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chapter 8

Foreign Exchange

and International

Financial

Markets

International Business, 6th E

dition

Griffin & Pustay

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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 one’s 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 world’s

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 Foreign-Exchange 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 foreign-exchange 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

Arbitrage of Money

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Arbitrage of Money

Two-point

Covered-interestThree-point

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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 World’s Largest Banks

• ING Group

• Fortis

• Citigroup

• Dexia Group

• HSBC Holding

• BNP Paribas

• Credit Agricole

• Deutsche Bank

• Bank of America Corp.

• HBOS

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Establishment of Overseas Banking Operations

Subsidiary bank

Affiliated bankBranch bank

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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:

– World’s 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 country’s 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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