in two Riskless markets + markets 10 10 Interest Rate Swaps
x Interest rate speculator holds equal Interest positions on short (sell) and long (buy) sides. sides. x Only value dates are different. x Protects against risk of holding a net Protects exchange position where spot might shift for other reasons. for x At end of month contract, can close 12month position and take the profit. +
11 11 The Eurocurrency Markets
x Eurocurrency is not just Eurodollars. x Eurocurrencies were over $3 trillion in 1992. x Important to US in that over 1/2 of the Important transactions of US money center banks are conducted in Euromarkets. conducted x Eurodollar replaced the British pound in Eurodollar international trade. + international
12 12 Banking In A Foreign Banking Environment Environment
x Foreign operations conducted in two possible Foreign currency regimes: currency
– Eurocurrency regime-bank takes deposits and makes Eurocurrency loans in currencies other than that of host country. (Unregulated+international) (Unregulated+international) – Domestic or local currency market-competing in a Domestic domestic or local currency. (Regulated by local laws) domestic x Eurodollar liabilities are normally fixed-rate Eurodollar deposits with specific maturities. deposits x Eurodollar assets normally loans at LIBOR rates. Eurodollar 13 13 + U. S. Dependency on Foreign U. Financing Financing
x U.S. dependency on foreign financing will U.S. have major impact on international financing. have x Until 1970s, Americans invested money Until overseas to get higher yield. overseas x In 1980s, U.S. debt far exceeded peak creditor In position that was previously enjoyed. position x Foreign borrowing got easier for Americans. x Higher U.S. rates brought in foreign lenders. +
14 14 Foreign Bank’s U.S. Assets Source: American Banker April 12, 1994 April 15 15 ...
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- Fall '10
- International Finance