chapter 8

Foreign Exchange and International Financial Markets

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International Business, 6th Edition

Griffin & Pustay

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Chapter Objectives
Describe how demand and supply determine the price of foreign exchange Discuss the role of international banks in the foreign-exchange market Assess the different ways firms can use the spot and forward markets to settle international transactions

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Chapter Objectives (continued)

Summarize the role of arbitrage in the foreign-exchange market Discuss the important aspects of the international capital market

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Foreign Exchange
Foreign exchange is a commodity that consists of currencies issued by countries other than ones own.

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Figure 8.1 Demand for Yen

Demand for Japanese yen is derived from foreigners demand for Japanese products

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Figure 8.2 Supply of Yen

Supply for Japanese yen is derived from Japanese demand for foreign products

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Figure 8.3 The Market for Yen

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Foreign-Exchange Rates
Direct exchange rate
Direct quote Price of the foreign currency in terms of home currency

Indirect exchange rate

Indirect quote Price of the home country in terms of the foreign currency
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Figure 8.4 Direct and Indirect Exchange Rates

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Structure of the Foreign-Exchange Markets The foreign-exchange market comprises buyers and sellers of currencies issued by the worlds countries.

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Foreign-Exchange Trading
The largest center for foreign exchange trading is London, followed by New York and Tokyo.

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Figure 8.5 Currencies Involved in ForeignExchange Market Transactions

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The Role of Banks

Buy or sell major traded currencies Markets
Wholesale market Retail market

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Map 8.1 A Day of Foreign-Exchange Trading

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Bank Foreign Exchange Clients

Commercial customers Speculators

Arbitrageurs

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Foreign-Exchange Trading
The Tel Aviv foreignexchange trader is an important link in the $3.2 trillion-per-day global exchange market.
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Spot and Forward Markets

Spot Market: foreign exchange transactions that are consummated immediately Forward Market: foreign exchange transactions that are to occur sometime in the future

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Spot and Forward Markets

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Mechanisms for Future Foreign Exchanges Currency future Currency option

Call option Put option

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Arbitrage
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. There are two types of arbitrage activities that affect the foreign-exchange market: arbitrage of goods and arbitrage of money.

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Arbitrage

Arbitrage of Goods

Arbitrage of Money

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Arbitrage of Money

Two-point

Three-point

Covered-interest

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Figure 8.6 Three-Point Arbitrage

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International Capital Market

Major International Banks International Bond Market Global Equity Markets Offshore Financial Centers

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Table 8.1 The Worlds Largest Banks

ING Group Fortis Citigroup Dexia Group HSBC Holding BNP Paribas Credit Agricole Deutsche Bank Bank of America Corp. HBOS

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Establishment of Overseas Banking Operations

Subsidiary bank

Branch bank

Affiliated bank

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The Eurocurrency Market

Originated in the early 1950s Eurodollars U.S. dollars deposited in European bank accounts
Euroyen Europounds

Eurocurrency currency on deposit outside in banks worldwide Euroloans quoted on basis of LIBOR
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The International Bond Market

Major source of debt financing for:
Worlds governments International organizations Larger firms

Two types of bonds

Foreign bonds Eurobonds
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Figure 8.7 International Bond Issues

2007, by Currency (in billions of U.S. dollars)

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Global Equity Markets

Start-up companies are no longer restricted to raising new equity only from domestic sources Development of country funds
Mutual fund specializing in a given countrys funds

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Offshore Financial Centers

Focus on offering banking and other financial services to nonresident customers Locations
Bahamas, Bahrain, the Cayman Islands, Bermuda, the Netherlands Antilles, Singapore, Luxembourg, Switzerland
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All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America.

Copyright 2010 Pearson Education, Inc. publishing as Prentice Hall