Management 80 Chapter 9: International Financial Markets
What are the instruments used to restrict currencies?
- Central Bank approval may be required regarding foreign exchange transactions - Government may impose import licenses - Multiple exchange rates to reduce importation of certain goods while also ensuring that important goods enter the country. - Import deposit requirements may force businesses to deposit %'s of their foreign exchange in special accounts before being granted import licenses. - Quantity restrictions limit the amount of foreign currency that residens can take out of the home country.
What is the appeal of Eurocurrency Markets?
- Euromarkets are appealing because they are completely UNREGULATED plus they have LOW transaction costs. This lowers the cost of banking. - Downsides are a Greater Risk of default due to lack of government regulation.
What are the main functions of the Foreign Exchange Market?
1) Currency Conversion: helps facilitate international transactions, investments abroad, and the repatriation of profits back to the home country. 2) Currency Hedging helps insure against potential losses from adverse changes in exchange rates 3) Currency Arbitrage: investors seek profits by conducting an instantaneous purchase and sale of a currency in different markets. 4) Currency Speculation lets traders purchase a currency with the expectation that its value will change over time and generate a profit.
Name the forces that are driving International Capital Market Expansion
1) Expansion of Information Technology allowing companies to gather data to analyze and evaluate customer behaviors. Allows for quicker communication. 2) Deregulation promotes more competition, lowers cost of transactions, and opens up more internaitonal markets to global investing and borrowing. 3) Financial Instruments: Securitization is an instrument that unbundles and repackages hard-to-trade financial assets into more liquid, negotiable, and marketable financial instruments. ex: Federal Mortgage loan Association guarantees mortgages against default.
What is a convertible(hard) currency? What are the goals of currency restriction?
A convertible Currency is currency that is traded freely in the foreign exchange market, and whose prices are determined by supply and demand. USually developed countries allow full convertability b/c they have strong financial position and excess reserves of foreign currency. The goals of Currency Restriction are: 1) Preserve a country's reserve of hard currencies with which to repay debts owed to other nations. this measure prevents likelyhood of defaulting on debts 2) Preserve its own hard currencies in order to pay for imports and to finance trade deficits. This is to limit imports and to preserve the trade balance. 3) Protect currency from speculators. 4) Keep resident individuals and businesses from investing in other nations. Force investments to remain at home which can generate more rapid economic growth.
What is a Cross Rate?
A cross rate is calculated by using 2 currencies' exchange rates against a 3rd currency..Use direct or indirect exchange rates against a 3rd currency.
What is one way to get around national restrictions on currency convertability?
Countertrading is the practice of selling goods and services that are paid for with another good or service. Ex. Bartering oil for wheat.
What is the difference between a direct quote and an indirect quote? Give the formula and examples
Example: It takes 84.3770 Japanese Yen to boy 1 USD. The Yen is the quoted currency and the dollar is the base currency. B/c the Yen is the quoted currency, this is a DIRECT QUOTE on the yen, and an INDIRECT QUOTE on the dollar. - Formula: Direct Quote = 1/Indirect Quote - Formula: Indirect Quote = 1/Direct Quote Example: To find direct quote of dollar, and for dollar to be quoted currency, ==> 1/84.3770 = $0.001852 dollars per 1 Yen. - DIRECT QUOTE = QUOTED CURRENCY - INDIRECT QUOTE = BASE CURRENCY
Define foreign exchange market and exchange rates
Foreign exchange markets are markets where currencies are bought and sold and their prices determined. Financial institutions convert currencies using an exchange rate: The rate at which one currency is exchanged for another. Supply and Demand forces determine currency prices.
What is a Forward Rate?
Forward rate is the rate at which two parties agree to exchange currencies on a specified future date. A forward contract requires the exchange of an agreed-on amount of a currency on an agreed-on date at a specified exchange rate. The purpose is to insure against unfavorable changes in exchange rates. Usually these forward contracts are created for 30, 90, and 180 days into the future.
Name the Differences between interbank markets, securities exchanges, and over the counter markets.
INTERBANK markets are the market in which the world's largest banks exchange currencies at forward and spot rates. SECURITY EXCHANGES specialize in currency futures and options transactions. Lastly, OVER THE COUNTER markets are decentralized exchanges that encompass a global computer network of foreign exchange traders and other market participants.There is no central trade location and allows for more customized transactions.
What are the purposes of international capital markets? How do they affect borrowers and lenders?
International capital markets benefit borrowers by: - Expanding money supply for borrowers - lowering cost of money for borrowers(Markets with high money supply, low interest rates These international Capital markets also reduce risk for LENDERS by: - Choosing from a larger set of opportunities. - Gains in overseas securities can offset losses.
What is the difference between the London Inter Bank Offer Rate(LIBOR) and the London Inter Bank Bid Rate(LIBID)?
LIBID is the bid rate that banks are willing to pay for eurocurrency deposits. LIBOR is the interest rate at which banks borrow money from other banks.
What is the driving force in the international bond market?
LOW INTEREST RATES. Borrowers in emerging markets borrow money in developed nations that have a lower interest rate. Investors in developed nations buy bnds of companies in emerging markets to earn higher rates of return. Higher risk of currency devaluation for investors that buy bonds of emerging markets.
What are offshore financial centers and why are they gaining popularity? Name the 2 kinds of centers.
Offshore financial centers are countries or territories whose financial sector may have very few regulations and few taxes. Usually tend to have economic and political stability, and provide access to international capital market. - 2 categories of offshore financial centers: 1) Operational Centers are where the financial activity and currency trading occur. 2) Booking Centers are where funds pass through on their way to operational centers. Generally on small islands, they have favorable tax laws.
How do you find the percent change in currency?
Percent Change% = (Pn - Po)/Po Pn = exchange rate at the end of a period(new) Po = exchange rate at the beginning of that period(old) Example: Change in USD against Norwegian Krone.. February 1 = Nok 5/1$... March 1 = Nok 4/$1 %Change = (4-5)/5 = -20%. USD fell 20%
What is a Spot Rate?
Spot rates A.K.A on the spot rates are exchange rates requiring delivery of the traded currency within 2 business days. Spot Markets assist companies in performing any of these 3 functions: - Convert INCOME generated from sales abroad into their home country currency - Convert funds into the currency of an international SUPPLIER - convert funds into the currency of a country in which they wish to INVEST
What is a capital market? What are the roles of debt and equity?
The Capital Market is a system that allocates financial resources to their most efficient uses through debts and equity. - Equity is given out in the form of stocks, that shares the financial risks and gains of future transactions with shareholders. - Debt allows companies to raise capital. Bonds are debt instruments that promise a loaner the date the principal is going to be paid back plus interest.
Describe and give examples of the eurocurrency market. Where do the deposits originate from?
The Eurocurrency market consists all the world's currencies(EUROCURRENCY) that are banked(invested/deposited) outside their country of origin and are traded. Ex: US dollars deposited in a bank in Australia are called Eurodollars.. Deposits originate from 4 sources: Governments with excess funds, commercial banks with excess currency, international companies with excess cash, and extremely wealthy individuals.
What are the 4 drivers that are responsible for the growth of the international equity market?
1) Spread of privatization(transferring gov. owned industry to public) places billions of dollars of new equity on stock markets 2) Economic Growth in emerging markets is fueled by economies requiring greater investment to grow, and increase domestic capital. 3) Investment Banks facilitate the sale of company stocks worldwide by bringing together sellers and large potential buyers. These banks search for investors outside their country to raise funds. 4) Electronic Cyber markets allow companies to list their stocks worldwide all day.
What is the International Bond Market? Name the 2 types of bonds.
The International Bond Market is the market of bonds sold by issuing companies, governments, and others outside their own countries. - The Eurobond is issued by a borrowing country in their own currency, to a different country whose currency is different from the bond that was just sold. Ex: A USD bond issued in Mexico and sold in Greece. - A Foreign bond is a bond that the borrowing country sells to a lending country in the lending country's currency. Ex: A German company issuing a USD bond in the US market.
What is the difference between a quoted currency and a base currency?
The QUOTED currency is how much of a currency it will take to buy 1 unit of the BASE currency. The quoted currency is always the numerator and the base currency is the denominator. ex: Yen/Dollar = Japanese yen needed to buy $1.
What is the difference between a currency swap, currency option, and currency futures contract?
These 3 currency instruments are produced by the forward market. A currency SWAP is the simultaneous purchase and sale of foreign exchange for 2 different dates. This is used to reduce exchange rate risk and lock in a future exchange rate. Ex: USD receives yen from a Chinese company. At same time it enters a forward contract to sell its Yen in 90 days. - Currency OPTION is the option/right to exchange a specified amount of currency on a specific date at a specific rate. This is used to hedge against risk and obtain foreign currency at a favorable rate. - Currency FUTURES CONTRACT: Requires the exchange of a specific amount of currency on a specified date at a specified exchange rate. All conditions fixed.