Flashcards in FINC 327 Chapter 3: International Finc markets Deck (38)
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
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
bank buying currency at low
bank selling currency at high
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= (Ask rate - Bid rate) / Ask rate
The spread is normally larger for
illiquid currencies that are less frequently traded.
Order costs are the costs of processing orders; these costs include clearing costs and the costs of recording transactions.
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.
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.
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
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
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.
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