Chapter 13 – The Foreign-Exchange Market
The market for foreign exchange arises for tourism, exports/import, and international
Usually only tourism requires actual currency, the majority of the market for
foreign exchange involves the transfer of bank deposits.
For example, if GM needs to purchase
€10m to pay for an order of foreign car parts, or needs to sell €10m it received for the sale of
car engines, it won’t actually use currency, it will use a bank transfer of funds.
exchange trading is done through an international network of large commercial banks, like JP
Morgan Chase, to facilitate international trade for MNCs.
Currency trading is virtual -
automated and electronic, like NASDAQ, using computer terminals and telephones, with no
physical market or trading.
Like many markets (commodities, stock indexes, T-bonds, currency), there is a) the spot (cash)
market, where spot (cash) rates are quoted for immediate delivery (two days to clear for
currency); and b) the forward or futures market, where forward rates are quoted for future
Spot rates for foreign exchange are quoted in Table 13.1 on p. 337 (Jan. 31, 2003) and in the
Swiss francs are selling for $.7332/SF, and dollars are selling for SF1.3639/$, in
amounts of $1m or more.
For smaller amounts, the price will be higher.
Example, an importer needs to buy $10,000 worth of SF, price might be $.75/SF instead of
$10,000 / ($.75/SF) =
Or equivalently, $.75/SF = SF1.3333/$, so
$10,000 x 1.3333 = SF13,333.33.
To convert $10,000 to a foreign currency, DIVIDE by the ex-rate if quoted as
$/SF and MULTIPLY by the ex-rate if quoted as SF/$.
Point: We want the dollars to cancel.
The ex-rates in Table 13.1 are quoted as “mid-range rates,” which is the average of the bid
(buying rate) – ask (selling rate) spread.
See Table 13.2 on p. 338 for the average spreads.
the SF, the bank will pay SF1.3571 to buy dollars and would sell dollars for SF1.3576, making .
0005SF per dollar, or SF500 per $1m, and the mid-range quote would be SF1.3574.
At the bid
quote, SF500 / SF1.3571 ≈ $368.
Note that the spread represents a commission of only .0368%
(or less than 1/25
of 1%), and is even less for the Euro (.0199%).
The spread will _________
for currencies that are thinly traded, i.e., currencies with low volume and infrequent trading.
Large commercial banks like Citibank stand ready to buy currency at the bid ex-rate and sell
currency at the ask ex-rate, and help to “make a market” for foreign exchange.
See currency symbols in Table 13.3 on p. 339.
January 23, 2012