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International Financial Markets Dealer


           International Financial Markets
Financial markets are often designated as money markets
  and capital markets.
* Money Markets are markets for short term financial assets
  (short-term instruments) e.g., T-Bills, Certificates of
  Deposits (CDs), Bankers Acceptance (BA), Commercial
  Papers (CP), Repurchase Agreements (Repos) …
* Capital Markets are markets for long term financial assets
  like Bonds, Stocks, Mortgages, etc.

Two Major Components of International Financial Markets:
i. The Foreign Exchange Market
ii. Eurocurrency, Eurocredit, & Eurobond Markets
   The Foreign Exchange Market is the world's largest
    financial market.
    The Bank for International Settlements estimates daily
    trading of about $4 trillion (WSJ 09-01-10)
   The Foreign Exchange Market is an over-the-counter
   That means there is no physical location where traders
    get together to exchange currencies.
   Traders located in the offices of major commercial
    banks around the world and communicate using the
    computer terminals, telephones, telexes, and other
    communication channels.
 Most trading activities take place in a few currencies
  like the US dollar, The Euro, British Pounds, Yen,
  and Canadian Dollars.
 Foreign Exchange traders not only buy and sell
  currencies but, they create prices.
 Market Makers are those traders in major money-center
  banks around the world who are always ready to buy or
  sell by quoting the bid/ask prices.
  The difference between the two prices is called the
  “spread." They create the market by setting bid/ask prices
  and dealing at those prices.
 Participants include importers, exporters, portfolio
  managers, central banks, brokers, commercial banks,
  arbitragers, speculators, tourists, governments, etc. 3
    The Foreign Exchange Market can be subdivided into:
   The Retail Market: Permits the firms and individuals to
    obtain foreign exchange for business or personal use.
   The Interbank Market: Major participants are foreign
    exchange traders employed by large banks.
    Also large Multinational Corporations often maintain
    trading departments that operate directly in this market.
    Traders in the interbank market are called "Dealers."
    They make the market.
   Brokers: Bring buyers and sellers together for a small
    commission thereby helping to preserve the anonymity.
   Arbitragers: Seek to earn riskless profit from price
    differences in different foreign exchange markets.
 Speculators: Buy and sell in the hope that a price
  change will result in a profit.
 Governments: Central Banks, Treasury Departments
  and other Government Agencies sometimes participate
  in the market in order to influence the exchange rate of
  a particular currency.
  For Example:
   FED buys dollars in the foreign exchange market to
     increase the value of the dollar.
   FED sells dollars in the foreign exchange market to
     reduce the value of the dollar.
 Coordinated efforts among central banks are often used.
  Example: The Federal Reserve Bank bought Mexican
  pesos to help prop up the value of the currency in 1995.
      Other Participants :
   Traders: Use forward contracts to eliminate or cover
    the risk of loss on export or import orders that are
    denominated in foreign currencies.
   Hedgers: Hedgers, mostly Multinational corporations,
    enter into forward contracts to protect domestic
    currency value of foreign currency denominated asset
    and liabilities on their balance sheet.
    The increasing importance attached to exchange rates
    results from the globalization or internationalization of
    modern business, the continuing growth in world trade,
    the trend towards economic integration, and the rapid
    pace of change in the technology of money transfer.
    Functions of Foreign Exchange Markets
 Transfer of Purchasing Power: International trade and
  capital transaction usually involve parties with different
  functional currencies.
  Trade and capital transactions can be invoiced in any
  convenient currency.
 Therefore, one or more of the parties must transfer
  purchasing power to or from own national currency.
  The Foreign exchange market facilitates this transfer of
  purchasing power.
 Provisions of credit: Movement of goods and services
  between countries takes time. This gives rise to financing
  of inventory in transit and sales inventory.
 The foreign exchange market provides a means of transfer
  of credit. Specialized instruments like Bankers'
  Acceptances and Letters of Credit, are made possible
  through the foreign exchange market.                    7
   Minimizing Foreign Exchange Risk: The foreign
    exchange market provides "risk transfer" facilities to third
    parties through Forward, Futures, Options, and Swaps
   During the past decade the foreign exchange market has
    served as the invisible hand guiding the purchase and
    sale of goods, services, raw materials, and flow of
    investments in every corner of the globe.
   The market directly affects every country’s bonds,
    equities, private property, manufacturing, and all assets
    that are accessible to foreign investors.
   It plays a major role in determining who finances
    government deficits, who buys equity in companies, who
    owns real estates, who buys companies, and who hires
    and fires employees.                                8
   The market affects every aspect of our daily personal
    or corporate lives and influences the economic and
    political destiny of every nation.

   The foreign exchange market is a stabilizing factor in
    global system of monetary exchange.

            Formal Definition:
  The Foreign exchange rate can be defined as units of
   domestic currency per unit of a foreign currency.
  This is a “direct quote” for the foreign currency.
Example: Let the U.S. be "domestic"
1. If you need $1.75 to purchase 1 unit of the British Pound
   Sterling, then
   $/£ = 1.75 (d/f)
   Dollars per pound , the dollar price of one pound, is
   a “direct quote” for the pound in the U.S.
   It means units of the home currency, in this case the
   $, (or domestic currency) needed to acquire one unit
   of a foreign currency, in this case the pound.        10
   The foreign exchange rate can be defined as units of
    a foreign currency per unit of domestic currency.
    This is an “indirect quote” for the foreign currency.

2. If 105 units of the Japanese Yen are needed to
  purchase one unit of the U.S. Dollar, then

    ¥/$ = 105 (f/d).

    This is an indirect quote for the Yen in the US.
Since the direct and the indirect quotations are
alternative means of stating exchange rates, the two
methods are related.
One is the inverse of the other. Thus:
                        $ = 1
                        £  £/$
                        ¥ = 1
                        $ $/¥
If $/£ = 1.4435, obtain £/$
If SF/$ = 7.3848, obtain $/SF
If R/$ = 2.2019, obtain $/R
 Most interbank quotes around the world are stated
    in “European terms” which means foreign
    currency price of one dollar, e.g.
    Won/$ = 1225.50, ¥/$ = 95.25, Peso/$ = 12.1045

   The alternate way, dollar price of one unit of
    foreign currency, is called “American terms” e.g.
    $/£ = 1.6235, and $/€ = 1.4155

 Spot   Rates:
    A spot transaction is the purchase of foreign exchange
    for immediate delivery (usually, delivery is within the
    following two business days).

 Forward     Rates:
   A forward exchange rate or forward rate, is the price
    agreed upon today for purchase or sale of foreign
    currency for future delivery (transfer/settlement) and
   The rate is agreed upon at the time the contract is
    made, but payment and delivery are not required until
    maturity.                                           14
   Forward maturities are normally 30, 60, 90, 180, 360
    days in the future.
    Maturities of one or two weeks are also common.
    Odd maturities may be negotiated even up to 5 years.

 Cross   Rates:
 Frequently, the need arises to obtain the relationship
 (price) between two currencies from their relationship
 with (quotation in) a third currency.

 Formally, given two currencies A & B,
 If $/A and $/B are given, then
 The value of A in terms of B (or B per unit of A) is
 given by :
                  $/A = $ * B = B
                  $/B     A   $    A
  This is the cross rate.
         Example: Given $/£ and $/SF, then:

               $/£   =   $   *
                                 SF   = SF
              $/SF       £        $      £

Given:     $/£ = 1.4155 and SF/£ = 3.1318, then
             SF = SF/£ = 3.1318 = 2.2125
              $        $/ £      1.4155
Given:     $/£ = 1.8632, $/ ¥ = .008013, then:

               ¥ = $/£       =   1.8632 =     232.52
               £   $/ ¥          .008013

1. Given P/$ = 12.4250, C$/$ = 1.1607, Obtain C$/P
2. Given Y/$ = 95.53, SF/$ = 1.1566, Compute Y/SF
3. You have just received a gift of 600,000 Yen that you
   wish to convert to Euros. You are given that
   $/€=1.2865 and Y/$=83.63. How many Euros would
   you get ?

                   The Bid-ask Spread:
   Bid Price: price at which a dealer will buy a currency.
   Ask price: price at which the dealer will sell a currency
    (= offer price).
   Dealers do not normally charge a commission on their
    currency transactions but profit from the bid/ask spread.

Computing the bid/ask spread in percentage terms:

Bid/Ask spread =       Ask Rate - Bid Rate * 100
                            Ask Rate                1
    This expresses the spread in terms of the "discount"
    obtained by the dealer.
Bid/Ask spread      =   Ask Rate - Bid Rate      *
                            Bid Rate                  1
    This expresses the spread in terms of the markup
    established by the dealer.
   In practice, the £ may be quoted at $1.7019-36.
    This means a bid price of 1.7019 and an ask price
    of 1.7036.
   In practice, this quotation may simply be given as 19-36
    as the dealers are sufficiently up to date to know the
    preceding numbers.
    A point is the last digit in a quotation, and convention
    dictates the numbers of decimal points in each quotations.
    Premium or Discount on Forward Rate:
   If the forward rate exceeds the existing spot rate (direct
    quotes) that forward rate contains a premium.
   If the forward rate is less than the spot rate, that forward
    rate contains a discount.
To compute the Premium (Discount):
        Let, F = Forward rate e.g., $/£ = d/f
              S = spot rate
              n = time to maturity
 Then given a direct quote of the £:
    F- S * 360 = premium (discount) on the £.
     S         n                              21
     For an indirect quote, (e.g. £ quoted as £/$ = .6564)
    the premium (discount) on the £ is given by:

           S-F     *
                       360    = premium (discount)
            F           n

     A premium means that the direct price in the forward
      market is higher than the direct price in the spot market.
     A discount is the reverse.
    Exercise: Given that spot C$/$ = 1.1596 and 6- month
                 fwd C$/$ = 1.1618, obtain:
      i). P(d) on US dollar.
     ii). P(d) on Canadian dollar.                      22
             Using The Forward Contract:
    A U.S. importer of German BMW receives a bill of
    €2 million for the 700 series. The Bill is due in 90
    days. Assume that Spot $/ € = 1.4775 and 90-day
    forward $/ € = 1.4856. The spot $/€ in 90 days is
    unknown. What should the importer do?

   The Forward contract is a means of locking in the
    price at which Euros will be acquired in 90 days.
    The importer can enter into a fwd contract to
    purchase Euros for delivery in 90 days at the fwd rate
    of $/€ = 1.4856.                                  23
  Percentage Change in Exchange Rates
The percentage change in exchange rates can
be obtained as follows:

%  = Ending Rate - Beginning Rate * 100
           Beginning Rate             1

The percentage change in exchange rate indicates
an upward or downward movement in the value of
a currency against other currencies over time.

                        o                                  t
Let et = $/£                |--------------------------------|
                            S0                              St
at    t = 0, $/£ = 1.7557
      t = 1, $/£ = 1.9567

%=      1.9567 - 1.7557       * 100       = 0.11448
             1.7557               1

 The BP has appreciated in value against the dollar by
 about 11% during this period.
                 Common Terms
 Depreciation -- Devaluation -- Weakening
 Appreciation -- Revaluation -- Strengthening
 Soft Currency -- Expected to decrease in value

   Hard Currency -- Expected to maintain its value
                    or increase in value
“The Dollar is Mixed” indicates that the $ did not
    move in one direction against major currencies.
    It is up against some, and down against others.

             The Eurocurrency Markets
 A Eurodollar is a U.S.-dollar denominated bank
  deposit held outside the U.S.
   More generally, a Eurocurrency deposit is a
    domestic-currency denominated bank deposit held
    outside the domestic geographical area.
   In other words, Eurocurrencies are typically time
    deposits denominated in currencies other than
    those of the countries in which they are located.
   Other important Eurocurrencies are:
    Euro-Canadian dollar, Euro-Swiss franc,
    Euro-Sterling, Euro-yen and now Euro- Euro!.
   Smaller offshore banking centers which participate
    in the eurocurrency market include such locations
    as the Cayman Islands, Bahamas, Bahrain,
   The Singapore market is often called:
       "Asian Dollar Market.”

         The Evolution of the Market:

 The development and expansion of the
 Eurocurrency markets have their roots in overt
 and covert events.

1) In the late 1950s British-owned banks utilized
  foreign currency deposits (in the UK) as a lending
  medium in order to save the business that was at
  that time endangered by exchange controls (in the
  UK) on transactions in pounds sterling.

2) The Soviet Union: provided impetus for the early
    growth of the market.
   As the cold war heated up, the Soviet Union began
    to worry about the U.S. Government freezing its
    deposits in New York.
   The Soviets needed to maintain dollar accounts for
    international trade and investment.
   The dollar was then virtually the only currency
    acceptable worldwide.
   The Soviet Union responded to this problem by
    placing its dollar-denominated deposits in banks
    outside the U.S. jurisdiction.
   British banks were the primary recipients of these
    deposits.                                          30
3) Changes in U.S. Balance of Payment Situation:
   From 1945-50 the U.S. had persistent surpluses.
  These were replaced by deficits in 1957.
  Deficits resulted in increased foreign holding of US
  dollars. (What is the percentage of $s in circulation held outside the US?)
  By mid 1958 the European market in dollar deposits and
  loans had become established.

4) The Interbank Market and Global Financial

5) Regulatory Developments in the US:
  (i) "Regulation Q": Interest rate ceilings existed in the
     U.S. during the 1960s and 1970s.
     With higher interest on dollars deposited in the
     eurodollar market, funds moved to banks in Europe.
     Many U.S. banks opened European offices to receive
     these funds.
  (ii) Federal Reserve "Regulation M": This regulation
     requires the keeping of reserves against deposits.
     Since reserves constitute idle funds, the cost of operating
     in the Eurocurrency market is relatively less since there
     are no reserve requirements in the eurocurrency market.
     Many American banks moved some of their operations to
     the relatively unregulated eurocurrency market.
(iii) Controls and Restrictions on Borrowing
  Funds in the U.S. for Reinvestment Abroad:
  (voluntary in 1965, mandatory in 1968) Forced many
  borrowers to seek sources of loans in Europe, thereby
  increasing the demand for funds deposited in the
  eurocurrency markets.

(iv) The U.S. Interest Equalization Tax (1963):
   Imposed a tax on U.S. residents' earnings on foreign
  This increased the interest foreign borrowers were forced
   to pay on funds borrowed directly from the U.S. market.
   By channeling funds through the eurocurrency market,
   this tax is avoided.
6) The Role of Narrow Spreads:
 The desire of depositors to receive highest
 possible yields and of borrowers to pay lowest
 possible costs are met in the Eurocurrency
 Absence of regulation permits higher yields to
 depositors and lower costs to borrowers.

7) Desire of British Banks - to maintain their
  leading position in international finance plus the
  favorable regulatory environment in the United
8) The Role of OPEC: OPEC countries use the
  Eurocurrency market to invest part of their
  petrodollars, so that the eurocurrency market provides
  a medium for what is commonly called "Petrodollar
9) Another factor explaining Eurocurrency development
  is the improvement in clearing operations.
 In October 1981, the Clearing House Interbank
  Payment System (CHIPS) shifted from next-day to
  same-day settlement.
 To better compete with domestic market in the US,
  CHIPS had to match the Fed Wire's immediate
  availability of funds service.                 35
10) Other Features of the Eurocurrency Market:
   Low costs per transaction because of relatively
    large size of transactions.
   Costs of complying with regulations are low since
    there are no deposit insurance assessments.
   Borrowers' credit worthiness is well known so that
    the need for credit investigation is low.
   No taxes are withheld from interest payments to
    Eurocurrency depositors.
   Taxes and fees levied on euro-banking operations
    are generally lower than those applied to domestic
 Eurocurrency markets need not be located in Europe,
  though they originate in Europe.

 For example, in the U.S., domestic banks are (since
  1981) permitted to open International Banking
  Facilities (IBF) which are computerized account
  records kept separate from U.S. banks' domestic

 They must be domiciled inside U.S. territory and
  focus on international commerce.

 They accept foreign currency denominated deposits.

These "onshore/offshore" bank accounts are
 permitted in an effort to regain deposits lost to
 offshore banking operations.

IBF accounts are free from reserve requirements
 and assessment for deposit insurance; are also
 exempt from federal taxes, becoming taxable only
 when transferred to the banks' regular accounts.

   The primary participants in the Eurocurrency market
    are large banks called Eurobanks.
   Transactions are predominantly interbank, hence the
    market is frequently called "interbank market." In
    addition, large scale or "wholesale" transactions take
    place between banks and non-bank customers.
   Transactions are typically priced off the London
    Interbank Offer Rate (LIBOR) which is a floating
    rate commonly charged for loans between Eurobanks.
    LIBOR is the world's most widely used benchmark
    for short-term interest rates.
    It is the rate at which the world’s most credit worthy
    borrowers are able to borrow money.
             The Eurocredit Market:
   Loans of 1 year or longer extended by Eurobanks are
    called Eurocredit Loans.
    These loans are popular with corporations and
    government agencies.
    Since Eurobanks accept short-term deposits, there exists
    the problem of maturity mismatch between deposits and
    To avoid the risk Eurobanks commonly use Floating Rate
    Eurocredit Loans.
    Loan rates float in accordance with movement of some
    market interest, such as the LIBOR.
   Syndicated Eurocredit Loans are provided to large
    corporate or government borrowers by a group of banks
    participating in the syndicate.                    40
                   The Eurobond Market:
   Eurocurrency and Eurocredit loans help to accommodate
    short and medium term borrowers.
   The Eurobond was created to accommodate long-term
    borrowers. Partially the result of Interest Equalization Tax
    (IET) imposed in the U.S. in 1963 to discourage U.S.
    investors from investing in foreign securities.
    Foreign borrowers are thus forced to look elsewhere for
    funds and the Eurobond market fills the void.
   The Eurobond market facilitates the transfer of long-term
    funds from surplus spending units to deficit spending
    units around the world.
    This market helps to link investors with borrowers around
    the world, and thereby helps to integrate the world's
    financial system.                                       41
 International Stock Markets
 Major Stock Exchanges and Indexes …..
 Emerging Stock Market Exchanges and Indexes...
 Morgan Stanley Capital International (MSCI)
 World Index …
 Stock Market Capitalizations Around the World...
 Investing Internationally: Avenues.
  -- Direct Purchase of Foreign Shares
  -- Purchase of MNC stocks
  -- American Depository Receipts (ADRs)
  -- World Equity Benchmark Shares: I-shares, ETFs
  -- International Mutual Funds                42
   The US stock market is a Continuous Market.
    Securities are available for trading throughout trading
   Other markets use a system of Call Market.
    Each security is called for trading at a specific time
    and can be traded only at that time.
   Rules for listing stocks on exchanges differ markedly
    Some stocks are listed on multiple exchanges.
   US listing requirements are among the most restrictive.
   What is FX/Forex/Foreign Exchange/Currency Exchange?
   Who are the participants in the FX market?
   What is the margin?: Collateral (cash, or security) that an investor is
    required to keep on deposit to cover potential losses. Typically 5% in FX.
   What is the bid price? / ask (offer) price?
   What is the “pip”: The smallest price movement available in an instrument.
    1 pip is equivalent to 1 basis point.
   What is a “long” or “short” position?
   Explain “market” and “limit” orders: Market orders are executed
    immediately at current market price. Limit orders are executed when market price
    reached a specified price trigger.
   What is a “round trip” transaction? Speculative currency trading is
    designated “round trip” because positions are settled within the same
    account and same currency from which trade originated

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