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Foreign Exchange

and International
Financial

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Markets

Griffin & Pustay


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Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall

International Business, 6th Edition

chapter 8

Chapter Objectives
Describe how demand and supply
determine the price of foreign exchange
Discuss the role of international banks in
the foreign-exchange market
Assess the different ways firms can use
the spot and forward markets to settle
international transactions

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Chapter Objectives (continued)


Summarize the role of arbitrage in the
foreign-exchange market
Discuss the important aspects of the
international capital market

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Foreign Exchange
Foreign exchange is a commodity
that consists of currencies issued by
countries other than ones own.

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Figure 8.1 Demand for Yen

Demand for
Japanese yen is
derived from
foreigners demand
for Japanese
products

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Figure 8.2 Supply of Yen

Supply for
Japanese yen is
derived from
Japanese
demand for
foreign products

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Figure 8.3 The Market for Yen

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Foreign-Exchange Rates
Direct exchange rate
Direct quote
Price of the foreign currency in terms of home
currency

Indirect exchange rate


Indirect quote
Price of the home country in terms of the foreign
currency

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Figure 8.4 Direct and Indirect


Exchange Rates

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Structure of the Foreign-Exchange


Markets
The foreign-exchange market
comprises buyers and sellers of
currencies issued by the worlds
countries.

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Foreign-Exchange Trading
The largest center for foreign
exchange trading is London, followed
by New York and Tokyo.

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Figure 8.5 Currencies Involved in ForeignExchange Market Transactions

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The Role of Banks


Buy or sell major traded currencies
Markets
Wholesale market
Retail market

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Map 8.1 A Day of


Foreign-Exchange Trading

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Bank Foreign Exchange Clients

Commercial customers
Speculators
Arbitrageurs

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Foreign-Exchange Trading
The Tel Aviv
foreignexchange
trader is an
important link
in the $3.2
trillion-per-day
global
exchange
market.
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Spot and Forward Markets


Spot Market: foreign exchange
transactions that are consummated
immediately
Forward Market: foreign exchange
transactions that are to occur
sometime in the future

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Spot and Forward Markets

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Mechanisms for Future Foreign


Exchanges
Currency future
Currency option
Call option
Put option

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Arbitrage
Arbitrage is the riskless purchase of
a product in one market for
immediate resale in a second market
in order to profit from a price
discrepancy. There are two types of
arbitrage activities that affect the
foreign-exchange market: arbitrage
of goods and arbitrage of money.
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Arbitrage

Arbitrage
of Goods

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Arbitrage
of Money

Arbitrage of Money

Two-point

Three-point

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Covered-interest

Figure 8.6
Three-Point Arbitrage

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International Capital Market


Major International Banks
International Bond Market
Global Equity Markets
Offshore Financial Centers

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Table 8.1 The Worlds Largest Banks


ING Group

BNP Paribas

Fortis

Credit Agricole

Citigroup

Deutsche Bank

Dexia Group

Bank of America
Corp.

HSBC Holding

HBOS

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Establishment of Overseas
Banking Operations

Subsidiary bank

Branch bank

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Affiliated bank

The Eurocurrency Market


Originated in the early 1950s
Eurodollars U.S. dollars deposited in
European bank accounts
Euroyen
Europounds

Eurocurrency currency on deposit outside


in banks worldwide
Euroloans quoted on basis of LIBOR
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The International Bond Market


Major source of debt financing for:
Worlds governments
International organizations
Larger firms

Two types of bonds


Foreign bonds
Eurobonds
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Figure 8.7 International Bond Issues


2007, by Currency (in billions of U.S. dollars)

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Global Equity Markets


Start-up companies are no longer
restricted to raising new equity only
from domestic sources
Development of country funds
Mutual fund specializing in a given
countrys funds

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Offshore Financial Centers


Focus on offering banking and other
financial services to nonresident
customers
Locations
Bahamas, Bahrain, the Cayman Islands,
Bermuda, the Netherlands Antilles,
Singapore, Luxembourg, Switzerland

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photocopying, recording, or otherwise, without the prior
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States of America.

Copyright 2010 Pearson Education, Inc.


publishing as Prentice Hall

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