The Foreign Exchange Market

International Business (MB 92)

The Foreign Exchange Market

Characteristics24 Hour Global OTC Market

Principal CentersTokyo London New York

Volume: $1.3 trillion daily, up from $100 billion in the 1980sMain Participants

UsersMarket Makers

ParticipantsUsers

MultinationalsInstitutional InvestorsSpeculators—92% of the daily market activity driven by speculationTrading CompaniesIndividuals

Market MakersCommercial BanksInvestment BanksCentral BanksExchanges

Major Trading CentersPercentage of Market

London 32%New York 18%Tokyo 8%Singapore 7%

Europe 55%Asia 26%North America 19%

Currency Composition% of Average Daily Turnover

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Other currencies

ECU and EMS Currencies

Australian dollar

Canadian dollar

Sw iss Franc

French Franc

Pound sterling

Japanese yen

Deutsche mark

US Dollar

Types of Instruments in the FX Market

% of Average Daily Turnover

Forw ards56%

Spot37%

Futures1%

Currency sw aps5%

Options1%

Types of Foreign Exchange Trades

Spot Trade--The Standard TradeFor delivery of currency bought and sold

two business days from trade dateForward Trade

For delivery of both currencies more than two business days from trade dateSwap Trade

Simultaneous buying and selling of a currency with different maturities (usually from spot to a forward date)

Exchange Rate Quotations

“Direct,” “American,” or “Normal Quotations¥1 = $0.007547THB1 = $0.02265

Price of domestic currency per unit of foreign currency“Indirect,” “European,” “Reciprocal”, or “Volume” Quoatations

$1 = ¥132.50$1= THB44.15

Effectively quotes the volume of foreign currency purchased by fixed quantity of domestic currency

Currency PricesSpot

Agree on price today, settle two business days later

Bid Offer

Yen per US $ 134.42 134.60Trader Buys US $ Sells US $Client Sells US $ Buys US $Thai Baht/$ 44.15 44.19Trader Buys US $ Sells US $Client Sells US $ Buys US $

Currency Prices

Bid Offer

U.S. Dollar/¥0.007541 0.007547Trader Buys ¥ Sells ¥Client Sells ¥ Buys

¥U.S. Dollar/THB 0.02263 0.02265Trader Buys THB Sells THBClient Sells THB Buys THB

Exchange Rate Determination

Meaning of Exchange RateAppreciation/Depreciation of a CurrencyDetermination of Exchange Rates—Forces of Demand and SupplyFactors that influence exchange rates

Inflation RatesInterest RatesIncome LevelsGovernment Controls

Exchange Rate Systems

Fixed Exchange Rate SystemsFloating Exchange Rate SystemsManaged FloatPegged Exchange Rate Systems