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CHAPTER 5 - THE MARKET FOR FOREIGN EXCHANGE (FX) Money represents purchasing power (JS Mill: "There is nothing more insignificant than money"), but usually only in one country. ¥, £, or € have no purchasing power in U.S. Exchanging one currency for another takes place in the FX market (converting purchasing power from one currency into another). FX is world's largest financial market in world. Daily trading is about $4 trillion or $2000 billion ($300 per person) vs. $120 billion per day in U.S. stocks. FX market trading has increased in recent years. Reasons?? FX traded 24/7/365. Three major areas: Australasia (Sydney, Tokyo, Hong Kong, Singapore), Europe (London, Paris, Amsterdam, Frankfurt) and N. America (NY, Montreal, Toronto, SF, Chicago, LA, etc.) Due to time zone differences, trading takes place 24 hours/day, see Exhibit 5.2 on page 110 (Electronic trades per hour). Most trading rooms operate 9-12 hour days. Trading volume is high when the N. America and Europe markets overlap (early in the day in U.S.) and late in the day in Asia when the European market is opening. Two largest trading centers: 31% of daily trading volume in London/UK ($753B daily), and 19% in U.S. ($461B daily), see Exhibit 5.1, p. 109, and see the NY Fed article here: http://www.newyorkfed.org/education/addpub/usfxm/chap3.pdf FX actually covers spot currency markets, forward currency markets, currency options, currency swaps, currency futures, foreign trade financing and credit arrangement, etc. This chapter covers spot and forward markets only. FUNCTION AND STRUCTURE OF FX MKT FX markets are part of Commercial Banking activities, assisting corporate clients/MNCs to conduct international commerce. Banks provide the service of buying/selling foreign currency for commercial customers, e.g. importers who are buying foreign products and need to buy foreign currency with $, or exporters who are receiving foreign currency and need to sell foreign currency for $. FX is an OTC (over-the-counter) market, like NASDAQ. How does OTC differ from non-OTC?? FX OTC: Int'l. network of bank currency traders, nonbank dealers, FX brokers, linked by computers, phone lines, telex machines, automated quotation systems, etc. The communication system of FX dealers is extremely advanced, sophisticated and reliable. FX MARKET PARTICIPANTS MGT 566: International Finance – CH 5 Professor Mark J. Perry 1
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Two levels : Wholesale (Interbank, 83% of trading volume) and Retail (Client market, 17% of market). Why so much wholesale? Much wholesale trading is speculative trading (trying to correctly judge the direction of currency values) or arbitrage trading (exploiting ex-rate discrepancies between dealers). Currency trading is a profit center for large banks.
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