Topic 8: Foreign Exchange Markets

floating exchange rate

an exchange rate determined by the supply & demand factors in the FX markets

pegged exchange rate

the value of the pegged currency is tied to the value of another currency or a basket of currencies

one of the key factors that explains exchange rate fluctuations

a country's balance of payments

what is the balance of the current account before accounting for the transfer component generally referred to as?

the balance of trade

2 types of international deposits in eurocurrency markets

time deposits (non-negotiable) and CSs (negotiable)

What are the two kinds of international markets to facilitate international markets?

The international money and capital markets which provide the market for credit & the foreign exchange markets which deal in the means of payment.

What is an exchange rate?

the rate at which one nation's currency can be exchanged for another's at the present time

What is the first currency in the quote called?

base currency (e.g. EUR/USD, Euro is base currency.)

What is the second currency in the quote called?

terms currency

What is a direct quote?

if the base currency is a foreign currency and the terms currency is the domestic currency

what is an indirect quote?

if the base currency is the domestic currency and the terms currency is the foreign currency

Bid

Dealer buys base currency

Ask (offer)

dealer sells base currency

Appreciation

currency increases in value. it costs more to buy that currency

Depreciation

currency falls in value. It costs less to buy that currency

When a country's currency appreaciates

the countries goods abroad become more expensive and foreign goods in that country become cheaper

bretton wood system (1944-1971 international monetary system)

fix their e/r relative to the USD. then 35 dollars could be exchanged for an ounce of gold.

fixed exchange rate

a constant rate of exchange between currencies

managed float

an exchange rate that is allowed to float or move within a defined or set band relative to another currency

crawling peg

a managed float where an exchange rate is allowed to appreciate in controlled steps over time

what is the primary function of foreign exchange markets?

to facilitate the transfer of purchasing power from those who deal in one currency to those who deal in another

is the foreign exchange market an over the counter market?

Yes

Spot market

the market in which foreign exchange is sold or purchased on the spot

forward market

market in which parties agree to exchange a fixed amount of one currency for a fixed amount of a secondary currency, but actual delivery & exchange of the two currencies occurs at some time forward.

FX swap

one currency is purchased (or sold) in a spot transaction and subsequently sold (or purchased) in a forward transaction

what is the balance of payments

set of accounts that summarises a country's international balance of trade (exports less imports) and the payments to and receipts from foreigners

what sign is a payment to foreigners given in BOP (a debit)

negative

what sign is a receipt from foreigners given in BOP (credit)

positive

Under BOP, what are the two types of international transactions

Current account & capital account (financial account)

current account

transactions that involve the import or export of goods and services or transfers (without a service)

Capital account (financial account)

transactions that involve the purchase or sale of assets

three components of the current account

net exchange (exports minus imports), net exchange of services, net transfers to and from the country

what does a current account deficit mean

we a spending more than we are earning overseas (we import more than we export)

5 factors which may cause changes in demand for exports/imports

relative prices, barriers to trade, resource endowments, tastes, productivity.

What are Eurodollars?

US-dollar denominated deposits held in banks outside of the US

What are Euroyen?

Yen denominated deposits held by banks located outside of Japan

where was the worlds financial heart before WW2

London

5 historic causes of Eurocurrency market growth

Liberalization of trade and exchange, US trade deficit, political risk, UK capital controls and restricitons, US capital controls and restrictions

3 functions of eurocurrency markets

A source of working capital for multinational firms at comepetitive rates, storehoouses for excess liquidity, facilitate international trade

LIBOR

London Interbank Offered Rate

What was LIBOR

an interest rate average calculated from estimates submitted by the leading banks in London

SOFR

Secured overnight financing rate

SONIA

Sterling overnight index average

eurobond market

market for long term borrowing or lending of large amounts of capital in the form of Eurobonds.