FINANCIAL MARKETS

Phan Quynh Trang

FINANCIAL MARKETS

CHAPTER 7. FOREIGN EXCHANGE

MARKETS
 GOALS

1. Foreign exchange markets and foreign exchange rates

2. Spot foreign exchange transaction and forward foreign
exchange transaction; real and nominal exchange rates
3. Calculate return and risk on foreign exchange transactions.
4. Describe the role of financial institutions in foreign
exchange transactions; the relations among interest rates,
inflation, and exchange rates.
5. Explain how prices and inflation affect exchange rates in
the long run.
6. The supply of and demand for currencies; government
intervention in foreign exchange markets.
 INTRODUCTION

1. The euro is the name of the European Union’s (EU’s) single

currency
2. The use of a foreign currency in parallel to the local
currency is referred to as dollarization
3. Free floating Yuan
 FOREIGN EXCHANGE RATE

1. A foreign exchange rate is the price at which one currency

(e.g., the U.S. dollar) can be exchanged for another
currency (e.g., the Swiss franc)
 QUOTE

In the U.S (host country)

1. Direct quote: U.S dollar received for one unit of the foreign
currency exchanged
2. Indirect quote: foreign currency received for one unit of U.S
dollar
 QUOTE

In Vietnam (host country): VN dong received for one unit of

the foreign currency (U.S dollar) exchanged => direct or
indirect?
 FOREIGN EXCHANGE TRANSACTIONS

1. Spot foreign exchange transactions involve the immediate

exchange of currencies at the current (or spot) exchange rate
2. A forward foreign exchange transaction is the exchange of
currencies at a specified exchange rate (or forward
exchange rate) at some specified date in the future
FOREIGN EXCHANGE TRANSACTIONS
 RISK AND RETURN

Depreciation: a country’s currency falls in value relative to

other currencies

Appreciation: a country’s currency rises in value relative to

other currencies
 RISK AND RETURN

1. The risk involved with a spot foreign exchange transaction

is that the value of the foreign currency may change relative
to the U.S. dollar over a holding period
2. Hedging
 Forward
 On-balance-sheet
 FINANCIAL INSTITUTIONS

1. The purchase and sale of foreign currencies to allow

customers to partake in and complete international
commercial trade transactions.
2. The purchase and sale of foreign currencies to allow
customers (or the financial institution itself) to take
positions in foreign real and financial investments.
3. The purchase and sale of foreign currencies for hedging
purposes to offset customer (or financial institution)
exposure in any given currency.
4. The purchase and sale of foreign currencies for speculative
purposes through forecasting or anticipating future
movements in foreign exchange rates.
 INFLATION, INTEREST RATE,
EXCHANGE RATE

1. Fisher effects
2. Purchasing power parity (PPP)
3. Interest rate parity (IRP)