Foreign Exchange markets o The set of markets where foreign currencies and other assets are exchanged for domestic ones Institutions buy and sell deposits of currencies or other assets for investment purposes The daily volume of foreign exchange transactions was $4.0 trillion in april 2010 up from $500 billion in 1989 Most transactions(85% in April 2010 exchange foreign currencies for U.s. dollars Copyright G 2012 Pearson Education. All rights reserved 14-16
Copyright © 2012 Pearson Education. All rights reserved. 14-16 Foreign Exchange Markets • The set of markets where foreign currencies and other assets are exchanged for domestic ones – Institutions buy and sell deposits of currencies or other assets for investment purposes. • The daily volume of foreign exchange transactions was $4.0 trillion in April 2010 – up from $500 billion in 1989. • Most transactions (85% in April 2010) exchange foreign currencies for U.S. dollars
Foreign Exchange markets The participants: 1. Commercial banks and other depository institutions transactions involve buying/selling of deposits in different currencies for investment purposes 2. Non-bank financial institutions(mutual funds hedge funds securities firms insurance companies pension funds)may buy/sell foreign assets for investment 3. Non-financial businesses conduct foreign currency transactions to buy/sell goods, services and assets 4. Central banks: conduct official international reserves transactions Copyright G 2012 Pearson Education. All rights reserved 14-17
Copyright © 2012 Pearson Education. All rights reserved. 14-17 Foreign Exchange Markets The participants: 1. Commercial banks and other depository institutions: transactions involve buying/selling of deposits in different currencies for investment purposes. 2. Non-bank financial institutions (mutual funds, hedge funds, securities firms, insurance companies, pension funds) may buy/sell foreign assets for investment. 3. Non-financial businesses conduct foreign currency transactions to buy/sell goods, services and assets. 4. Central banks: conduct official international reserves transactions
Foreign Exchange Markets(cont.) Buying and selling in the foreign exchange market are dominated by commercial and investment banks Inter-bank transactions of deposits in foreign currencies occur in amounts $1 million or more per transaction. Central banks sometimes intervene the impact of their transactions may be large even though the volume of transactions is small Copyright 2012 Pearson Education. All rights reserved 14-18
Copyright © 2012 Pearson Education. All rights reserved. 14-18 Foreign Exchange Markets (cont.) • Buying and selling in the foreign exchange market are dominated by commercial and investment banks. – Inter-bank transactions of deposits in foreign currencies occur in amounts $1 million or more per transaction. – Central banks sometimes intervene, the impact of their transactions may be large even though the volume of transactions is small
Foreign Exchange Markets(cont) Computer and telecommunications technology transmit information rapidly and have integrated markets The integration of financial markets implies that there can be no significant differences in exchange rates across locations Arbitrage: buy at low price and sell at higher price for a profit If the euro were to sell for $1. 1 in New York and $1. 2 in London, could buy euros in New York(where cheaper ) and sell them in London at a profit. No arbitrage the market is efficient. U.S. dollar is used as vehicle currency which improves the efficiency of transactions Copyright G 2012 Pearson Education. All rights reserved 14-19
Copyright © 2012 Pearson Education. All rights reserved. 14-19 Foreign Exchange Markets (cont.) • Computer and telecommunications technology transmit information rapidly and have integrated markets. • The integration of financial markets implies that there can be no significant differences in exchange rates across locations. – Arbitrage: buy at low price and sell at higher price for a profit. – If the euro were to sell for $1.1 in New York and $1.2 in London, could buy euros in New York (where cheaper) and sell them in London at a profit. – No arbitrage: the market is efficient! • U.S. dollar is used as vehicle currency, which improves the efficiency of transactions
Spot Rates and forward rates Spot rates are exchange rates for currency exchanges on the spot, or when trading is executed in the present o Forward rates are exchange rates for currency exchanges that will occur at a future(forward" date Forward dates are typically 30, 90, 180, or 360 days in the future Rates are negotiated between two parties in the present but the exchange occurs in the future Reduces the risk of exchange rate Copyright 2012 Pearson Education. All rights reserved 14-20
Copyright © 2012 Pearson Education. All rights reserved. 14-20 Spot Rates and Forward Rates • Spot rates are exchange rates for currency exchanges “on the spot,” or when trading is executed in the present. • Forward rates are exchange rates for currency exchanges that will occur at a future (“forward”) date. – Forward dates are typically 30, 90, 180, or 360 days in the future. – Rates are negotiated between two parties in the present, but the exchange occurs in the future. – Reduces the risk of exchange rate