Foreign Exchange and International Financial fffffff Markets Griffin & Pustay 8-1 Copyright 2010 Pearson Education, Inc publishing as Prentice Hall International Business, 6th Edition chapter 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 8-2 Copyright 2010 Pearson Education, Inc publishing as Prentice Hall Chapter Objectives (continued) • Summarize the role of arbitrage in the foreign-exchange market • Discuss the important aspects of the international capital market 8-3 Copyright 2010 Pearson Education, Inc publishing as Prentice Hall Foreign Exchange Foreign exchange is a commodity that consists of currencies issued by countries other than one’s own 8-4 Copyright 2010 Pearson Education, Inc publishing as Prentice Hall Figure 8.1 Demand for Yen Demand for Japanese yen is derived from foreigners’ demand for Japanese products 8-5 Copyright 2010 Pearson Education, Inc publishing as Prentice Hall Figure 8.2 Supply of Yen Supply for Japanese yen is derived from Japanese demand for foreign products 8-6 Copyright 2010 Pearson Education, Inc publishing as Prentice Hall Figure 8.3 The Market for Yen 8-7 Copyright 2010 Pearson Education, Inc publishing as Prentice Hall 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 8-8 Copyright 2010 Pearson Education, Inc publishing as Prentice Hall Figure 8.4 Direct and Indirect Exchange Rates 8-9 Copyright 2010 Pearson Education, Inc publishing as Prentice Hall Structure of the Foreign-Exchange Markets The foreign-exchange market comprises buyers and sellers of currencies issued by the world’s countries 8-10 Copyright 2010 Pearson Education, Inc publishing as Prentice Hall Spot and Forward Markets 8-18 Copyright 2010 Pearson Education, Inc publishing as Prentice Hall Mechanisms for Future Foreign Exchanges • Currency future • Currency option – Call option – Put option 8-19 Copyright 2010 Pearson Education, Inc publishing as Prentice Hall 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 8-20 Copyright 2010 Pearson Education, Inc publishing as Prentice Hall Arbitrage Arbitrage of Goods 8-21 Copyright 2010 Pearson Education, Inc publishing as Prentice Hall Arbitrage of Money Arbitrage of Money Two-point Three-point 8-22 Copyright 2010 Pearson Education, Inc publishing as Prentice Hall Covered-interest Figure 8.6 Three-Point Arbitrage 8-23 Copyright 2010 Pearson Education, Inc publishing as Prentice Hall International Capital Market • Major International Banks • International Bond Market • Global Equity Markets • Offshore Financial Centers 8-24 Copyright 2010 Pearson Education, Inc publishing as Prentice Hall Table 8.1 The World’s Largest Banks • ING Group • BNP Paribas • Fortis • Credit Agricole • Citigroup • Deutsche Bank • Dexia Group • Bank of America Corp • HSBC Holding • HBOS 8-25 Copyright 2010 Pearson Education, Inc publishing as Prentice Hall Establishment of Overseas Banking Operations Subsidiary bank Branch bank 8-26 Copyright 2010 Pearson Education, Inc publishing as Prentice Hall Affiliated bank 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 8-27 Copyright 2010 Pearson Education, Inc publishing as Prentice Hall The International Bond Market • Major source of debt financing for: – World’s governments – International organizations – Larger firms • Two types of bonds – Foreign bonds – Eurobonds 8-28 Copyright 2010 Pearson Education, Inc publishing as Prentice Hall Figure 8.7 International Bond Issues 2007, by Currency (in billions of U.S dollars) 8-29 Copyright 2010 Pearson Education, Inc publishing as Prentice Hall 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 country’s funds 8-30 Copyright 2010 Pearson Education, Inc publishing as Prentice Hall 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 8-31 Copyright 2010 Pearson Education, Inc publishing as Prentice Hall All rights reserved No part of this publication may 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Copyright 2010 Pearson Education, Inc publishing as Prentice Hall International Capital Market • Major International Banks • International Bond Market • Global Equity Markets • Offshore Financial... can use the spot and forward markets to settle international transactions 8-2 Copyright 2010 Pearson Education, Inc publishing as Prentice Hall Chapter Objectives (continued) • Summarize the.. .Chapter Objectives • Describe how demand and supply determine the price of foreign exchange • Discuss the role of international banks in the foreign-exchange