foundations of multinational financial...
TRANSCRIPT
1
Foundations of Multinational Financial Management
Alan Shapiro
John Wiley & Sons
Power Points by
Joseph F. Greco, Ph.D.
California State University, Fullerton
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The Foreign Exchange Markets
Chapter 6
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CHAPTER OVERVIEW
6.1 ORGANIZATION OF THE FOREIGN EXCHANGE MARKET
6.2 THE SPOT MARKET
6.3 THE FORWARD MARKET
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PART I. INTRODUCTION
I. INTRODUCTION
A. The Market:
the place where money denominated in one currency is bought and sold with money denominated in another currency.
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INTRODUCTION
B. International Trade and Capital Transactions:
- facilitated with the ability
to transfer purchasing power
between countries
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INTRODUCTION
C. Location
1. OTC-type: no specific location
2. Most trades by phone,
telex, or SWIFT*
*SWIFT: Society for Worldwide Interbank
Financial Telecommunications
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PART II.ORGANIZATION OF THE FOREIGN
EXCHANGE MARKET
I . PARTICIPANTS IN THE FOREIGN EXCHANGE MARKET
A. Participants at 2 Levels
1. Wholesale Level (95%)
- major banks
2. Retail Level- banks deal with
business customers.
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ORGANIZATION OF THE FOREIGN EXCHANGE MARKET
B. Two Types of Currency Markets
1. Spot Market:
- immediate transaction
- recorded by 2nd business day
2. Forward Market:
- transactions take place at a specified future date
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ORGANIZATION OF THE FOREIGN EXCHANGE MARKET
C. Participants by Market
1. Spot Market
a. commercial banks
b. brokers
c. customers of commercial and central banks
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ORGANIZATION OF THE FOREIGN EXCHANGE MARKET
2. Forward Market
a. arbitrageurs
b. traders
c. hedgers
d. speculators
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ORGANIZATION OF THE FOREIGN EXCHANGE MARKET
II. CLEARING SYSTEMS
A. Clearing House Interbank Payments System ( CHIPS)
- used in U.S. for electronic
fund transfers.
B. FedWire- operated by the Fed- used for domestic transfers
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ORGANIZATION OF THE FOREIGN EXCHANGE MARKET
III. ELECTRONIC TRADING
A. Automated Trading
- genuine screen-based market
B. Results:
1. Reduces cost of trading2. Threatens traders’
oligopoly of information 3. Provides liquidity
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ORGANIZATION OF THE FOREIGN EXCHANGE MARKET
IV. SIZE OF THE MARKET
A. Largest in the world
1995: $1.2 trillion daily
B. Market Centers (1995):
London = $464 billion daily
New York= $244 billion daily
Tokyo = $161 billion daily
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PART III.THE SPOT MARKET
I. SPOT QUOTATIONS
A. Sources
1. All major newspapers
2. Major currencies have four different quotes:a. spot priceb. 30-dayc. 90-dayd. 180-day
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THE SPOT MARKET
B. Method of Quotation
1. For interbank dollar trades:
a. American terms
example: $.5838/dm
b. European terms
example: dm1.713/$
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THE SPOT MARKET
2. For nonbank customers:
Direct quote
gives the home currency price of one unit of foreign
currency.
EXAMPLE:dm0.25/FF
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THE SPOT MARKET
C. Transactions Costs
1. Bid-Ask Spreadused to calculate the feecharged by the bank
2. Bid = the price at which the bank is willing to buy
3. Ask = the price it will sellthe currency
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THE SPOT MARKET
4. Percent Spread Formula:
Percent Spread = (Ask-Bid)/Ask x 100
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THE SPOT MARKET
D. Cross Rates
1. The exchange rate between 2 non-US$ currencies.
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THE SPOT MARKET
2. Calculating Cross RatesWhen you want to know what the dm/pound cross rate is, and youknow dm2/US$ and .55pounds/US$,
then
dm/pounds =
*dm2/US$ ÷÷÷÷ .55 pounds/US$
= dm3.60/ pound
*Hint: Keep the denominators alike. Convert to indirect if necessary.
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THE SPOT MARKET
E. Currency Arbitrage
1. When cross rates differ from
one financial center to another,
profit opportunities exist.
2. Buy cheap in one int’l market,
Sell at a higher price in another
3. Role of Available Information
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THE SPOT MARKET
F. Settlement Date
Value Date:
1. Date monies are due
2. 2nd Working day after date of original transaction.
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THE SPOT MARKET
G. Exchange Risk
1. Bankers = middlemen
a. Incurring risk of adverse
exchange rate moves.
b. Increased uncertainty about future exchange rate requires
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THE SPOT MARKET
1.) Demand for higher risk
premium
2.) Bankers widen bid-ask spread
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PART II.MECHANICS OF SPOT
TRANSACTIONS
SPOT TRANSACTIONS: An Example
Step 1. Currency transaction: verbal agreement U.S. Importer specifies
a. Account to debit (his acct)b. Account to credit (exporter)
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MECHANICS OF SPOT TRANSACTIONS
Step 2. Bank sends importer contract note including:
- amount of foreigncurrency
- agreed exchange rate
- confirmation of Step 1.
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MECHANICS OF SPOT TRANSACTIONS
Step 3. Settlement
Correspondent bank in HongKong transfers HK$ fromnostro account to exporter’s.
Value Date.U.S. bank debits importer’saccount.
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PART III.THE FORWARD MARKET
I. INTRODUCTION
A. Definition of a Forward Contract
an agreement between a bank and a
customer to deliver a specified amount
of currency against another currency
at a specified future date and at a fixed
exchange rate.
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THE FORWARD MARKET
2. Purpose of a Forward:
Hedging
the act of reducing exchange
rate risk.
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THE FORWARD MARKET
B. Forward Rate Quotations
1. Two Methods:
a. Outright Rate: quoted to
commercial customers.
b. Swap Rate: quoted in the
interbank market as a discount or premium.
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THE FORWARD MARKET
CALCULATING THE FORWARDPREMIUM OR DISCOUNT
= F-S x 12 x 100S n
where F = the forward rate of exchangeS = the spot rate of exchangen = the number of months in the
forward contract
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THE FORWARD MARKET
C. Forward Contract Maturities
1. Contract Terms
a. 30-day
b. 90-day
c. 180-day
d. 360-day
2. Longer-term Contracts
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PART III.THE FORWARD MARKET
I. INTRODUCTION
A. Definition of a Forward Contract
an agreement between a bank and a
customer to deliver a specified amount
of currency against another currency
at a specified future date and at a fixed
exchange rate.
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THE FORWARD MARKET
B. Forward Rate Quotations
1. Two Methods:
a. Outright Rate:
Pound 1.4326 1.4330
1 m f 1.4302 1.4309
b. Swap Rate: in the interbank
market as a discount or premium.
Pound 26-30
1 m f 24-21
Rule if fb<fa --> premium, if fb>fa --> discount
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THE FORWARD MARKET
CALCULATING THE FORWARDPREMIUM OR DISCOUNT
= F-S x 12 x 100 S n
where F = the forward rate of exchange S = the spot rate of exchange n = the number of months in the
forward contract
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THE FORWARD MARKET
C. Forward Contract Maturities
1. a. 30-day (1m)
b. 90-day (3m)
c. 180-day (6m)
2. 360-day (1yr) or longer-term Contracts