Date post: | 07-Aug-2018 |
Category: |
Documents |
Upload: | nilesh-mandlik |
View: | 226 times |
Download: | 0 times |
of 19
8/20/2019 Inflation, Interest Rates, and Exchange Rates.pptx
1/45
Infation, Interest Rates,
and Exchange RatesLower infation leads to lower interest rates, soborrowing in low-interest countries may appearattractive to multinational rms.
However, currencies in low-infation countries tend toappreciate against those in high-infation ratecountries, so the true interest cost increases over thelie o the loan.
8/20/2019 Inflation, Interest Rates, and Exchange Rates.pptx
2/45
!ypes o "inancial #ar$ets
• %hysical &sset versus "inancial &sset#ar$et
• #oney #ar$et versus 'apital #ar$et
• %rimary versus (econdary #ar$et
• )pen versus *egotiated #ar$et
• (pot versus "utures #ar$et
8/20/2019 Inflation, Interest Rates, and Exchange Rates.pptx
3/45
Recent !rends in "inancial#ar$ets
• +lobaliation
• erivatives
• (toc$ )wnership %atterns
8/20/2019 Inflation, Interest Rates, and Exchange Rates.pptx
4/45
hat /arious !ypes o Ris$s &risehen Investing )verseas0
• 'ountry ris$1 &rises rom investingor doing business in a particularcountry. It depends on the
country2s economic, political, andsocial environment.
• Exchange rate ris$1 I investment is
denominated in a currency otherthan the dollar, the investment2svalue will depend on what happens
to exchange rate.
8/20/2019 Inflation, Interest Rates, and Exchange Rates.pptx
5/45
!he 'ost o #oney
• hat do we call the price, or cost, odebt capital0
• hat do we call the price, or cost, o e3uity capital0
8/20/2019 Inflation, Interest Rates, and Exchange Rates.pptx
6/45
"undamental "actors &4ecting the'ost o #oney
• %roduction opportunities
• !ime preerences or consumption
• Ris$• Expected infation
8/20/2019 Inflation, Interest Rates, and Exchange Rates.pptx
7/45
• International nancial mar$et comprise o1 – International 'apital #ar$et
• )btaining external nancing.
• #ain purpose is to provide a mechanism throughwhich those who wish to borrow or invest moneycan do so e5ciently.
– "oreign-Exchange #ar$et6made up o1 – over-the-counter 7)!'8
» commercial and investment ban$s
» ma9ority o oreign-exchange activity
– security exchanges
» trade certain types o oreign-exchange instruments
8/20/2019 Inflation, Interest Rates, and Exchange Rates.pptx
8/45
Essential !erms
• (ecurity - a contract that can beassigned a value and traded 7stoc$s,bonds, derivatives and other
nancial assets8
• (toc$s : & instrument representingownership
• ;onds - a debt agreement
• erivatives - the rights to ownership7nancial instruments< utures,
orwards, options, swaps8
8/20/2019 Inflation, Interest Rates, and Exchange Rates.pptx
9/45
Essential !erms II
• (toc$ exchange, share mar$et or bourse - is acorporation or mutual organiation which providesacilities or stoc$ bro$ers and traders, to tradecompany stoc$s and other securities
• )ver-the-counter 7)!'8 trading - is to tradenancial instruments such as stoc$s, bonds,commodities or derivatives directly between twoparties. It is contrasted with exchange trading,
which occurs via corporate-owned acilitiesconstructed or the purpose o trading 7i.e.,exchanges8, such as utures exchanges or stoc$exchanges.
8/20/2019 Inflation, Interest Rates, and Exchange Rates.pptx
10/45
'apital #ar$et
• System that allocates financial resources according
• to their most efficient uses
• Common capital market intermediaries:• Commercial Banks
• Investment Banks
Debt1 Repay principal plus interest Bond has timed principal & interest payments
Equity1 %art ownership o a company Stock shares in fnancial gains or losses
8/20/2019 Inflation, Interest Rates, and Exchange Rates.pptx
11/45
International 'apital #ar$et7I'#8
• Network of people, firms, financial institutions andgovernments borrowing and investing internationally
• %urposes
•Borrowers
Expands money supply
educes cost of money
!=enders
Spread / reduce risk Oset gains / losses
8/20/2019 Inflation, Interest Rates, and Exchange Rates.pptx
12/45
International 'apital#ar$et rivers
"nformation technology
#eregulation
$inancial instruments
%securiti&ation'
8/20/2019 Inflation, Interest Rates, and Exchange Rates.pptx
13/45
orld "inancial 'enters
• &t present, the three main nancial centers areLondon !e" #ork and $okyo
• London is one o the three leading world nancial
centres. It is amous or its ban$s and Europe>slargest stoc$ exchange, that have been establishedover hundreds o years 7e.g. =loyd>s o =ondon,=ondon (toc$ Exchange8. !he nancial mar$et o=ondon is also commonly reerred to as the 'ity. It
has historically been situated around the part o=ondon called (3uare #ile, but in the ?@AB>s and?@@B>s a large part o the 'ity o =ondon>s wholesalenancial services relocated to 'anary har.
8/20/2019 Inflation, Interest Rates, and Exchange Rates.pptx
14/45
Country or territorywhose financial sector
features few regulationsand few, if any, taxes
Country or territorywhose financial sector
features few regulationsand few, if any, taxes
Operational centerExtensive financial activity
and currency trading
Operational centerExtensive financial activity
and currency trading
Booking center(ostly for bookkeeping
and tax purposes
Booking center(ostly for bookkeeping
and tax purposes
)4shore "inancial 'enters
8/20/2019 Inflation, Interest Rates, and Exchange Rates.pptx
15/45
I#" denes )"' as1
• Curisdictions that have relatively largenumbers o nancial institutionsengaged primarily in business with non-
residents<• "inancial systems with external assets
and liabilities out o proportion todomestic nancial intermediation
designed to nance domesticeconomies< and
• #ore popularly, centers which providesome or all o the ollowing services1 low
or ero taxation< moderate or lightnancial re ulation ban$in secrec
8/20/2019 Inflation, Interest Rates, and Exchange Rates.pptx
16/45
#ain 'omponents o I'#1
International ;ond #ar$et
Foreign bond Interest ratesEurobond
Bond that is
issued outside the
country in whose
currency the bond
is denominated
Bond sold outside a
borrower’s country
and denominated in
the currency of the
country in which it
is sold
Driving growth are
differential interest
rates between
developed and
developing nations
(arket of bonds sold by issuing companies,governments and others outside their own countries
8/20/2019 Inflation, Interest Rates, and Exchange Rates.pptx
17/45
International E3uity #ar$et
(arket of stocks bought and soldoutside the issuer)s home country
$actors contributing towards growth:
• Spread of Privatization
•
Economic Growth in Developin Co!ntries• "ctivities of Investment Banks
• "dvent of C#$ermarkets
8/20/2019 Inflation, Interest Rates, and Exchange Rates.pptx
18/45
+overnments 'ommercial ban$s International companies
ealthy individuals
Eurocurrency #ar$et
*nregulated market ofcurrencies banked outside
their countries of origin
8/20/2019 Inflation, Interest Rates, and Exchange Rates.pptx
19/45
Introduction
• %oreign echange market' a
mar$et or converting the currencyo one country into the currency oanother.
• Echange rate' the rate at whichone currency is converted intoanother
• %oreign echange risk' the ris$that arises rom changes in
"oreign Exchange #ar$et
8/20/2019 Inflation, Interest Rates, and Exchange Rates.pptx
20/45
"oreign Exchange #ar$et
'onversion1 $o (acilitate sale or purchase or
in)est directly abroad Hedging1 *nsure against potential losses (rom
ad)erse echange+rate changes
&rbitrage1 *nstantaneous purchase and sale o(
a currency in dierent markets (or proft (peculation1 Sequential purchase and sale ,or
)ice+)ersa- o( a currency (or proft
(arket in which currencies are bought and soldand their prices are determined
8/20/2019 Inflation, Interest Rates, and Exchange Rates.pptx
21/45
!he "unctions o the"oreign Exchange #ar$et
• !he oreign exchange mar$etserves two main unctions1
– 'onvert the currency o one countryinto the currency o another
– %rovide some insurance against
oreign exchange ris$• %orein e&chane risk' the adverse
conse(!ences of !npredicta$le chanes inthe e&chane rates
8/20/2019 Inflation, Interest Rates, and Exchange Rates.pptx
22/45
'urrency 'onversion
• 'onsumers can compare the relativeprices o goods and services in di4erentcountries using exchange rates
• International business have our mainuses o oreign exchange mar$ets
• To exchange currency received in
the course of doing business
abroad back into the currency of itshome country
• To pay a foreign company for its
products or services in its
country’s currency
• To invest excess cash for
short terms in foreign markets• To profit from the short-term
movement of funds from onecurrency to another in the
hopes of profiting from shifts
in exchange rates, also called
currency speculation
8/20/2019 Inflation, Interest Rates, and Exchange Rates.pptx
23/45
Insuring against "oreignExchange Ris$
• & spot exchangeoccurs when twoparties agree to
exchange currencyand execute the dealimmediately
• !he spot exchangerate is the rate atwhich a oreignexchange dealerconverts onecurrency into
another currency ona articular da
8/20/2019 Inflation, Interest Rates, and Exchange Rates.pptx
24/45
Insuring against "oreignExchange Ris$
• "orward exchanges occur when two parties agree toexchange currency and execute the deal at somespecic date in the uture
– E&chane rates overnin s!ch f!t!re transactions arereferred to as forward e&chane rates
– %or most ma*or c!rrencies+ forward e&chane rates are(!oted for ,- da#s+ .- da#s+ and /0- da#s into the f!t!re
• hen a rm enters into a orward exchange contract,it is ta$ing out insurance against the possibility thatuture exchange rate movements will ma$e atransaction unprotable by the time that transactionhas been executed
8/20/2019 Inflation, Interest Rates, and Exchange Rates.pptx
25/45
!he *ature o the "oreignExchange #ar$et
• !he oreign exchange mar$et is a global networ$o ban$s, bro$ers and oreign exchange dealersconnected by electronic communications systems
• !he most important trading centers include1=ondon, *ew Dor$, !o$yo, and (ingapore• =ondon2s dominance is explained by1
– 1istor# 2capital of the first ma*or ind!strialized nation3 –
Georaph# 2$etween 4ok#o5Sinapore and 6ew 7ork3• !wo ma9or eatures o the oreign exchangemar$et1
– 4he market never sleeps – 8arket is hihl# interated
8/20/2019 Inflation, Interest Rates, and Exchange Rates.pptx
26/45
Institutions o"oreign Exchange #ar$et
• Interban$ #ar$et1 mar$et in which theworld2s largest ban$s exchange currenciesat spot and orward rates. – 'learing mechanismF
• (ecurities Exchanges1 exchangespecialiing in currency utures andoptions transactions.
• )ver-the-'ounter #ar$et1 Exchangeconsisting o a global computer networ$ ooreign exchange traders and other mar$etparticipants.
8/20/2019 Inflation, Interest Rates, and Exchange Rates.pptx
27/45
27
!he "oreign-Exchange #ar$et(ie o oreign-exchange mar$et
GBB billion spotG?. trillion in derivatives, ie
GJBB billion in outright orwardsG? trillion in orex swapsG?BB billion in "K options. 7JBBL8
M.(. dollar is the most important currency because it is1
• &n investment currency in many capital mar$ets
• & reserve currency held by many central ban$s
• & transaction currency in many international commoditymar$ets
• &n invoice currency in many contracts• &n intervention currency employed by monetary
authorities to infuence their exchange rates
8/20/2019 Inflation, Interest Rates, and Exchange Rates.pptx
28/45
Nuoting 'urrencies
9!oted c!rrenc# : n!merator Base c!rrenc# : denominator
9!oted c!rrenc# : n!merator Base c!rrenc# : denominator
2;5?S? dollar 2;5?S? dollar 7en is (!oted c!rrenc#+ dollar is $ase c!rrenc#7en is (!oted c!rrenc#+ dollar is $ase c!rrenc#
8/20/2019 Inflation, Interest Rates, and Exchange Rates.pptx
29/45
'urrency /alues
.hange in S dollaragainst 0olish 1loty
$ebruary +: -. /01
(arch +: -. 201
3change 4 5%26/'0/7 x +88 4 6983
*S dollar fell 983
.hange in 0olish 1lotyagainst S dollar
(ake &loty base currency %+ -.01' $ebruary +: 1!980-. (arch +: 1!9/0-.
3change 4 5%!9/6!98'0!987 x +88 4 9/3
olish &loty rose 9/3
8/20/2019 Inflation, Interest Rates, and Exchange Rates.pptx
30/45
'ross Rate
• Exchange rate calculated using two other exchange rates
• *se direct or indirect exchange rates against a third currency
8/20/2019 Inflation, Interest Rates, and Exchange Rates.pptx
31/45
'ross Rate Example
Direct quote method
/3 9!ote on e!ro : @ -?0A/5<
3 9!ote on #en : ; //A?-5<
,3
@ -?0A/5< ; //A?-5< : @ -?--FA5;A3 Costs -?--FA e!ros to $!# / #en
*ndirect quote method
/3 9!ote on e!ro : < /?/0/.5@
3 9!ote on #en : < -?--0F,A5;
,3 < /?/0/.5@ < -?--0F,A5; : @ /,?,5;
A3 %inal step' / @ /,?,5; : @ -?--FA5;
3 Costs -?--FA e!ros to $!# / #en
8/20/2019 Inflation, Interest Rates, and Exchange Rates.pptx
32/45
'urrency 'onvertibility
• +overnments can place restrictions on theconvertibility o currency
– " co!ntr#2s c!rrenc# is said to $e freelyconvertible when the co!ntr#2s overnment
allows $oth residents and nonresidents top!rchase !nlimited amo!nts of a forein c!rrenc#with it
– " c!rrenc# is said to $e externally convertiblewhen onl# nonresidents ma# convert it into aforein c!rrenc# witho!t an# limitations
– " c!rrenc# is nonconvertible when neitherresidents nor nonresidents are allowed to convertit into a forein c!rrenc#
8/20/2019 Inflation, Interest Rates, and Exchange Rates.pptx
33/45
• +overnment restrictions can include – " restriction on residents2 a$ilit# to convert the
domestic c!rrenc# into a forein c!rrenc#
– )estrictin domestic $!sinesses2 a$ilit# to takeforein c!rrenc# o!t of the co!ntr#
• +overnments will limit or restrictconvertibility or a number o reasonsthat include1 – Preservin forein e&chane reserves
– " fear that free converti$ilit# will lead to a r!n ontheir forein e&chane reserves : known as capitalfliht
8/20/2019 Inflation, Interest Rates, and Exchange Rates.pptx
34/45
• +overnment restrictions can include – " restriction on residents2 a$ilit# to convert the
domestic c!rrenc# into a forein c!rrenc#
– )estrictin domestic $!sinesses2 a$ilit# to takeforein c!rrenc# o!t of the co!ntr#
• +overnments will limit or restrictconvertibility or a number o reasonsthat include1 – Preservin forein e&chane reserves
– " fear that free converti$ilit# will lead to a r!n ontheir forein e&chane reserves : known as capitalfliht
8/20/2019 Inflation, Interest Rates, and Exchange Rates.pptx
35/45
35
+overnmental Restrictions on "oreign-Exchange 'onvertibility
Restrictions used to conserve scarce oreign exchange
• =icensing6government regulates all oreign-exchangetransactions
– those who receive oreign currency re3uired to sellit to its central ban$ at the o5cial buying rate
– central ban$ rations oreign currency
• #ultiple exchange-rate system6di4erent exchange ratesset or di4erent transactions
• &dvance import deposit6re3uires importers to ma$e adeposit with central ban$ covering price o goods theywould purchase rom abroad
• Nuantity controls6limit the amount o currency thatresident can purchase or oreign travel
'urrency controls increase the cost o international businessand reduce overall international trade
8/20/2019 Inflation, Interest Rates, and Exchange Rates.pptx
36/45
3
How 'ompanies Mse "oreign Exchange
#ost oreign-exchange transactions involve international
departments o commercial ban$s• ;an$s buy and sell oreign currency< ban$s collect and
pay money in transaction with oreign buyers and sellers
• ;an$s lend money in oreign currency
'ompanies use oreign-exchange mar$et or1
•Import and export transactions
• "inancial transactions such as "I
&rbitrage6purchase o oreign currency on one mar$et orimmediate resale on another mar$et
• &rbitragers hope to prot rom price discrepancy
•
Interest arbitrage6investing in debt instruments indi4erent countries
(peculation6buying or selling oreign currency has both ris$and high prot potential
8/20/2019 Inflation, Interest Rates, and Exchange Rates.pptx
37/45
37
"oreign-Exchange !rading %rocess
'ompanies wor$ through their local ban$s to settle oreign-
exchange balances• 'ommercial ban$s in ma9or money centers became
intermediaries or small ban$s
#ost oreign-exchange activity ta$es place in traditionalinstruments
• 'ommercial and investment ban$s and other nancialinstitutions handle spot, outright orward, and "K swaps
• "oreign-exchange mar$et made up o about J,BBB dealerinstitutions worldwide
• #ost oreign-exchange ta$es place in )!' mar$et
ealers can trade oreign exchange1• irectly with other dealers
• !hrough voice bro$ers
• !hrough electronic bro$erage systems
– Internet trades o currency are more popular
8/20/2019 Inflation, Interest Rates, and Exchange Rates.pptx
38/45
3!
'ommercial and Investment ;an$s
+reatest volume o oreign-exchange activity ta$es place
with the big ban$s• !op ban$s in the interban$ mar$et in oreign
exchange are so ran$ed because o their ability to1
– trade in specic mar$et locations
– engage in ma9or currencies and cross-trades
– deal in specic currencies
– handle derivatives
» orwards, options, uture swaps
– conduct $ey mar$et research
• ;an$s may specialie in geographic areas,instruments, or currencies
– exotic currency6currency o a developingcountry
» oten unstable, wea$, and unpredictable
8/20/2019 Inflation, Interest Rates, and Exchange Rates.pptx
39/45
$op 23 .urrency $raders 7O o overall volume, #ay JBBP 8
"ank #ame $ of volume
% &eutsche 'ank %7()
2 *'+ %2(5
3 itigroup 7(5
.+' (
5 'arclays 5(/
0errill 1ynch 5(7
7 (( 0organ hase 5(3
! 4oldman +achs (
/ '# 0"6 (2
%) 0organ +tanley 3(/
8/20/2019 Inflation, Interest Rates, and Exchange Rates.pptx
40/45
International #onetary(ystem
• Rules and procedures by which di4erentnational currencies are exchanged oreach other in world trade.
• (uch a system is necessary to dene acommon standard o value or theworld>s currencies.
• Reer to the institutional arrangements
that countries adopt to governexchange rates – "loating – %egged exchange rate – irty foat – "ixed exchange rate
8/20/2019 Inflation, Interest Rates, and Exchange Rates.pptx
41/45
• "loating exchange rates occur
when the oreign exchangemar$et determines the relativevalue o a currency
• !he world2s our ma9orcurrencies : dollar, euro, yen,and pound : are all ree to foat
against each other• 0egged echange rates occurwhen the value o a currency isxed relative to a reerence
8/20/2019 Inflation, Interest Rates, and Exchange Rates.pptx
42/45
• Dirty 4oat occurs when countrieshold the value o their currencywithin a range o a reerencecurrency
• %ied echange rate occurswhen a set o currencies are xedagainst each other at some
mutually agreed upon exchangerate
• %egged exchange rates, dirty foats
and xed exchange rates all
8/20/2019 Inflation, Interest Rates, and Exchange Rates.pptx
43/45
Evolution o International #onetary(ystem
!he +old (tandard In place rom ?QBBs to ?@@ a monetary standard that pegs
currencies to gold and guarantees
convertibility to gold It was thought that gold standard
contained an automatic mechanism thatcontributed to the simultaneous
achievement o a balance-o-paymentse3uilibrium by all countries.
!he gold standard bro$e down duringthe ?@Bs as countries engaged in
competitive devaluations
8/20/2019 Inflation, Interest Rates, and Exchange Rates.pptx
44/45
!he +old (tandard
• Roots in oldmercantile trade
• Inconvenient toship gold,changed topaper-
redeemable orgold
• ant to achieve
balance-o-trade
*+Japan
G o l d
T r a d e
8/20/2019 Inflation, Interest Rates, and Exchange Rates.pptx
45/45
;alance o !rade E3uilibrium
Trade Surplus
GoldIncreased
money supply
= price
inflation.
Decreased
money supply
= price decline.
As prices decline, exports
increase and trade goes
into equilibrium.