dr katarzyna sum chair of international finance warsaw school of economics
DESCRIPTION
Dr Katarzyna Sum Chair of International Finance Warsaw School of Economics. INTERNATIONAL FINANCE. Getting started. Slides available for download: http://akson.sgh.waw.pl/~ksum/ Contact: [email protected] Office hours: Tuesday 01.30-02.30 PM, room 20M. - PowerPoint PPT PresentationTRANSCRIPT
International Finance 130440-1165
Dr Katarzyna SumChair of International FinanceWarsaw School of Economics
INTERNATIONAL FINANCE
International Finance 130440-1165
Getting started
Slides available for download:
http://akson.sgh.waw.pl/~ksum/
Contact:[email protected]
Office hours:Tuesday 01.30-02.30 PM, room 20M
International Finance 130440-1165
International Finance 130440-1165
Final note
A multiple choice test
The scope of test - according to the
syllabus available on
http://akson.sgh.waw.pl/~ksum/
International Finance 130440-1165
International Finance 130440-1165
Broad lecture outline
The foreign exchange market The balance of payments International monetary system
International Finance 130440-1165
International Finance 130440-1165
Basic literature
P. Krugman, M.Obstfeld, International economics: theory and policy.Part II, Pearson, Addison Wesley, Boston 2009.
F. Mishkin, The economics of money banking and
financial markets, 8e., Prentice Hall, 2007
International Finance 130440-1165
International Finance 130440-1165
Financial markets-classification and functions
The notion of financial markets Classification, instruments, participants Current developments The FX market and the derivatives
market
International Finance 130440-1165
International Finance 130440-1165
The notion of financial markets
Financial markets enable the flow of savings from households to companies
Allocation of savings Offering instruments enabling financial
management
International Finance 130440-1165
International Finance 130440-1165
Classification
Money market Capital market Foreign exchange market Derivatives market
International Finance 130440-1165
International Finance 130440-1165
Spot and forward market
Spot- transaction within 2 working days-
primary intruments
Forward: transaction within 30,90 or 180 days- derivatives
International Finance 130440-1165
International Finance 130440-1165
International Finance 130440-1165
International Finance 130440-1165
Money market
Enables liquidity management of several institutions
Short term borrowing and lending (up to 1 year)
Participants- banks
International Finance 130440-1165
International Finance 130440-1165
Money market
Short term (few days-3 months) repo – conducting two contrary transactions on
the spot and the forward market
Long term (3 months-1 year) treasury bills- issued by governements certificates of deposits- issued by banks commercial papers- issued by companies
International Finance 130440-1165
International Finance 130440-1165
Capital market
Enables participants to allocate or gain capital
Long term fundraising Stock and bond market Participants:
stock market- issuers (companies) and shareholders (institutional and private investors)
bond market- issuers (governements or
companies), banks
International Finance 130440-1165
International Finance 130440-1165
Foreign exchange market
Enables currency exchange in order to conduct international trade, enables also currency investment trade
Participants: commercial banks, central banks, companies,
hedge funds, investment funds
acting as hedgers, arbitrageurs, speculators
International Finance 130440-1165
International Finance 130440-1165
Foreign exchange market
Spot transactionsCurrency futuresCurrency/ FX swaps Currency options
International Finance 130440-1165
International Finance 130440-1165
Derivatives market
Enables institutions to hedge the risk of changes in security prices and exchange rates
The price derives from the value of the underlying instrument
Participants: commercial banks, central banks, companies,
hedge funds, investment funds
acting as hedgers, arbitrageurs, speculators
International Finance 130440-1165
International Finance 130440-1165
Derivatives market
Forward transactions
Swaps
Options
International Finance 130440-1165
International Finance 130440-1165
Financial market intermediaries
Commercial banks
Investment banks
Investment funds and insurance companies
Hedge fundsInternational Finance
130440-1165
International Finance 130440-1165
Raising capital- banks vs FM
Financial markets are able to take higher risks than banks
Lower risk premium + no colleteral needed lower cost of fundraising at the financial markets
Financial markets are more future oriented than banks
Monitoring the efficiency of the borrower
International Finance 130440-1165
International Finance 130440-1165
Current issues
Growing liquidity Growing importance of the derivatives
market Growing importance of capital markets
International Finance 130440-1165
International Finance 130440-1165
Growing liquidity
Capital flow liberalisation IT progress New instruments and products New methods of risk management
International Finance 130440-1165
International Finance 130440-1165
Growing importance of derivatives market
The need of new risk hedging techniques
Basic and structurized instruments
Growing role of speculation
International Finance 130440-1165
International Finance 130440-1165
Growing importance of capital markets
Shrinking role of banks as financial intermediary
Growing role of bond issuance
Growing role of stock market transactions
International Finance 130440-1165
International Finance 130440-1165
FX market- daily turnover
Source: BIS
0
500
1000
1500
2000
2500
3000
3500
4000
4500
1992 1995 1998 2001 2004 2007 2010
billions USD
International Finance 130440-1165
International Finance 130440-1165
FX market- numbers
10% of the transactions related to trade, 90% speculation
Financial centres:
London 36% of global transactions Nowy Jork 18% of global transactions Tokio 6% of global transactions
International Finance 130440-1165
International Finance 130440-1165
FX market- numbers
Spot turnover 37% of the whole turnover 48% growth during 2007-2010
Forward turnover 63% of the whole turnover 7% growth during 2007-2010
International Finance 130440-1165
International Finance 130440-1165
Market participants
Hedgers
Arbitrageurs
Speculators
International Finance 130440-1165
International Finance 130440-1165
Market participants
Hedging- taking a bet on price changes or buying „insurance” against price changes
Speculation and arbitrage- looking for extraordinary gains
International Finance 130440-1165
International Finance 130440-1165
Turnover by instrument
Source: BIS
International Finance 130440-1165
International Finance 130440-1165
FX swaps
an instrument being a contract for exchanging one currency against another at the spot ER parallely aggreeing on a reversed transaction at the forward ER in the future
betting on ER changes
Example:
a company wants to invest an amount of USD in bonds denominated in EUR knowing to be needing USD back in 3 months
International Finance 130440-1165
International Finance 130440-1165
Currency futures
An instrument being a contract for exchanging one currency for another at a specified date in the future at a specified ER
Betting on ER changes
Example:
arbitrageurs expecting high volatility of the spot ER
International Finance 130440-1165
International Finance 130440-1165
Currency options
An instrument which gives the owner the right but no
obligation to buy or sell an amount of foreign currency at
a specified ER
„Insurance” against potential losses
Put and call options
The option issuer is obliged to buy or sell the foreign
currency if the owner wishes to execute his right
International Finance 130440-1165
International Finance 130440-1165
Currency options
Example:
Receiving payments in foreign currency at an unspecified date- put option
Settling payments in a foreign currency at an unspecified date- call option
Popular for commercial banks and institutions managing large investments abroad due to high market risk exposure
International Finance 130440-1165
International Finance 130440-1165
Derivatives- daily turnover
Source: BIS
0
500
1000
1500
2000
2500
3000
3500
4000
4500
5000
1998 2001 2004 2007 2010
billions USD
International Finance 130440-1165
International Finance 130440-1165
Participants
Hedgers
Arbitrageurs
Speculators
International Finance 130440-1165
International Finance 130440-1165
Instruments
Forward transactions
Swaps
Options
International Finance 130440-1165
International Finance 130440-1165
Interest rate derivatives market
Forward rate agreement
Interest rate swap
Interest rate options
International Finance 130440-1165
International Finance 130440-1165
Daily derivatives market turnover by instrument
Source: BIS
International Finance 130440-1165
International Finance 130440-1165
FRA
Forward rate agreement- an instrument being a contract
for settling the difference between the forward rate at
the day of signing the contract and the interest rate on
the day of the settlement of the contract
Example:
having 3 months bonds and hedging the risk of their
value decrease by signing a FRA contract
International Finance 130440-1165
International Finance 130440-1165
IRS
Interest rate swap- an instrument being a contract for
settling periodically interest rate differences between the
long term interest rate at the day of signing the contract
and the short term interest rate in the next periods
Example:
the purchase of 5 year bonds financed through a 3
months loan- hegding the risk of their price decrease
International Finance 130440-1165
International Finance 130440-1165
Interest rate options
Higher cost than other derivatives
We actually have to buy the „insurance” against price changes
In practice- investors buying and issuing options at the same time
International Finance 130440-1165
International Finance 130440-1165
Arbitrage
F-S/S>i*t/360 or
F-S/S<i*t/360
Arbitrage
F-S/S=i*t/360
The price difference reflects the interest rate
The prices on the spot and forward market change
paralelly!
International Finance 130440-1165
International Finance 130440-1165
Spot and forward on the FX market
Premium FR> SR
Discount FR<SR
Slower fluctuations of FR than SR
International Finance 130440-1165
International Finance 130440-1165
Speculation
The possibility to apply leverages
Low collateral needed
Daily settling of transactions
Larger risks and potential gains and losses
International Finance 130440-1165
International Finance 130440-1165
Derivatives-problems
Misusage of derivatives
Wrong risk ditribution on FM
Wrong assesment of risks
Eg. Currency options during the crisis
International Finance 130440-1165
International Finance 130440-1165
Summing up
Financial marktes enable the flow of
savings from households to comapnies
Raising capital on financial markets may
be avantagous vs banks
International Finance 130440-1165
International Finance 130440-1165
Summing up
Currently-growing liquidity of the financial markets
Currently- growing importance of the derivatives market
Currently-growing imoprtance of capital markets
International Finance 130440-1165
International Finance 130440-1165
Summing up
The largest turnover on derivatives market
A large amount currency market derivatives
Only 10% related to trade
Derivatives can be usufull intruments provided
there is proper risk assesment
International Finance 130440-1165
International Finance 130440-1165
References
P. Krugman, M.Obstfeld, International economics: theory and
policy.Part II, Pearson, Addison Wesley, Boston 2009
F. Mishkin, The economics of money banking and financial
markets, 8e., Prentice Hall, 2007
A. Sławiński, Rynki finansowe, PWE, Warszawa 2006.
Triennial Central Bank Survey, Foreign exchange and derivatives
market activity in April 2010, Monetary and Economic Department,
Bank of International Settlements, 2010
International Finance 130440-1165