PART FOUR

WORLD FINANCIAL ENVIRONMENT

International Business

Chapter Nine
Global Foreign Exchange and
Capital Markets
 Chapter 9 Objectives

• How does the foreign exchange work?

• Why do companies deal in foreign exchange?
• Who are the different institutions that deal in foreign
exchange?
• How do companies make payment for international
transactions?

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 The Foreign Exchange includes . . .

Foreign exchange (Fx):

money denominated in
the currency of another
nation or group of nations

Exchange rate: the price of

one currency expressed in
terms another currency

What do you think causes the values of currencies to change daily?

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 Where do people go to exchange
their currency?

• The Foreign Exchange Market

 Most are Over-the-counter (OTC) market through
commercial and investment banks
 The Exchange-trade market specializes in securities,
futures and options
 www.forex-markets.com to learn how to do-it-yourself

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 Top OTC Banks

ESTIMATED BEST IN BEST IN BEST IN BEST IN

TRADING BANK MKT.SHARE LONDON NEW YORK EURO/US$ US$/YEN
1. Deutsche Bank 19.75% 2 3 1 4
2. UBS Warburg 11.61% 5 4 4 3
3. Citigroup 7.33% 3 1 3 1
4. HSBC 6.64% 1 5 2 2
5. Barclays 6.41% 4 — 7 7
6. JP Morgan 5.38% 7 2 5 5
7. ABN Amro 4.57% 9 7 6 6
8. Merrill Lynch 4.45% — — — —
9. Goldman Sachs 4.38% 8 8 10 10
10.Morgan Stanley 4.20% — 9 — —
Source: “2005 Euromoney Foreign Exchange Poll,” Euromoney (May 2005).

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 Which currency is the
most actively traded?

CURRENCY 1989 1992 1995 1998 2001 2004

U.S. Dollar 90 82 83 87 90 89
Euro — — — — 38 37
Japanese Yen 27 23 24 21 23 20
Pound Sterling 15 14 10 11 13 17
Swiss Franc 10 9 7 7 6 6
All others 31 32 39 44 30 31
Source: Bank for International Settlements, Central BankSurvey of Foreign Exchange and Derivatives Market Activity, 2004.

Why do you think these currencies so popular?

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The stability of the U.S. dollar has made it the most
widely traded in the world

• Dollars are invested in many capital markets

• Dollars are used as a reserve currency for many
governments’ central banks
• Dollars are a transaction currency in many
international commodity markets
• Dollars are an invoice currency
• Dollars are an intervention currency used by
monetary authorities to influence their own exchange
rates

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Why do you think the U.K. has the most Fx
market activity?

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 Location of the 4 Biggest
Foreign Exchange Market

• London is the largest foreign exchange market (followed by New York, Tokyo, and Singapore) because
of its strategic location between Asia and the Americas.
 1st peak when Asia & Europe are open
 2nd peak when Europe and U.S. are open
The most frequently traded currency pairs are:
 U.S. Dollar/Euro (28%)
 U.S. Dollar/Yen (17%)

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The Circadian Rhythms of the Foreign
Exchange Market

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 What are Futures & Options?

• Futures: a contractual agreement to buy or sell a

given currency at a negotiated price on a specified
future date.

• Option: gives the buyer the right (but not the

obligation) to buy or sell a certain amount of foreign
currency at a specified exchange rate “strike price”
within a specified amount of time.
 more flexible & expensive than forward contracts
 Premium: the fee paid to the writer of the option

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Foreign Exchange Markets: Thursday,
April 28, 2005
US$ EQUIVALENT CURRENCY PER US$
COUNTRY THUR WED THUR WED
Brazil (Real) .3917 .3972 2.5530 2.5176
Canada (Dollar) .7991 .8004 1.2514 1.2494
India (Rupee) .02291 .02288 43.649 43.706
Japan (Yen) .009430 .009445 106.04 105.88
Russia (Ruble) .03597 .03607 27.801 27.724
South Africa (Rand) .1630 .1646 6.1350 6.0753
Switzerland (Franc).8383 .8390 1.1929 1.1919
U.K. (Pound) 1.9068 1.9059 .5244 .5247
Special Drawing Right 1.5135 1.5121 .6607 .6613
Euro 1.2895 1.2933 .7755 .7732
Special Drawing Rights (SDRs) are based on exchange rates for the US dollar, the euro, the Japanese yen,
and the British pound.
Sources: International Monetary Fund; Wall Street Journal, 2005.

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 Is ALL currency convertible?

Convertibility: How easy/hard it is to purchase foreign

currency with a domestic currency without government
restrictions
 Hard currencies are fully convertible with no govt restrictions on
trade
 External convertibility: Govt. limits non-resident trading
 Soft currencies are non-convertible because of total govt.
restriction on trading

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 Currency As a Trade Barrier

A government currency restrictions include:

 licensing
 a multiple exchange rate system
 advance import deposits
 quantity controls

Currency controls add to the cost of doing

business and thus serve as serious impediments to
trade and investment.

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 Why do Businesses Fx?

1. To covert currency for trade transactions

2. hedging [risk reduction through loss protection]
3. speculation [currency trading on expectations of future prices]
4. arbitrage [risk-free profit based on price differentials]
 interest arbitrage

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Structure of Foreign Exchange Markets

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Global Capital Markets: International
Bonds
• Companies borrow money in the international bond market to diversify funding
sources.
 Foreign bonds: sold outside of home country but denominated in the currency of the
country of issue.
 Eurobonds: sold in countries other than the one in whose currency the bond is
denominated; usually underwritten
 Global bond: registered in different national markets according to the registration
requirements of each market

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 Equity Capital Markets = Stock Market

• The growth of emerging stock markets has been very

sensitive to global economic conditions and events.

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Conclusions

• at least $1.2 trillion in foreign exchange is traded

each day by banks and securities exchanges.
• The U.S. dollar is the most widely traded currency
in the world.
• Currency is exchanged to
 settle trade transactions
 For direct investment
 portfolio investment and speculation

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