Tài chính doanh nghiệp - Chapter 9: The foreign exchange market

Chapter 9:The Foreign Exchange MarketLecture Plan:Determination of exchange ratesForeign exchange quotationsSpot and forward ratesStructure and size of the foreign exchange marketEconomic theories of exchange rate determination Case: The Fall of the BahtFOREIGN EXCHANGE TRANSACTIONSthe foreign exchange rate is the price of one currency expressed in terms of another currency!AppreciationDepreciation1A$=US$ 0.551A$= US$ 0.601A$= US$ 0.50Determination of the exchange ratesPrice $A1 Sin $US 0.55 E D Quantity of $AFloating Currencies:Demand for the National CurrencyNation’s exporters paid in other hard currencies Foreign companies undertaking direct and portfolio investment in the nation’s economy"Bull" speculators in the nation’s currencyNation’s Central Bank(RBA) selling US$ and other hard currencies for the nation’s currencyForeign tourists visiting your country. Floating Currencies:Supply of the National CurrencyNation’s importers paying in US $, Yen etc.Domestic firms investing abroad "Bear" speculators in the national currencyNation’s central bank buying US $, Yen etc. Individual residents travelling overseasThe EUROBenefits:significant savings for businesses and individualseasier comparability of prices; more competitionboost to the development of a highly liquid pan-European capital marketmore investment options Drawbacks:national authorities lose control over monetary policyEU is not an “optimal currency area”SPOT TRANSACTIONSSpot transaction:is the purchase of FX with delivery and payment (referred to as settlement,on the following business day.The foreign exchange traders always quote:a bid (buy) and offer (sell) rateThe SPREAD is the difference between the bid and offer rates and is the margin on which the trader earns a profitMarket QuotationsDealers always “buy low” and “sell high”Selling rates and Buying rates are always from the perspective of the dealer/bank FORWARD TRANSACTIONSA FORWARD RATE is the price agreed on today for purchase or sale of foreign exchange at a future date.Usually agreed for less than 1 yearPremiums and Discounts: Forward quotations are either at a PREMIUM: forward >spotDISCOUNT:forward< spot Structure of the FX Market Large commercial banks deal at two levels:Retail:with bank customersInterbank(wholesale):with other domestic and foreign banksA third market, the FX futures/options market came into existence in the 1970’s with the inauguration of trading in foreign exchange futures and options by certain commodity and stock exchanges in the US,subsequently adopted by other financial centresFunctions of the Foreign Exchange MarketCurrency conversionReduction of foreign exchange riskStructure of the FX Market Large commercial banks deal at two levels:Retail:with bank customersInterbank(wholesale):with other domestic and foreign banksA third market, the FX futures/options market came into existence in the 1970’s with the inauguration of trading in foreign exchange futures and options by certain commodity and stock exchanges in the US,subsequently adopted by other financial centresGeographical distribution of global reported foreign exchange market turnover, %Share of traditional foreign exchange transactions in the total turnover, %.Economic theories of exchange rate determinationPrices and Exchange ratesThe Law of one priceThe Purchasing Power parity(PPP)Money supply and price inflationInterest rates and exchange ratesInvestor psychology and band wagon effectsFactors affecting the Australian dollar exchange rateRelative interest ratesCommodity prices and terms of tradeRelative inflation ratesThe external accountThe role of the Central BankThe Fall of the Baht