Chapter 8
annualized forward premium or discount
((forward price - spot price) / spot price) * n
two-point arbitrage
(also called geographic arbitrage) involves profiting from price differences in two geographically distinct markets.
agent; home
A correspondent relationship is an _____ relationship whereby one bank acts as a correspondent, or agent, for another bank in the first bank's ____ country, and vice versa.
subsidiary; branch; affiliated
An overseas banking operation can be established in several ways. If it is separately incorporated from the parent, it is called a _____ bank; if it is not separately incorporated, it is called a ____ bank. Sometimes an international bank may choose to create an ______ bank, an overseas operation in which it takes part ownership in conjunction with a local or foreign partner.
87, primary
Approximately __% of the transactions involve the U.S. dollar, a dominance stemming from the dollar's role in the Bretton Woods system. Because the dollar is used to facilitate most currency exchange, it is known as the ______ transaction currency for the foreign-exchange market.
call option
BUY: It grants the right to buy the foreign currency in question.
The clients of the foreign-exchange departments of banks fall into several categories
Commercial customers Speculators deliberately Arbitrgeurs
convertible currencies/hard
Currencies that are freely tradable
inconvertible/soft
Currencies that are not freely tradable because of domestic laws or the unwillingness of foreigners to hold them the currencies of many developing countries fall in this category
derived; acquire; falls
Economists call this demand curve a _______ demand curve because the demand for yen is derived from foreigners' desire to ______ Japanese goods, services, and assets. To buy Japanese goods, foreigners first need to buy Japanese yen. Like other demand curves, it is downward sloping, so as the price of the yen ____, the quantity of yen demanded increases. This is shown as a movement from point A to point B on the demand curve.
forward discount
If the forward price (using a direct quote) is less than the spot price, the currency is selling at a the foreign-exchange market believes that the currency will depreciate over time, firms may want to reduce their holdings of assets and liabilities denominated in such a currency (OFTEN BOP trade defecit or high inflation rates)
forward premium
If the forward price is higher than the spot price, the currency is selling at a the foreign-exchange market believes the currency will appreciate over time, firms may want to increase their holdings of assets and liabilities denomiated in such a currency (OFTEN BOP trade surpluses or low inflation rates)
arbitrage of goods
If the price of a good differs between two markets, people will tend to buy the good in the market offering the lower price, the "cheap" market, and resell it in the market offering the higher price, the "expensive" market. Under the law of one price, such arbitrage activities will continue until the price of the good is identical in both markets (excluding transaction costs, transportation costs, taxes, and so on).
not; regulations; compete
In 1981, the Federal Reserve Board authorized the creation of international banking facilities (IBFs). They are subsidiaries of U.S. banks; however, they are distinct from the domestic operations of those banks, and they may offer only international banking services. Because IBFs do____ need to observe U.S. domestic banking ________, they enable U.S. banks to _________ with other international bankers in the Euroloan marketplace.x
Major Players: Foreign Exchange Market
International Banks Corporate Treasurers Pension Funds Hedge Funds Insurance Companies Central Banks Treasury Departments
reciprocal; different
International banking takes many forms. Originally, most international banking was done through ______ correspondent relationships among banks located in ______ countries.
retail; individual
International banks also play a key role in the _____ market for foreign exchange, dealing with ________ customers who want to buy or sell foreign currencies in large or small amounts. typically the price paid by retail customers for foreign exchange is the prevailing wholesale exchange rate plus a premium
financing; investment
International banks and their overseas operations are important providers of international commercial banking services. Exporters and tourists use such banking services when they exchange their home currency or traveler's checks for local currency. Although the physical exchange of one country's paper currency for another's is part of international banking operations, a far more important part entails ______ and facilitating everyday commercial transactions. In addition to commercial banking services, most international banks provide ______ banking services.
low; benefits; deposits
MNEs often use offshore financial centers to obtain ___-cost Eurocurrency loans. Many MNEs locate financing subsidiaries in these centers to take advantage of the _______ they offer: political stability, a regulatory climate that facilitates international capital transactions, excellent communications links to other major financial centers, and availability of legal, accounting, financial, and other expertise needed to package large loans. The efficiency of offshore financial centers in attracting ______ and then lending these funds to customers worldwide is an important factor in the growing globalization of the capital market.
currency future
Publicly traded on many exchanges worldwide is a contract that resembles a forward contract. However, unlike the forward contract, it is for a standard amount on a standard delivery date (for example, the third Wednesday of the contract's maturity month). a firm wanting to be released from obligation can make an offsetting transaction
put option
SELL: grants the right to sell the foreign currency.
betting; headed
Sometimes international banks act as speculators, ______ that they can guess in which direction exchange rates are _____. Such speculation can be enormously profitable, although it is always risky.
domestic; global; country
Start-up companies are no longer restricted to raising new equity solely from _______ sources. Established firms can tap into the ______ equity market. Another innovation is ________- fund, which is a mutual fund that specializes in investing in a given country's firms.
cost; large; borrowers
The Euroloan market has grown up with the Eurocurrency market. Euroloans are often quoted on the basis of the London Interbank Offer Rate (LIBOR), the interest rate that London banks charge each other for short-term Eurocurrency loans. This market is a low-____ source of loans for _____, creditworthy ______, such as governments and multinational enterprises.
Eurocurrency; outside
The ________ market originated in the early 1950s. At first, the term Eurodollars was applied to U.S. dollars deposited in any bank account outside the United States. As other currencies became stronger, the market broadened to include Euroyen, Europounds, and other currencies. Today, a currency on deposit ______ of its country of issue is defined as a Eurocurrency.
theory of purchasing power parity (PPP)
The arbitrage of goods across national boundaries is represented by this the prices of tradable goods, when expressed in a common currency, will tend to equalize across countries as a result of exchange rate changes. This occurs because the process of buying a good in the cheap market and reselling it in the expensive market affects the following: the demand for and the price of the foreign currency and the market price of the good itself in the two product markets in question.
large; dominant; major; spread
The foreign-exchange departments of _____ international banks such as JPMorgan Chase and Deutsche Bank in major financial centers like New York, London, and Hong Kong play a ______ role in the foreign-exchange market. These banks stand ready to buy or sell the ______ traded currencies. They profit from the ______ between the bid and ask prices for foreign exchange.
owns; convert; second
The foreign-exchange market consists of buyers and sellers of currencies issued by the world's countries. Anyone who _____ money denominated in one currency and wants to _____ that money to a _____ currency participates in the foreign-exchange market.
currency future and currency option
The foreign-exchange market has developed two other mechanisms to allow firms to obtain foreign exchange in the future. Neither, however, provides the flexibility in amount and in timing that international banks offer.
multinational; technology; global
The growing importance of ______ operations and the improvements in telecommunications ________ have made equity markets more _____.
large; financial; global
The international banking system is centered in ____ money market banks headquartered in the world's __________ centers—Japan, the United States, and the European Union. These banks are involved in international commerce on a ____ scale
Foreign bonds Eurobonds
The international bond market represents a major source of debt financing for the world's governments, international organizations, and larger firms. This market has traditionally consisted of two types of bonds:
London
The largest foreign-exchange market is in ______, followed by New York, Tokyo, and Singapore.
currency options
The second mechanism allows, but does not require, a firm to buy or sell a specified amount of a foreign currency at a specified price on a specified date. are publicly traded on organized exchanges worldwide.
5.3
The world wide volume of foreign-exchange trading is estimated at $___ trillion per day. Foreign exchange is being traded somewhere in the world every minute of the day.
foreign; obtain; selling; rises
Underlying the supply curve for yen is the desire by the Japanese to acquire ______ goods, services, and assets. To buy foreign products, Japanese need to ______ foreign currencies, which they do by selling yen and using the proceeds to buy the foreign currencies. ______ yen has the effect of supplying yen to the foreign-exchange market. As with other goods, as the price of the yen ______, the quantity supplied also rises; you can see this when you move from point A to point B along the supply curve people offer more yen for sale as the price of the yen rises
offshore; nonresident;
_________ financial centers focus on offering banking and other financial services to _________ customers. Many of these centers are located on island states, such as The Bahamas, Bahrain, the Cayman Islands, Bermuda, the Netherlands Antilles, and Singapore. Although they are not islands, Luxembourg and Switzerland are also important "offshore" financial centers.
foreign exchange
a commodity that consists of currencies issued by countries other than one's own
global bond
a large, liquid financial asset that can be traded anywhere at any time
international Fisher effect
an increase in expected inflation implies higher rates of interest
foreign bonds
are issued by a resident of country "A" but sold to residents of country "B" and denominated in the currency of country "B." For example, the Nestlé Corporation, a Swiss resident, might issue a foreign bond denominated in yen and sold primarily to residents of Japan.
Speculators deliberately
assume exchange rate risks by acquiring positions in a currency, hoping that they can correctly predict changes in the currency's market value. Foreign-exchange speculation can be very lucrative if one guesses correctly, but it is also extremely risky. playing on the market - love exchange rate risk
Arbitrageurs
attempt to exploit small differences in the price of a currency between markets. They seek to obtain riskless profits by simultaneously buying the currency in the lower-priced market and selling it in the higher-priced market.
the spot market
consists of foreign-exchange transactions that are to be consummated immediately (normally defined as two days after the trade date). Spot transactions account for 38 percent of all foreign-exchange transactions.
the forward market
consists of foreign-exchange transactions that will occur sometime in the future. Prices are often published for foreign exchange that will be delivered one month, three months, and six months in the future. Many users of the forward market engage in swap transactions.
foreign exchange rates are quoted in two ways
direct exchange rate (direct quote) indirect exchange rate (indirect quote)
Commercial customers
engage in foreign-exchange transactions as part of their normal business activities. These activities include exporting or importing goods and services, paying or receiving dividends and interest from foreign sources, and purchasing or selling foreign assets and investments. Some commercial customers use the market to hedge against unfavorable changes in foreign-exchange rates for moneys to be paid or received in the future. do not like foreign exchange risk
foreign-exchange market
exists to facilitate the conversion of currencies also facilitates international investment and capital flows
US interest rates lower
foreign discount means
US interest rates higher
foreign premium means
forward discount or premium on the foreign currency
interest rate differential is equal to the
Eurobonds
is a bond issued in the currency of country "A" but sold to residents of other countries. For example, American Airlines could borrow $500 million by selling Eurobonds denominated in dollars to residents of Denmark and Germany.
swap transaction
is a transaction in which the same currency is bought and sold simultaneously, but delivery is made at two different points in time.
Covered-interest arbitrage
is arbitrage that occurs when the difference between two countries' interest rates is not equal to the forward discount/premium on their currencies. If forward premium - US higher interest rates - foreign lower interest rates. Likewise, if forward discount - US lower interest rates - foreign higher interest rates
three-point arbitrage
is the buying and selling of three different currencies to make a riskless profit. because of this, change in any one foreign-exchange market can affect prices in all other foreign-exchange markets
cross rate
is the exchange rate between two currencies calculated through the use of a third currency the us dollar is the primary third currency used
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
equilibrium; equal
market for three currencies will be in ______ only when arbitrage profits do not exist when the direct quote and the cross rate for each possible pair of the three currencies are ______
purchase call option on forward
no exchange rate risk can still claim capital gain if dollar appreciates
purchase forward or future
no exchange rate risk lose opportunity for capital gain if dollar appreciates
buy today and hold
no exchange rate risk opportunity cost of money
cost; directly; cross
professional currency traders can make profits through three-point arbitrage whenever the ____ of buying a currency ______ differs from the _____ rate of exchange
Go naked (wait)
retain exposure to foreign exchange risk no capital outlay
price of foreign exchange
set by demand and supply in the marketplace. (given a flexible exchange rate system)
market's; economic
the difference in spot and forward prices of currency often signals the _______ expectations regarding that country's ______ policies and prospects
reciprocals; convenience
the direct exchange rate and the indirect exchange rate are ________ of each other. By tradition—and sometimes for ________—certain exchange rates are typically quoted on a direct basis and others on an indirect basis. For example, common U.S. practice is to quote British pounds on a direct basis but Japanese yen on an indirect basis.
direct exchange rate (or direct quote)
the price of the foreign currency in terms of the home currency ex: US dollar equivalent
indirect exchange rate (or indirect quote)
the price of the home currency in terms of the foreign currency. ex: currency per U.S. dollar
convertible/hard inconvertible/soft
two types of currencies
interbank transactions
typically involving at least $1 million (or the foreign currency equivalent), account for a majority of foreign-exchange transactions.
US interest rates higher
us discount means
US interest rates lower
us premium means