International Business Exam 3

The Foreign Exchange Market

• Market for converting currency of one country into that of another country.

• Exchange rate is the rate at which one currency is converted into another.

• Future exchange rates cannot be accurately predicted.

• Foreign exchange market provides some insurance against foreign exchange risk

Businesses use the foreign exchange market to:

1. Convert payments received for its exports, income received from foreign investments, or income received from licensing agreements with foreign firms.

2. Make payment to a foreign company for its products or services in its country’s currency.

3. Invest cash for short terms in foreign money markets.

4. Engage in currency speculation.

Insuring against foreign exchange risk: spot exchange rates

• Rate at which a foreign exchange dealer converts one currency into another currency on a particular day.

• Change continually.

• Value determined by supply and demand.

Insuring against foreign exchange risk: forward exchange rates

• A forward exchange is when two parties agree to exchange currency and execute the deal at some specific date in the future.

• Exchange rates governing such future transactions are forward exchange rates.

• Usually quoted for 30, 90, and 180 days

Insuring against foreign exchange risk: currency swaps

• Simultaneous purchase and sale of a given amount of foreign exchange for two different value dates.

• Transacted between international businesses and their banks, between banks, and between governments.

• Common type: spot against forward.

Foreign Exchange Market

• Global network of banks, brokers, and foreign exchange dealers connected by electronic communications systems.

• Continues to grow rapidly.

• Most important trading centers are London (largest), New York, Zurich, Tokyo, and Singapore.

• In 2022, 88 percent of all foreign exchange transactions involved dollars on one side.

• After the dollar, the most important vehicle currencies were the euro (31 percent), the Japanese yen (17 percent), and the British pound (13 percent)