Seminar. Global Foreign Exchange Markets Chapter 9. Copyright 2013 Pearson Education. 20 Kasım 13 Çarşamba

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1 Seminar Global Foreign Exchange Markets Chapter 9 9-

2 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 9-

3 Chapter 10 The Determination of Exchange Rates 10-

4 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 10-

5 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. 9-

6 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. 9-

7 Introduction - Chapter 9 Learning Objective 1: To learn the fundamentals of foreign exchange 9-

8 What Is Foreign Exchange? Foreign exchange money denominated in the currency of another nation or group of nations Foreign exchange market where foreign exchange transactions take place Exchange rate the price of a currency 9-

9 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 9-

10 Players On The Foreign Exchange Market The Bank for International Settlements (BIS) divides the market into Reporting dealers Financial institutions Nonfinancial institutions 9-

11 Players On The Foreign Exchange Market Foreign Exchange Markets: Turnover by Counterparty 9-

12 How To Trade Foreign Exchange Learning Objective 3: To describe how the foreign-exchange market works 9-

13 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%) 9-

14 Some Aspects Of The Foreign Exchange Market The foreign exchange market has two segments OTC commercial and investment banks Securities exchanges 9-

15 Global OTC Foreign Exchange Instruments Global OTC foreign exchange instruments include Spot transactions Outright forward transactions FX swap Currency swaps Options Futures contracts 9-

16 Global OTC Foreign Exchange Instruments Foreign Exchange Markets: Turnover by Instrument 9-

17 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 9-

18 Size, Composition, and Location of the Foreign Exchange Market Foreign Exchange Markets: Average Daily Volume

19 Size, Composition, and Location of the Foreign Exchange Market Global Foreign Exchange: Currency Distribution 9-

20 Size, Composition, and Location of the Foreign Exchange Market Foreign Exchange Markets: Geographic Distribution 9-

21 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 9-

22 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 9-

23 The Forward Market Forward discounts when the forward rate is less than the spot rate Forward premiums Option when the forward rate is greater 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 9-

24 The Foreign Exchange Trading Process The Foreign Exchange Trading Process 9-

25 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 9-

26 Banks And Exchanges Foreign Exchange Trades: Top Commercial Banks, 2011 Ranked by Overall Market Share 9-

27 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 9-

28 How Companies Use Foreign Exchange Learning Objective 5: To understand why companies deal in foreign exchange 9-

29 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 9-

30 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 9-

31 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 9-

32 9-

33 Chapter 10 The Determination of Exchange Rates 10-

34 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 10-

35 Introduction Learning Objective 1: To describe the International Monetary Fund and its role in the determination of exchange rates 10-

36 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 10-

37 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 10-

38 The Quota System The IMF Today every member contributes a quota Assistance Programs the IMF lends money to ease balance-ofpayments difficulties Special drawing rights (SDRs) the IMF s unit of account 10-

39 The Global Financial Crisis and the IMF The global crisis in raised concerns over global liquidity prompted the G20 to inject huge amounts of cash into the IMF Greece s financial crisis required assistance from the IMF and the EU the IMF required Greece to adopt very unpopular austerity measures 10-

40 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 10-

41 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 10-

42 Exchange Rate Arrangements Exchange Rate Arrangements and Anchors 10-

43 Three Choices: Hard Peg, Soft Peg, or Floating Learning Objective 2: To discuss the major exchange rate arrangements that countries use 10-

44 Three Choices: Hard Peg, Soft Peg, or Floating The IMF classifies currencies into three categories Hard peg 12.2% of total value is locked into something and does not change dollarization currency boards Soft peg 45.7% of total more flexible than hard peg Floating 42.1% of total floating or freely floating 10-

45 The Euro Learning Objective 3: To explain how the European Monetary System works and how the euro became the currency of the euro zone 10-

46 The Euro The European Monetary System (EMS) established to create exchange rate stability within the European Community European Monetary Union (EMU) 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 10-

47 Determining Exchange Rates Learning Objective 4: To identify the major determinants of exchange rates 10-

48 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 10-

49 Determining Exchange Rates The Equilibrium Exchange Rate and How it Moves 10-

50 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 10-

51 Black Markets A black market closely approximates a price based on supply and demand for a currency instead of a government controlled price 10-

52 Foreign Exchange Convertibility and Controls Hard currencies U.S. dollar, euro, British pound, Japanese yen Soft currencies developing countries Countries can control convertibility through licenses multiple exchange rate systems advance import deposits quantity controls 10-

53 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 10-

54 Exchange Rates and Interest Rates The Fisher Effect links inflation and interest rates The International Fisher Effect (IFE) links interest rates and exchange rates Other Factors in Exchange Rate Determination confidence information 10-

55 Forecasting Exchange Rate Movements Learning Objective 5: To show how managers try to forecast exchange-rate movements 10-

56 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 10-

57 Fundamental Factors to Monitor Monitor The institutional setting Fundamental analyses Confidence factors Events Technical analyses 10-

58 Business Implications of Exchange Rate Changes Learning Objective 6: To explain how exchange rate movements influence business decisions 10-

59 Business Implications of Exchange Rate Changes Marketing Decisions when the value of a country s currency rises, exporting becomes more difficult as the product becomes more expensive in foreign markets Production Decisions 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 10-

60 The Future: The Dollar, The Europe Euro, The Yen, The Yuan 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 Asia China is moving forward to establish the yuan as a major world currency Latin America emerging market currencies should strengthen as commodity prices recover 10-