Seminar
Global Foreign
Exchange Markets
Chapter 9
Copyright © 2013 Pearson Education
20 Kasım 13 Çarşamba
9-
Learning Objectives





To learn the fundamentals of foreign exchange
To identify the major characteristics of the
foreign-exchange market and how governments
control the flow of currencies across national
borders
To describe how the foreign-exchange market
works
To examine the different institutions that deal in
foreign exchange
To understand why companies deal in foreign
exchange
Copyright © 2013 Pearson Education
20 Kasım 13 Çarşamba
9-
Chapter 10
The Determination of
Exchange Rates
Copyright © 2013 Pearson Education
20 Kasım 13 Çarşamba
10-
Learning Objectives






To describe the International Monetary Fund and
its role in the determination of exchange rates
To discuss the major exchange-rate
arrangements that countries use
To explain how the European Monetary System
works and how the euro became the currency of
the euro zone
To identify the major determinants of exchange
rates
To show how managers try to forecast exchangerate movements
To explain how exchange rate movements
influence business decisions
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20 Kasım 13 Çarşamba
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Activities

Chapter 9

DOES GEOGRAPHY MATTER?
Foreign-Exchange Trades
Even though the U.S. dollar is the most widely traded currency in the world, some trading centers outside the U.S. are very
important in the global currency trade. London, for example, is a major trading center because it is close to the major capital
markets in Europe and is in a time zone that straddles the other major markets in Asia and the U.S. Despite the fact that the currency
market is a 24-hour market, the heaviest volumes of trade are concentrated in the hours when Asia and Europe are open or when
Europe and the U.S. are open. Also, prices tend to be better when markets are active and liquid. [See Map 9.1 and Fig 9.3]

POINT—COUNTERPOINT: Is it OK to Speculate on Currency?

LOOKING TO THE FUTURE:
Where Are Foreign-Exchange Markets Headed?
The speed at which transactions are processed and information is transmitted globally will continue to lead to greater efficiencies and
more opportunities in foreign exchange markets. Companies’ costs of trading foreign exchange should come down and they should
gain faster access to more currencies. Government exchange restrictions should diminish as currency markets are liberalized. As the
euro continues to solidify its position in Europe, it will reduce exchange-rate volatility and should lead to the euro taking some of the
pressure off the dollar so that it is no longer the only major vehicle currency in the world. The growth of Internet trades in currency
will take away some of the market share of dealers and allow more entrants in the foreign-exchange market. Internet trade will also
increase currency price transparency and increase the ease of trading.

Copyright © 2013 Pearson Education
20 Kasım 13 Çarşamba
9-
Activities

chapter 10

POINT—COUNTERPOINT: Should Africa Develop a
Common Currency?

CLOSING CASE: Welcome to the World of Sony – Unless the Yen
Keeps Rising

See handouts.
Copyright © 2013 Pearson Education
20 Kasım 13 Çarşamba
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Introduction - Chapter 9
Learning Objective 1:
To learn the fundamentals of foreign
exchange
Copyright © 2013 Pearson Education
20 Kasım 13 Çarşamba
9-
What Is Foreign Exchange?

Foreign exchange


Foreign exchange market


money denominated in the currency of another
nation or group of nations
where foreign exchange transactions take
place
Exchange rate

the price of a currency
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Players On The Foreign
Exchange Market
Learning Objective 2:
To identify the major characteristics of the
foreign-exchange market and how
governments control the flow of currencies
across national borders
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Players On The Foreign
Exchange Market

The Bank for International
Settlements (BIS) divides the market
into



Reporting dealers
Financial institutions
Nonfinancial institutions
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Players On The Foreign
Exchange Market
Foreign Exchange Markets: Turnover by Counterparty
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How To Trade
Foreign Exchange
Learning Objective 3:
To describe how the foreign-exchange
market works
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How To Trade
Foreign Exchange

Dealers can trade foreign exchange




Using electronic methods (41.3%)
Directly with customers (24.3%)
Through the interbank market (18.5%)
Through voice brokers (15.9%)
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Some Aspects Of The Foreign
Exchange Market

The foreign exchange market has two
segments


OTC commercial and investment banks
Securities exchanges
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Global OTC
Foreign Exchange Instruments

Global OTC foreign exchange instruments
include






Spot transactions
Outright forward transactions
FX swap
Currency swaps
Options
Futures contracts
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Global OTC
Foreign Exchange Instruments
Foreign Exchange Markets: Turnover by Instrument
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Size, Composition, and Location
of the Foreign Exchange Market

Market size is $4 trillion daily



the U.S. dollar is the most important currency
on the foreign-exchange market
London is the main foreign exchange market in
the world
The most commonly traded currency pairs
are EUR/USD and USD/JPY
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Size, Composition, and Location
of the Foreign Exchange Market
Foreign Exchange Markets: Average Daily Volume 1998-2010
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Size, Composition, and Location
of the Foreign Exchange Market
Global Foreign Exchange: Currency Distribution
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Size, Composition, and Location
of the Foreign Exchange Market
Foreign Exchange Markets: Geographic Distribution
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Major Foreign
Exchange Markets

Foreign exchange dealers quote rates



Bid (buy) rate
 the rate at which traders buy foreign
exchange
Offer (sell) rate
 the rate at which traders sell foreign exchange
Spread
 the difference between bid and offer rates
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Major Foreign
Exchange Markets

American terms (direct quote)


the number of dollars per unit of foreign
currency
European terms (indirect quote)

the number of units of foreign currency per
dollar
Base currency
 Terms currency

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The Forward Market

Forward discounts


Forward premiums


when the forward rate is greater than the spot rate
Option


when the forward rate is less than the spot rate
the right, but not the obligation, to trade a foreign
currency at a specific exchange rate
Futures


specifies an exchange rate in
advance of the
actual exchange of currency
not as flexible as a forward contract
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The Foreign Exchange
Trading Process
The Foreign Exchange Trading Process
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Banks And Exchanges

The top banks in the inter-bank market in
foreign exchange can





trade in specific market locations
engage in major currencies and cross-trades
deal in specific currencies
handle derivatives
 forwards, options, futures, swaps
conduct key market research
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Banks And Exchanges
Foreign Exchange Trades: Top Commercial Banks, 2011
Ranked by Overall Market Share
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Top Exchanges For Trading
Foreign Exchange

Three of the best-known exchanges are



the Chicago Mercantile Exchange (CME)
Group
the NASDAQ OMX
the NYSE Liffe
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How Companies
Use Foreign Exchange
Learning Objective 5:
To understand why companies deal in
foreign exchange
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How Companies
Use Foreign Exchange

Import and export cash flow options


Commercial bills of exchange
 sight draft
 time draft
Letters of credit
 confirmed letter of credit
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How Companies
Use Foreign Exchange

Other financial flows for business


Speculation
 buying or selling of a foreign currency that
has an element of risk and a chance of great
profits
Arbitrage
 the buying and selling of foreign currencies
at a profit due to price discrepancies
 interest arbitrage
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Where Are Foreign Exchange
Markets Headed?

More efficient markets



create more opportunities for foreign exchange
trading
lower costs
Financial crisis in Europe

future of the euro
Rise of the Chinese yaun and Brazilian real
 Technology developments


more electronic trades
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20 Kasım 13 Çarşamba
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Copyright © 2013 Pearson Education
20 Kasım 13 Çarşamba
9-
Chapter 10
The Determination of
Exchange Rates
Copyright © 2013 Pearson Education
20 Kasım 13 Çarşamba
10-
Learning Objectives






To describe the International Monetary Fund and
its role in the determination of exchange rates
To discuss the major exchange-rate
arrangements that countries use
To explain how the European Monetary System
works and how the euro became the currency of
the euro zone
To identify the major determinants of exchange
rates
To show how managers try to forecast exchangerate movements
To explain how exchange rate movements
influence business decisions
Copyright © 2013 Pearson Education
20 Kasım 13 Çarşamba
10-
Introduction
Learning Objective 1:
To describe the International Monetary
Fund and its role in the determination of
exchange rates
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The International Monetary Fund

The goals of the International Monetary
Fund (IMF) are to




ensure stability in the international monetary
system
promote international monetary cooperation
and exchange-rate stability
facilitate the balanced growth of international
trade
provide resources to help members in balanceof-payments difficulties or to assist with
poverty reduction
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The International Monetary Fund

The Bretton Woods Agreement


established a par value, or benchmark value,
for each currency initially quoted in terms of
gold and the U.S. dollar
The dollar became the world benchmark
for trading currencies and continues in
that role today
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The IMF Today

The Quota System


Assistance Programs


every member contributes a quota
the IMF lends money to ease balance-ofpayments difficulties
Special drawing rights (SDRs)

the IMF’s unit of account
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The Global Financial Crisis
and the IMF

The global crisis in 2008-2009 raised
concerns over global liquidity


prompted the G20 to inject huge amounts of
cash into the IMF
Greece’s 2010-2011 financial crisis
required assistance from the IMF and the
EU

the IMF required Greece to adopt very
unpopular austerity measures
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Evolution to
Floating Exchange Rates

The Smithsonian Agreement




8% devaluation of the dollar
revaluation of other currencies
widening of exchange rate flexibility
The Jamaica Agreement


provided greater exchange rate flexibility
eliminated the use of par values
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Exchange Rate Arrangements
Under the Jamaica Agreement countries
selected and maintained their own
exchange rate arrangements
 The IMF monitors the exchange rate
policies of countries to see if they are
acting openly and responsibly

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Exchange Rate Arrangements
Exchange Rate Arrangements and Anchors
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Three Choices:
Hard Peg, Soft Peg, or Floating
Learning Objective 2:
To discuss the major exchange rate
arrangements that countries use
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Three Choices:
Hard Peg, Soft Peg, or Floating


The IMF classifies currencies into three categories
Hard peg





Soft peg



12.2% of total
value is locked into something and does not change
dollarization
currency boards
45.7% of total
more flexible than hard peg
Floating


42.1% of total
floating or freely floating
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The Euro
Learning Objective 3:
To explain how the European Monetary
System works and how the euro became
the currency of the euro zone
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The Euro

The European Monetary System (EMS)


European Monetary Union (EMU)


established to create exchange rate stability
within the European Community
outlined the criteria for euro applicants
 the U.K., Sweden, and Denmark opted not
to adopt the euro
The European Central Bank (ECB)

sets monetary policy for the adopters of the
euro
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Determining Exchange Rates
Learning Objective 4:
To identify the major determinants of
exchange rates
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Determining Exchange Rates

Currency in a floating rate world

demand for a country’s currency is a function
of the demand for that country’s goods and
services and financial assets
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Determining Exchange Rates
The Equilibrium Exchange Rate and How it Moves
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Determining Exchange Rates

Currency in a fixed rate or managed
floating rate world


Role of central banks
 reserve assets
 intervening in the market
 attitudes toward intervention
The Bank for International Settlements
(BIS)
 the central banks’ bank
 coordinates central bank intervention
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Black Markets

A black market closely approximates a
price based on supply and demand for a
currency instead of a government
controlled price
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Foreign Exchange
Convertibility and Controls

Hard currencies


Soft currencies


U.S. dollar, euro, British pound, Japanese yen
developing countries
Countries can control convertibility
through




licenses
multiple exchange rate systems
advance import deposits
quantity controls
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Exchange Rates and
Purchasing Power Parity

Purchasing power parity (PPP)


a change in relative inflation between two
countries must cause a change in exchange
rates to keep the prices of goods in the
countries fairly similar
The Big Mac Index
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Exchange Rates
and Interest Rates

The Fisher Effect


The International Fisher Effect (IFE)


links inflation and interest rates
links interest rates and exchange rates
Other Factors in Exchange Rate
Determination


confidence
information
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Forecasting
Exchange Rate Movements
Learning Objective 5:
To show how managers try to forecast
exchange-rate movements
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Fundamental and Technical
Forecasting

Forecasting exchange rates




Fundamental forecasting
 uses trends in economic variables to predict
future rates
Technical forecasting
 uses past trends in exchange rates to spot
future trends
Biases can skew forecasts
Timing, direction, and magnitude of exchange
rate movements are important to consider
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Fundamental Factors
to Monitor

Monitor
 The institutional setting
 Fundamental analyses
 Confidence factors
 Events
 Technical analyses
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Business Implications of
Exchange Rate Changes
Learning Objective 6:
To explain how exchange rate movements
influence business decisions
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Business Implications of
Exchange Rate Changes

Marketing Decisions


Production Decisions


when the value of a country’s currency rises, exporting
becomes more difficult as the product becomes more
expensive in foreign markets
might locate production in a weak currency country
because the initial investment is cheap and it will make
a good base for exports
Financial Decisions

currency rates influence sourcing, cross-border
remittance of funds, and the reporting of financial
results
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The Future: The Dollar, The
Euro, The Yen, The Yuan

Europe


Asia


the euro should take market share away from
the dollar as the prime reserve asset assuming
the problems in Greece and other countries are
controlled
China is moving forward to establish the yuan
as a major world currency
Latin America

emerging market currencies should strengthen
as commodity prices recover
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