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PART FOURWORLD FINANCIAL ENVIRONMENT

International Business

Chapter Nine

Global Foreign Exchangeand Capital Markets

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Chapter 9 Objectives

How does the foreign exchange work?

Why do companies deal in foreign exchange?

Who are the different institutions that deal inforeign 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 priceof one currencyexpressed in termsanother 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

M ost are Ov er-the-counter ( OTC ) market through

commercial and investment banks T he 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 INTR ADING BANK MKT.SH ARE LONDON NEW YORK EURO/US$ US$/YEN

1. Deutsche Bank 19.75% 2 3 1 4

2. UBS Warburg 11.61% 5 4 4 33. Citigroup 7.33% 3 1 3 14. HSBC 6.64% 1 5 2 2

5. Barclays 6.41% 4 ² 7 76. JP Morgan 5.38% 7 2 5 5

7. ABN Amro 4.57% 9 7 6 6

8. Merrill Lynch 4.45% ² ² ² ²9. Goldman Sachs 4.38% 8 8 10 1010.Morgan Stanley 4.20% ² 9 ² ²S ource: ³2005 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 ² ² ² ² 38 37Japanese 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 31S ource: Bank for International Settlements, Central Bank S urvey of Foreign Exchange and Derivatives M arket 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 manygovernments¶ central banks

Dollars are a transaction currency in manyinternational commodity markets

Dollars are an invoice currency

Dollars are an intervention currency used by

monetary authorities to influence their ownexchange 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 andthe 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 sella given currency at a negotiated price on aspecified future date.

Option: gives the buyer the right (but not theobligation) to buy or sell a certain amount of foreign currency at a specified exchange rate³strike 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$ EQUIV ALENT CURRENCY PER US$

COUNTRY THUR WED THUR WEDBrazil (Real) .3917 .3972 2.5530 2.5176Canada (Dollar ) .7991 .8004 1.2514 1.2494

India (Rupee) .02291 .02288 43.649 43.706Japan (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 1.1919U.K. (Pound) 1.9068 1.9059 .5244 .5247Special 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.

S ources: International Monetary Fund; Wall S treet Journal, 2005.

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Is ALL currency convertible?

Convertibility: How easy/hard it is to purchase foreigncurrency with a domestic currency without governmentrestrictions 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 seriousimpediments to trade and investment.

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Why do Businesses Fx?

1. To covert currency for trade transactions2. 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

C ompanies borrow money in the international bond market todi v ersify 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 G lobal 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 beenvery sensitive to global economic conditions andevents.

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Conclusions

at least $1.2 trillion in foreign exchange istraded 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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