Lesson:

Foreign Exchange Market

PBL
Mexican based company with sales in Latin America, North America and West
Europe. Sells products made mostly in Latin America.

Headquarters plans to expand its sales to even more countries. They need to
know if viable.

Its Net Income is unstable even though its EBITDA is healthy and steadily
growing.

For this purpose it has asked its financial department to elaborate a budget. To
see where they stand on future cash flow and elaborate a CAPEX program.
 ● 8th-9th semester
Audience ● International Finance
Objective

To understand when and how to use the Foreign Exchange Market

For different purposes

With different instruments

 ● Functions

● Players

Materials ● Market size and transactions

● Exchange rates and quotes

● Spot and Forward

Foreign Exchange Market

The market in which participants are able to buy, sell, exchange and
speculate on currencies.

Because of its size and liquidity, it's believed to be the most efficient
financial market.

NOT a single market. Global network of computers.

Read more: Foreign Exchange Markets - Forex - Investopedia Definition | Investopedia
http://www.investopedia.com/terms/forex/f/foreign-exchange-markets.asp#ixzz3whbd9glZ
Foreign Exchange Market

The foreign exchange market (forex, FX, or currency market) is a global decentralized
market for the trading of currencies. This includes all aspects of buying, selling and
exchanging currencies at current or determined prices. In terms of volume of trading, it is
by far the largest market in the world.

The foreign exchange market works through financial institutions, and it operates on
several levels. Behind the scenes banks turn to a smaller number of financial firms known
as "dealers", who are actively involved in large quantities of foreign exchange trading.
Most foreign exchange dealers are banks, so this behind-the-scenes market is sometimes
called the "interbank market", although a few insurance companies and other kinds of
financial firms are involved. Trades between foreign exchange dealers can be very large,
involving hundreds of millions of dollars. Because of the sovereignty issue when involving
two currencies, forex has little (if any) supervisory entity regulating its actions.
Foreign Exchange Market
is Unique

● Its huge trading volume representing the largest asset class in the world leading to
high liquidity;
● Its geographical dispersion;
● Its continuous operation: 24 hours a day except weekends, i.e., trading from 22:00
GMT on Sunday (Sydney) until 22:00 GMT Friday (New York);
● The variety of factors that affect exchange rates;
● The low margins of relative profit compared with other markets of fixed income; and
● The use of leverage to enhance profit and loss margins and with respect to account
size.
Functions

Transfer: It transfers purchasing power between the countries involved in the transaction. This
function is performed through credit instruments like bills of foreign exchange, bank drafts and
telephonic transfers.

Credit: It provides credit for foreign trade. Bills of exchange, with maturity period of three months,
are generally used for international payments. Credit is required for this period in order to enable the
importer to take possession of goods, sell them and obtain money to pay off the bill.

Hedging: When exporters and importers enter into an agreement to sell and buy goods on some
future date at the current prices and exchange rate, it is called hedging. The purpose of hedging is to
avoid losses that might be caused due to exchange rate variations in the future.

http://www.yourarticlelibrary.com/macro-economics/balance-of-payment/foreign-exchange-market-meaning-functions-and-kinds/30428/
Players

● Banks
● Commercial companies
● Central banks
● Investment management firms
● Hedge funds
● Retail forex brokers and investors.
● UK 41%, US 19%, Singapore 5.7%, Japan 5.6% & HK 4.1%
Investopedia http://www.investopedia.com/terms/forex/f/foreign-exchange-markets.asp#ixzz3whbd9glZ
Bank for International Settlements http://www.bis.org/publ/rpfx13.htm
Top 10 Currency traders

https://en.wikipedia.org/wiki/Foreign_exchange_market#Market_participants
 Market size & transactions
Considered to be the largest financial market in the world.

Bank for International Settlements https://www.bis.org/statistics/rpfx19.htm

Top Most traded currencies by value

https://en.wikipedia.org/wiki/Template:Most_traded_currencies
International trade flows as % of GDP

● World: 56%
● Mexico: 78%
● Europe: 86%
● USA: 27%
● UK: 62%
● Volume of trade has grown over time for most countries
● https://data.worldbank.org/indicator/NE.TRD.GNFS.ZS?end=2017&name_
desc=false&start=2017&view=bar&year=2017
Balance of payments
International transactions for any given country on a given period of time. With
a double-entry bookkeeping (recorded as both credit and debit).

Current account = Capital Account + Financial Account

● Current account: goods & services, income from financial assets and
transfers (Eg. balance of trade).
● Capital account: Shifts in assets not current income (Eg. debt forgiveness,
transfers by immigrants, sale or purchase of rights).
● Financial account: Flow of funds resulting from sale of assets (Eg.
reserves, FDI, investments in securities).
US Balance of payments
Factors affecting international
trade flows

An increase in the following factors will decrease its current account:

● Inflation (more buying abroad)

● National income (more imports)
● Exchange rates: when country’s currency appreciates (less exports)

Additionally:

● Government restrictions: may impose tariffs (Trump tariffs, import

restrictions, subsidies to exporters, piracy restrictions, etc)
Factors affecting foreign direct investment

The following changes may improve FDI:

● Changes in restrictions (new opportunities may arise with barriers

removed)
● Privatization (selling government operations)
● Potential economic growth
● Tax (lower rates)
● Exchange rates (when expected to strengthen)
Factors affecting International Portfolio
Investment (IPI)

The following changes may improve IPI:

● Tax rates on interest or dividends (lower tax rates)

● Interest rates (when high)
● Exchange rates (when expected to strengthen)
Exchange rate and quotes
Function: MXN CURNCY GIP
Forwards

In finance, a forward contract or simply a forward is a

non-standardized contract between two parties to buy
or to sell an asset at a specified future time at a price
agreed upon today, making it a type of derivative
instrument.
Function:
MXN
CURNCY
FRD
“Education costs money, but
then so does ignorance” -
Claus Moser