Chapter 5 End of the Chapter Solutions

Chapter 5 End of the Chapter Solutions - Chapter 05 - The...

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Chapter 05 - The Market for Foreign Exchange 5-1 CHAPTER 5 THE MARKET FOR FOREIGN EXCHANGE ANSWERS & SOLUTIONS TO END-OF-CHAPTER QUESTIONS AND PROBLEMS QUESTIONS 1. Give a full definition of the market for foreign exchange. Answer: Broadly defined, the foreign exchange (FX) market encompasses the conversion of purchasing power from one currency into another, bank deposits of foreign currency, the extension of credit denominated in a foreign currency, foreign trade financing, and trading in foreign currency options and futures contracts. 2. What is the difference between the retail or client market and the wholesale or interbank market for foreign exchange? Answer: The market for foreign exchange can be viewed as a two-tier market. One tier is the wholesale or interbank market and the other tier is the retail or client market . International banks provide the core of the FX market. They stand willing to buy or sell foreign currency for their own account. These international banks serve their retail clients, corporations or individuals, in conducting foreign commerce or making international investment in financial assets that requires foreign exchange. Retail transactions account for only about 14 percent of FX trades. The other 86 percent is interbank trades between international banks, or non-bank dealers large enough to transact in the interbank market. 3. Who are the market participants in the foreign exchange market? Answer: The market participants that comprise the FX market can be categorized into five groups: international banks, bank customers, non-bank dealers, FX brokers, and central banks. International banks provide the core of the FX market. Approximately 100 to 200 banks worldwide make a market in foreign exchange, i.e., they stand willing to buy or sell foreign currency for their own account. These international banks serve their retail clients, the bank customers , in conducting foreign commerce or making international investment in financial assets that requires foreign exchange. Non-bank dealers are large non-bank financial institutions, such as investment banks, mutual funds, pension funds, and hedge
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Chapter 05 - The Market for Foreign Exchange 5-2 funds, whose size and frequency of trades make it cost- effective to establish their own dealing rooms to trade directly in the interbank market for their foreign exchange needs. Most interbank trades are speculative or arbitrage transactions where market participants attempt to correctly judge the future direction of price movements in one currency versus another or attempt to profit from temporary price discrepancies in currencies between competing dealers. FX brokers match dealer orders to buy and sell currencies for a fee, but do not take a position themselves. Interbank traders use a broker primarily to disseminate as quickly as possible a currency quote to many other dealers. Central banks
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This note was uploaded on 02/27/2012 for the course FIN 4604 taught by Professor Samiquemarch during the Spring '11 term at FIU.

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Chapter 5 End of the Chapter Solutions - Chapter 05 - The...

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