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CH 07
CH 07
CHAPTER OVERVIEW
I. II. INTRODUCTION ORGANIZATION OF THE FOREIGN EXCHANGE MARKET III. THE SPOT MARKET IV. THE FORWARD MARKET V. INTEREST RATE PARITY THEORY
PART I. INTRODUCTION
I. INTRODUCTION A. The Currency Market: where money denominated in one currency is bought and sold with money denominated in another currency.
INTRODUCTION B. International Trade and Capital Transactions: - facilitated with the ability to transfer purchasing power between countries
INTRODUCTION C. Location 1. OTC-type: no specific OTClocation 2. Most trades by phone, telex, or SWIFT SWIFT: Society for Worldwide
Interbank Financial Telecommunications
I . PARTICIPANTS IN THE FOREIGN EXCHANGE MARKET A. Participants at 2 Levels 1. Wholesale Level (95%) - major banks 2. Retail Level - business customers.
ORGANIZATION OF THE FOREIGN EXCHANGE MARKET B. Two Types of Currency Markets 1. Spot Market: - immediate transaction - recorded by 2nd business day
ORGANIZATION OF THE FOREIGN EXCHANGE MARKET 2. Forward Market: - transactions take place at a specified future date
ORGANIZATION OF THE FOREIGN EXCHANGE MARKET C. Participants by Market 1. Spot Market a. commercial banks b. brokers c. customers of commercial and central banks
ORGANIZATION OF THE FOREIGN EXCHANGE MARKET 2. Forward Market a. arbitrageurs b. traders c. hedgers d. speculators
ORGANIZATION OF THE FOREIGN EXCHANGE MARKET II. CLEARING SYSTEMS A. Clearing House Interbank Payments System (CHIPS) - used in U.S. for electronic fund transfers.
ORGANIZATION OF THE FOREIGN EXCHANGE MARKET B. FedWire - operated by the Fed - used for domestic transfers
ORGANIZATION OF THE FOREIGN EXCHANGE MARKET III. ELECTRONIC TRADING A. Automated Trading - genuine screen-based screenmarket
ORGANIZATION OF THE FOREIGN EXCHANGE MARKET B. Results: 1. 2. 3. Reduces cost of trading Threatens traders oligopoly of information Provides liquidity
ORGANIZATION OF THE FOREIGN EXCHANGE MARKET IV. SIZE OF THE MARKET A. Largest in the world 1995: $1.2 trillion daily
ORGANIZATION OF THE FOREIGN EXCHANGE MARKET B. Market Centers (1995): London = $464 billion daily New York= $244 billion daily Tokyo = $161 billion daily
b.
European terms
example: dm1.713/$
EXAMPLE: dm0.25/FF
3.
1. Date monies are due 2. 2nd Working day after date of original transaction.
b.
2.
PART IV. INTEREST RATE PARITY THEORY I. INTRODUCTION A. The Theory states: the forward rate (F) differs from the spot rate (S) at equilibrium by an amount equal to the interest differential (rh - rf) between two countries.