FINC 327 Chapter 3: International Finc markets Flashcards Preview

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Flashcards in FINC 327 Chapter 3: International Finc markets Deck (38)
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foreign exchange market

exchange of one currency for another


Foreign exchange dealers serve

intermediaries in the foreign exchange market by exchanging currencies desired by MNCs or individuals Large foreign exchange dealers include CitiFX (a subsidiary of Citigroup), JPMorgan Chase


interbank market

If a bank begins to experience a shortage of a particular foreign currency, it can purchase that currency from other banks.
This is trading between banks


Spot Market Liquidity

The more buyers and sellers there are, the more liquid a market is. The spot markets for heavily traded currencies such as the euro, the pound, and the yen are extremely liquid.

If a currency is illiquid, then the number of willing buyers and sellers is limited and so an MNC may be unable to purchase or sell that currency in a timely fashion and at a reasonable
exchange rate.


bid price

bank buying currency at low


ask price

bank selling currency at high


bid/ask spread

The difference between the bid and ask prices is known as the bid/ask spread, which is meant to cover the costs associated with fulfilling requests to exchange currencies. The bid/ask
spread is normally expressed as a percentage of the ask quote.


spread equation

Spread= (Ask rate - Bid rate) / Ask rate


The spread is normally larger for

illiquid currencies that are less frequently traded.


Order costs.

Order costs are the costs of processing orders; these costs include clearing costs and the costs of recording transactions.


Inventory costs.

Inventory costs are the costs of maintaining an inventory of a particular currency. Holding an inventory involves an opportunity cost because the funds could have been used for some other purpose.
If interest rates are relatively high, then the opportunity cost of holding an inventory should be relatively high.
The higher the inventory costs, the larger the spread that will be established to cover these costs.



The more intense the competition, the smaller the spread quoted by intermediaries.
it has forced dealers to reduce their spread in order to remain competitive.



Currencies that are more liquid are less likely to experience a sudden change in price. Currencies that have a large trading volume are more liquid because there are numerous buyers and sellers at any given time.


Currency risk.

Some currencies exhibit more volatility than others because of economic or political conditions that cause the demand for and supply of the currency to change abruptly. For example, currencies in countries that have frequent political
crises are subject to sudden price movements. Intermediaries that are willing to buy or sell these currencies could incur large losses due to such changes in their value.



The area containing the countries that have adopted the euro is referred to as the eurozone. Currently, the eurozone encompasses 17 European countries.


direct quotations

Quotations that report the value of a foreign currency in dollars (number of dollars per unit of other currency)
in terms of your home currency


indirect quotations

quotations that report the number of units of a foreign currency per dollar


if a currency’s direct exchange rate is rising over time, then its indirect exchange rate

must be declining over time (and vice versa).


cross exchange rate

reflects the amount of one foreign currency per unit of another foreign currency


forward contract

an agreement between an MNC and a foreign exchange dealer that specifies the currencies to be exchanged, the exchange rate, and the date at which the transaction will occur.


forward rate

exchange rate, specified in the forward contract, at which the currencies will be exchanged



dollar deposits in banks in Europe/ foreign countries



UK pound deposits in banks in foreign countries



Euro deposits in banks in foreign countries



Yen deposits in banks in foreign countries



LIBOR (London interbank offer rate) is the rate of interest at which banks in Europe lend to each other. It is used as a base from which loan rates on other loans are determined in the Eurocredit market.
The London Interbank Offer Rate (LIBOR) is the rate most often charged for very short-term loans (such as for one day) between banks.
As the supply and demand for funds changes, so does the LIBOR


money market interest rates

-- depend on the demand for short-term funds by borrowers relative to the supply of short-term funds
--a country that experiences both a high demand for and a small supply of short-term funds will have relatively high money market interest rates
---Money market rates tend to be higher in developing
countries because they experience higher rates of growth and so more funds are needed (relative to the available supply) to finance that growth


international money market securities

When MNCs and government agencies issue debt securities with a short-term maturity (one year or less) in the international money market


Eurocredits or Eurocredit loans

Loans of one year or longer that are extended by banks to MNCs or government agencies in Europe are commonly called Eurocredits or Eurocredit loans


A loan denominated in the currency of a country with very low inflation

normally has a relatively low interest rate