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International%20Finance%20chapter%206 - International...

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International Finance Chapter 6: The Foreign Exchange Market Chapter Outline Foreign Exchange means the money of a foreign country which includes foreign currency, bank balances, banknotes, checks and drafts. Foreign Exchange Transaction is an agreement between buyer and seller that a fixed amount of a currency will be exchanged another currency on a given date. This market spans the globe: Sydney and Tokyo (morning), Hong Kong and Singapore, Bahrain, European Markets: Frankfurt, Zurich, London, then to NY, Chicago, SF and LA. Banks operate trading rooms that open and close throughout the day. The exchange market is open 24 hours per day using telecommunication and computer networks. Reuters, Telerate and Bloomberg provide exchange rate information. This is an automatic matching system (the NYSE also operates such a system). The Electronic Broking System (EBS) has largely replaced the need for broker transactions: USD1-99 9Million. In some countries a portion of the trading is done on a floor and the closing price for the day becomes the official price (fixing) for certain commercial and investment transactions and acts as an official price. Functions of the Foreign Exchange Markets 1. Transfer of Purchasing Power: International Trade and Capital Movements normally involve difference currencies. 2. Financing Inventories: The shipment of goods takes time and needs to be financed using Bankers’ Acceptances and Letters of Credit: Bankers’ Acceptance (BA) is a promised future payment also called a time draft which is guaranteed by a bank and drawn on a deposit at the bank: specifies the amount of money, the date and the person to which the payment is owed. This draft is an unconditional liability of the bank. The holder of the draft can sell the draft at a discount or wait until the maturity date. Letter of Credit: A letter from a bank guaranteeing that a payment owed to a seller will be received on time and for the contractual amount. The bank pays if the buyer does not the remaining balance. 3. Hedging Opportunities are Available (long and short positions) Short Position: selling assets that have been borrowed from a third party with the intention of purchasing the same asset back at a later day and returning the asset to that third party: Stocks, commodities and foreign Exchange Long Position: The purchase of a security with the expectation that the asset will rise in value. Market Participants: 4 of them 1. Bank and Nonbank Dealers: They profits from buying foreign exchange at a bid price and selling as the higher ask price . Competition between dealers international narrows the difference between these two prices which makes the markets more efficient: Large Commercial Banks earn between 10-20 percent of income in USA: Citibank, Barclays 2. Individuals and Firms: Consists of Importer, Exporter, Multinational Corporations, tourists and others.
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3. Speculators and Arbitragers: Operate on own self- interest. Arbitrage: try to profit from simultaneous exchange rate differences in different markets which increase market efficiency.
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International%20Finance%20chapter%206 - International...

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