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Chapter 8
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall Chapter 8 - 1
Foreign Exchange and International Financial
Markets
Learning Objectives
• Describe how demand and supply affect the
price of foreign exchange
• Discuss the role of international banks in
the foreign-exchange market
• Learn how firms use the spot and forward
markets to settle international transactions
• Discuss arbitrage in foreign exchange
• Explore the international capital market
Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall Chapter 8 - 2
The Economics of Foreign Exchange
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Demand for Yen
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The demand for yen is
derived from foreigner’s
demand for Japanese
products
Supply of Yen
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The supply of yen is derived
from Japanese demand for
foreign products
The Market for Yen
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Equilibrium is reached when
supply and demand are
equal
Foreign Exchange Rate Quotes
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IndirectQuote
DirectQuote
Summary of Discussion
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Structure of the Foreign Exchange Market
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Currencies Involved in Foreign-Exchange Market Transactions
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The Role of Banks
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Foreign-Exchange Market
Speculation
and Arbitrage
Spread
Between Bid
and Ask Prices
Types of Markets
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Wholesa
le
Retail
Foreign-Exchange Clients
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• Commercial Customers
• Exchange-Rate Speculators
• Currency Arbitrageurs
Types of Currencies
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Convertible vs. Inconvertible
Summary of Discussion
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Spot and Forward Markets
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Types of Markets
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•Spot Market
•Forward Market
Futures Transactions
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•Swap Transactions
•Currency Futures
•Currency Options
Forward Pricing of Foreign Currency
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Current Price of
the British Pound (£)
Firm’s
Holdings
of
(£) Assets
Firm’s
Holdings
of
(£)
Liabilities•Selling at Forward
Discount
•Selling at Forward
Premium
Reduce Increase
Increase Reduce
Summary of Discussion
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Arbitrage and the Currency Market
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Arbitrage of Goods
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The Law of One Price
Buy in “Cheap”
Market
Sell in
“Expensive”
Market
Purchasing Power Parity
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PPP
Expensive
Market
Cheap
Market
Cost of
Currency “B”
Price of
Good “X”
Cost of
Currency “A”
Price of
Good “X”
Arbitrage of Money
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Professional Traders
Covered
Interest
Three-
Point
Two-
Point
Two-Point Arbitrage
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Risk-Free Profit
Three-Point Arbitrage
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$1 = ¥120
Sell $2, Get ¥240
Step 2
Step 1 Step 3
New York Tokyo
London
Gain£0.2
Covered-Interest Arbitrage
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Currencies of Two Countries
Interest Rate
Differences
Forward
Discount/Premi
um
≠
The International Fisher Effect
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Country’s Inflation
Rate
Expected to
Increase
Expected to
Decrease
Nomina
l
Interest
Forwar
d
Premiu
m
Forwar
d
Discou
nt
Higher Shrink Widen
Lower Widen Shrink
Summary of Discussion
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The International Capital Market
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The Eight Largest Banks
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Ran
k
Company Country Revenues
($Mil)
1 ING Group Netherlands 147,052
2 Bank of America United States 134,194
3 BNP Paribas France 128,726
4 J.P. Morgan Chase
& Co
United States 115,475
5 Citigroup United States 111,055
6 Crédit Agricole France 105,003
7 HSBC Holdings United
Kingdom
102,680
8 Banco Santander Spain 100,350
International Banking
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Correspondent
Relationship
Subsidiary
Bank
Affiliated BankBranch Bank
International Commercial Banking Services
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Everyday
Transactions
Currency
Exchange
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Mergers andAcquisitions
Long-TermDebt and Equity
Investment Banking
Eurocurrency Market
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Foreign Currency on Deposit
London Interbank Offer Rate
(LIBOR)
International Banking Facility
(IBF)
• Foreign Bonds
• Eurobonds
• Global Bonds
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The International Bond Market
Global Equity Markets
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•Capital Markets
•Country Funds
•Financial Services
Offshore Financial Centers
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Bahamas
Bahrain
Cayman Islands
Luxembourg
Bermuda
Netherlands
Antilles
Singapore
Switzerland
Summary of Discussion
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Chapter 8
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Foreign Exchange and International Financial
Markets
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