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FOREIGN EXCHANGE

MARKET
* Determination Of Foreign Exchange Rates
* Factors Affecting Foreign Exchange Rates
* Mechanics Of Foreign Exchange Market

DETERMINATION OF FOREIGN
EXCHANGE RATES

An exchange rate measures all the value of one unit of
currency in terms of units of another currency.

Example:

RM3.74 / USD 1.00
USD 0.27 / RM 1.00

 It would happen when home country people import/ buy good and services from foreign country. .Demand for a Foreign Currency  Referred also as supply of home currency.  Example: downward Demand sloping curve is a because Malaysian would be encouraged to purchase more US goods when the US dollar is worth less in ringgit.

Supply for a Foreign Currecny  Referred also as demand for home currency.  Positive relationship with the value of USD in term of RM and the Quantity of USD being supplied. .  Happens when foreigners import/buy goods and services from our country.

Equilibrium of Foreign Exchange  When the demand and supply curves combined. .  The primary function of foreign exchange is to transfer purchasing power of one currency to another and thereby facilitate international trade and investment. it will give us the exchange rate or price of foreign currency against the home currency.

Factors Affecting FOREX Rates Relative Inflation Rates Relative Interest Rates Factor Affecting FOREX Rates Relative Income Levels Government Control Expectations .

 Increase in Malaysia interest rate will invite foreign investment therefore supply of foreign currency will increase.  Ex: when Malaysia inflation increase.Factors Affecting FOREX Rates  RELATIVE INFLATION RATES The changes can affect international trade activities in the country.  .50 USD Appreciate USD1 = RM2. hence the demand for foreign currencies.  When Malaysia inflation demand for foreign products . Malaysian resident would desire less US bank deposits since Malaysia rate are now more attractive relative to US rate so.70   RELATIVE INTEREST RATE Assume that Malaysia interest rate while US interest rate remain constant  In this case.  Ex: RM appreciate . USD will appreciate (RM depreciate)  Ex: USD1 = RM2.USD depreciate. USD demand.

5. include: The imposition of foreign exchange barriers The imposition of foreign exchange trade barriers The imposition of capital flows/fund Intervening (buying & selling currencies) in the forex market. 4. .  Because. etc. bank negara Affecting macro variable such as inflation.  Supply USD = unchanged  Demand USD = because Malaysia demand more US goods   GOVERNMENT CONTROLS  1. Malaysia residents would demand for US goods. interest rate. reflecting increase in Malaysia income therefore demand USD. income level. 3.Factors Affecting FOREX Rates  RELATIVE INCOME LEVELS Assume that Malaysia income level substantially rises while the US income level remains unchanged. 2. Can influence equilibrium exchange rate in many ways. we would expect the equilibrium exchange rate of USD rises.

 This response places immediate downward pressure on the US dollars.Factors Affecting FOREX Rates  EXPECTATIONS  Forex market always react to any news that may have future effect.  Ex: news of a potential increase in US inflation rate may cause currency traders to sell US dollars. . anticipating a future decline in the dollar’s value.

24 hours a day follows the sun around the globe! .Mechanics of Foreign Exchange Market  FOREX market is an over-the-counter (OTC) market because trading does not take place in a central market place where buyers and sellers congregate. non bank dealers and FOREX market brokers.  It is open somewhere in the world 365 days a year.  Besides. FOREX market is a worldwide linkage of bank currency traders.  FOREX market is the largest financial market in the world by virtually any standard.

FOREX Market Participants International Central banks FOREX Bank brokers customers or banks dealers Non bank dealers .

Which are:  Spot Price  Forward Price  This quotes are for traders among dealers in the interbank market.PRICE/RATE QUOTATION  In FOREX market. there are 2 types of price rate. .

PRICE/RATE QUOTATION American Terms: number of U. $ per unit of foreign currency Example: SFr 1 = $0.8672 . S.

S.PRICE/RATE QUOTATION European Terms: number of foreign currency units per U.1531  . $ Example: $1 = SFr 1.

S.1531  . $ per unit of foreign currency  Example:  SFr1 = $0. S. $  Ex: $1 = SFr 1.PRICE/RATE QUOTATION  American Terms: Number of U.8672  European Terms:  Number of foreign currency units per U.

PRICE/RATE QUOTATION Direct Quotation: home currency price of foreign currency Example: (France) FF 3.3862 = 1 DM (Germany) DM 0.29531 = 1 FF .

PRICE/RATE QUOTATION Indirect Quotation: value of one unit of home currency in the foreign currency Example: (England) £1 = $ 1.6698 .

6510 Ask=RM3.THE BID-ASK SPREAD  BUY / BID price = price that banks willing to buy  SELL / ASK price = price that banks willing to sell  Example : RM 3. Bid=RM3.6510 .15 BID PRICE  Thus.6515 ASK PRICE .

15 Big figure REMEMBER!!  Banks will always buy low and sell high  Ask price always higher than Bid price  Banks always sell/buy foreign currency 2 digits of decimal is called small figure .THE BID-ASK SPREAD RM 3.6510 .

THE BID-ASK SPREAD  Banks make profit from the spread between the buying and selling price that is known as bid-ask spread  Also known of % cost of transferring X 100 Percent spread = Ask Price – Bid price Ask Price .

CROSS RATE  COMMON CURRENCY IS ON THE ONE UNIT SIDE  COMMON CURRENCY IS ON THE MANY UNITS SIDE  COMMON CURRENCY IS ON BOTH SIDES .

FOREX Market  There are two types of FOREX market:  The spot market – currencies are traded for immediate delivery. x 100 Percentage Change = New spot rate – old spot rate old spot rate  The forward market – contracts are made to buy/sell foreign currencies for future delivery . which within 2 business days after the transaction has been concluded.