The Foreign The Foreign Exchange MarketExchange Market
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The Global Capital The Global Capital MarketMarket
Chapter 9 & 11 - 2
Chapter PreviewChapter Preview
• Discuss the international capital market
• Describe the international bond, international equity and Eurocurrency markets
• Identify the foreign exchange market’s functions
• Explain currency quotes and the rates given
• Identify the instruments of foreign exchange
• Discuss government restrictions on currencies
Chapter 9 & 11 - 3
Capital MarketCapital Market
Debt: Repay principal plus interest Bond has timed principal & interest payments
Equity: Part ownership of a company Stock shares in financial gains or losses
System that allocates financial resourcesaccording to their most efficient uses
Chapter 9 & 11 - 4
International Capital MarketInternational Capital Market
Network of people, firms, financial institutions and governments borrowing and investing internationally
Borrowers
Expands money supply Reduces cost of money
Borrowers
Expands money supply Reduces cost of money
Lenders
Spread / reduce risk Offset gains / losses
Lenders
Spread / reduce risk Offset gains / losses
Chapter 9 & 11 - 5
International CapitalInternational CapitalMarket DriversMarket Drivers
Information technologyInformation technology
DeregulationDeregulation
Financial instrumentsFinancial instruments
Chapter 9 & 11 - 6
Country or territorywhose financial sector
features few regulationsand few, if any, taxes
Country or territorywhose financial sector
features few regulationsand few, if any, taxes
Operational centerExtensive financial activity
and currency trading
Operational centerExtensive financial activity
and currency trading
Booking centerMostly for bookkeeping
and tax purposes
Booking centerMostly for bookkeeping
and tax purposes
Offshore Financial CentersOffshore Financial Centers
Chapter 9 & 11 - 7
International Bond MarketInternational Bond Market
Foreign bond Interest ratesEurobond
Bond that is issued outside the country in whose currency the bond is denominated
Bond sold outside a borrower’s country and denominated in the currency of the country in which it is sold
Driving growth are differential interest rates between developed and developing nations
Market of bonds sold by issuing companies, governments and others outside their own countries
Chapter 9 & 11 - 8
International Equity MarketInternational Equity Market
Market of stocks bought and soldMarket of stocks bought and soldoutside the issuer’s home countryoutside the issuer’s home country
Market of stocks bought and soldMarket of stocks bought and soldoutside the issuer’s home countryoutside the issuer’s home country
PrivatizationPrivatizationPrivatizationPrivatization
Investment banksInvestment banksInvestment banksInvestment banks
Developing nationsDeveloping nationsDeveloping nationsDeveloping nations
Electronic marketsElectronic marketsElectronic marketsElectronic markets
Chapter 9 & 11 - 9
Governments Commercial banks International companies Wealthy individuals
Eurocurrency MarketEurocurrency Market
Unregulated market of currencies banked outside
their countries of origin
Chapter 9 & 11 - 10
Foreign Exchange MarketForeign Exchange Market
Conversion: To facilitate sale or purchase, or invest directly abroad
Hedging: Insure against potential losses from adverse exchange-rate changes
Arbitrage: Instantaneous purchase and sale of a currency in different markets for profit
Speculation: Sequential purchase and sale (or vice-versa) of a currency for profit
Market in which currencies are bought and soldand their prices are determined
Chapter 9 & 11 - 11
Quoting CurrenciesQuoting Currencies
Quoted currency = numeratorBase currency = denominatorQuoted currency = numeratorBase currency = denominator
(¥/$) = Japanese yen needed to buy one U.S. dollar(¥/$) = Japanese yen needed to buy one U.S. dollar
Yen is quoted currency, dollar is base currencyYen is quoted currency, dollar is base currency
Chapter 9 & 11 - 12
Currency ValuesCurrency Values
Change in US dollar against Polish zloty
February 1: PLZ 5/$ March 1: PLZ 4/$
%change = [(4-5)/5] x 100 = -20%
US dollar fell 20%
Change in Polish zloty against US dollar
Make zloty base currency (1÷ PLZ/$) February 1: $.20/PLZ March 1: $.25/PLZ
%change = [(.25-.20)/.20] x 100 = 25%
Polish zloty rose 25%
Change in Polish zloty against US dollar
Make zloty base currency (1÷ PLZ/$) February 1: $.20/PLZ March 1: $.25/PLZ
%change = [(.25-.20)/.20] x 100 = 25%
Polish zloty rose 25%
Chapter 9 & 11 - 13
Cross RateCross Rate
Dollar Euro Pound SFranc Peso Yen CdnDlr
Canada 1.3931 1.6466 2.4561 1.0695 0.1198 0.0122 ....
Japan 114.50 135.32 201.85 87.898 9.8420 .... 82.185
Mexico 11.633 13.749 20.510 8.9309 .... 0.1016 8.3504
Switzerland 1.3026 1.5395 2.2965 .... 0.1120 0.0114 0.9350
United Kingdom 0.5672 0.6704 .... 0.4355 0.0488 0.0050 0.4071
Euro 0.8461 .... 1.4917 0.6495 0.0727 0.0074 0.6073
United States .... 1.1819 1.7630 0.7677 0.0860 0.0087 0.7178
• Exchange rate calculated using two other exchange rates• Use direct or indirect exchange rates against a third currency
Cross Rate ExampleCross Rate Example
Direct quote method
1) Quote on euro = € 0.8461/$2) Quote on yen = ¥ 114.50/$3) € 0.8461/$ ÷ ¥ 114.50/$ = € 0.0074/¥4) Costs 0.0074 euros to buy 1 yen
Indirect quote method
1) Quote on euro = $ 1.1819/€2) Quote on yen = $ 0.008734/¥
3) $ 1.1819/€ ÷ $ 0.008734/¥ = ¥ 135.32/€4) Final step: 1 ÷ € 135.32/¥ = € 0.0074/¥5) Costs 0.0074 euros to buy 1 yen
Chapter 9 & 11 - 15
Spot RateSpot Rate
Exchange rate requiring deliveryExchange rate requiring deliveryof traded currency within two business daysof traded currency within two business days
Repatriate incomeRepatriate incomefrom sales abroadfrom sales abroad
Invest in anotherInvest in anothernational marketnational market
Pay supplier inPay supplier inits own currencyits own currency
Chapter 9 & 11 - 16
Forward RateForward Rate
Rate at which two parties will exchangecurrencies on a specified future date
Forward Contract
Derivative
Premium vs. Discount
Chapter 9 & 11 - 17
Currency swapCurrency swapSimultaneous purchase and sale of foreign exchange
for two different dates
Currency swapCurrency swapSimultaneous purchase and sale of foreign exchange
for two different dates
Currency optionCurrency optionOption to exchange a specific amount of a currency on a
specific date at a specific rate
Currency optionCurrency optionOption to exchange a specific amount of a currency on a
specific date at a specific rate
Currency futures contractCurrency futures contractContract requiring the exchange of a specific amount of a currency
on a specific date at a specific rate, with all conditionsfixed and not adjustable
Currency futures contractCurrency futures contractContract requiring the exchange of a specific amount of a currency
on a specific date at a specific rate, with all conditionsfixed and not adjustable
Swaps, Options and FuturesSwaps, Options and Futures
Chapter 9 & 11 - 18
24 Hour Trading24 Hour Trading
Chapter 9 & 11 - 19
Key Market InstitutionsKey Market Institutions
Interbankmarket
Securitiesexchange
Market in whichthe world’s largestbanks exchangecurrencies at spotand forward rates
Market in whichthe world’s largestbanks exchangecurrencies at spotand forward rates
Exchange that specializes in currency futures and options transactions
Exchange that specializes in currency futures and options transactions
Global computer network of foreignexchange tradersand other marketparticipants
Global computer network of foreignexchange tradersand other marketparticipants
Over-the-Counter(OTC) market
Chapter 9 & 11 - 20
Goals of Currency RestrictionGoals of Currency RestrictionGoals of Currency RestrictionGoals of Currency Restriction
Protect a currencyfrom speculators
Protect a currencyfrom speculators
Constrain individualsand companies from
investing abroad
Constrain individualsand companies from
investing abroad
Preserve hard currencyto repay debts owed
to other nations
Preserve hard currencyto repay debts owed
to other nations
Preserve hard currencyto pay for imports andfinance trade deficits
Preserve hard currencyto pay for imports andfinance trade deficits
Chapter 9 & 11 - 21
Currency Restriction PoliciesCurrency Restriction Policies
Multiple exchange rate system
Import deposit requirementsImport deposit requirements
What’s a firm to do??
“Countertrade”
Quantity restrictionsQuantity restrictions
Chapter 9 & 11 - 22
Chapter SummaryChapter Summary
• This chapter presents two systems that comprise international financial markets: the international capital market and the foreign exchange market. The international capital market offers advantages over domestic capital markets because it: (1) increases the supply of funds available to borrowers and lowers the cost of capital; and (2) provides a wider range of investment opportunities that allows investors to diversify their risk. The international capital market has grown dramatically because of information technology, deregulation by governments, and innovations in financial instruments. There are three main components of the international capital market: the international bond market; the international equity market; and the Eurocurrency market. The foreign exchange market is the market in which currencies are bought and sold and in which currency prices are determined. The foreign exchange market is not a place, but a network of banks, brokers, and dealers that exchange currencies 24 hours a day. The foreign exchange market is used for: (1) currency conversion, (2) currency hedging, (3) currency arbitrage, and (4) currency speculation.
International International Financial MarketsFinancial Markets
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