BASICS OF FOREIGN EXCHANGE MARKETS Team 2: Hunter Morris, Robert Dennis, Josh Gresh, Rachel Bryner, Mallory Banks, Lauren Stoney
BASICS OF FOREIGN EXCHANGE MARKETS
Team 2: Hunter Morris, Robert Dennis, Josh Gresh, Rachel Bryner, Mallory Banks, Lauren Stoney
EXCHANGE RATES
● Price of one currency in terms of another currency ● Example: 1 pound = $.89 US dollars: €.89/$ or $1.12/€● Appreciation of one currency means depreciation of the other currency● When calculating for exchange rates the currency you are valuing is always
your denominator
FOREIGN EXCHANGE MARKET
● Wholesale Markets● Retail Market● Never Sleeps● Pure Competition
SIX MARKETS● Spot Transactions● Outright Forwards● Foreign Exchange Swaps● Currency Swaps● Options & other products● Exchange traded Derivatives
MAJOR CURRENCIES ON EXCHANGE
MARKET
● USD: United States/Dollar● EUR: Euro Zone/ Euro● JPY: Japan/Yen● GBP: United Kingdom/Pound● CAD: Canada/Dollar● CHF: Switzerland/Franc● AUD: Australia/Dollar
PARTICIPANTS INFOREIGN EXCHANGE MARKET
● Foreign exchange market made up of three tiers:
○ Non-Financial Customers: Largest number of participants, lowest activity
○ Dealers and Other Financial Institutions: 91% of foreign exchange activity
○ Central Banks: Part of remaining 9% of foreign exchange transactions that is done between banks and large customers
EFFECTS OF FOREIGN EXCHANGE TRANSACTIONS ON NATION'S
MONETARY BASE
● When central banks buy or sell foreign currency, the transactions affect the size of the nation’s monetary base
● The line on the three-tier foreign exchange market represents the relationship between the central banks and monetary base
● The nation’s monetary base changes if it alters the size of the central bank’s balance sheet
CHECKING ACCOUNTS NEVER LEAVE THE COUNTRY
Foreign exchanges transactions are below the line transactions and do not affect the M2 money supply
SPOT FOREIGN EXCHANGE MARKET
Spot Markets - currencies are exchanged for immediate delivery (on the spot)
● Determines how much is paid to purchase or sell currencies for current delivery
● Changes in the exchange rates open and close opportunities for trade, investment, travel, and political gain.
● Execution of spot markets take two working days ● Foreign Exchange Market transactions are large and involve a transfer of
deposits between banks
BUYING AND SELLING FOREIGN EXCHANGE: BID AND ASK RATES
Bid Price = what the dealer is willing to pay for a currency.Ask Price = the rate at which a dealer will sell the same currency.
Example: EUR 1 = USD 1.30 / USD 1.40
● Ask Price: USD 1.40 (the higher price) is the cost to buy 1 Euro. Hunter wants to buy EUR 5,000, so he would have to pay the dealer USD 7,000.
● Bid Price: Josh, just back from Europe, needs to sell his EUR 5000 leftover from his trip. He can sell the Euros at the bid price of USD 1.30 (the lower price) and would receive USD 6,500 in exchange for his Euros.
Because of the bid-ask spread, the kiosk dealer is able to make a profit of USD 500 from this transaction (the difference between USD 7,000 and USD 6,500).
FORWARD EXCHANGE MARKETForward Exchange Market - Establishes prices today for the delivery of foreign exchange on a date in the future
● No cash flow effects until maturity● Is an over the counter market ● Uses the same dealers and financial institutions as spot market● Differs from spot market because actual exchange of currencies is
completed on a specific date in the future
REVIEW QUESTIONS