Multinational financial management 7th CH07

Multinational Financial Management Alan Shapiro 7th Edition Power Points by J.Wiley & Sons Joseph F Greco, Ph.D California State University, Fullerton CHAPTER THE FOREIGN EXCHANGE MARKET CHAPTER OVERVIEW I INTRODUCTION II.ORGANIZATION OF THE FOREIGN EXCHANGE MARKET III THE SPOT MARKET IV THE FORWARD MARKET PART I INTRODUCTION I INTRODUCTION A The Currency Market: where money denominated in one currency is bought and sold with money denominated in another currency INTRODUCTION B International Trade and Capital Transactions: facilitated with the ability to transfer purchasing power between countries INTRODUCTION C Location OTC-type: no specific location Most trades by phone, telex, or SWIFT SWIFT: Society for Worldwide Interbank Financial Telecommunications PART II ORGANIZATION OF THE FOREIGN EXCHANGE MARKET I PARTICIPANTS IN THE FOREIGN EXCHANGE MARKET A Participants at Levels Wholesale Level (95%) - major banks Retail Level - business customers ORGANIZATION OF THE FOREIGN EXCHANGE MARKET B Two Types of Currency Markets Spot Market: - immediate transaction - recorded by 2nd business day ORGANIZATION OF THE FOREIGN EXCHANGE MARKET Forward Market: - transactions take place at a specified future date ORGANIZATION OF THE FOREIGN EXCHANGE MARKET C Participants by Market Spot Market a commercial banks b brokers c customers of commercial and central banks 10 THE SPOT MARKET Percent Spread Formula (PS): Ask − Bid PS = x100 Ask 22 THE SPOT MARKET D Cross Rates The exchange rate between non - US$ currencies 23 THE SPOT MARKET Calculating Cross Rates When you want to know what the dm/ff cross rate is, and you know dm2/US$ and ff.55/US$ then dm/ff = dm2/US$ ÷ ff.55/US$ = dm3.636/ ff 24 THE SPOT MARKET E Currency Arbitrage If cross rates differ from one financial center to another, and profit opportunities exist 25 THE SPOT MARKET Buy cheap in one int’l market, sell at a higher price in another Role of Available Information 26 THE SPOT MARKET F.Settlement Date Value Date: Date monies are due 2nd Working day after date of original transaction 27 THE SPOT MARKET G Exchange Risk Bankers = middlemen a Incurring risk of adverse exchange rate moves b Increased uncertainty about future exchange rate requires 28 THE SPOT MARKET 1.) Demand for higher risk premium 2.) Bankers widen bid-ask spread 29 MECHANICS OF SPOT TRANSACTIONS SPOT TRANSACTIONS: An Example Step Currency transaction: verbal agreement, U.S importer specifies: a Account to debit (his acct) b Account to credit (exporter) 30 MECHANICS OF SPOT TRANSACTIONS Step Bank sends importer contract note including: - amount of foreign currency - agreed exchange rate - confirmation of Step 31 MECHANICS OF SPOT TRANSACTIONS Step Settlement Correspondent bank in Hong Kong transfers HK$ from nostro account to exporter’s Value Date U.S bank debits importer’s account 32 PART IV THE FORWARD MARKET I INTRODUCTION A Definition of a Forward Contract an agreement between a bank and a customer to deliver a specified amount of currency against another currency at a specified future date and at a fixed exchange rate 33 THE FORWARD MARKET Purpose of a Forward: Hedging the act of reducing exchange rate risk 34 THE FORWARD MARKET B Forward Rate Quotations Two Methods: a Outright Rate: quoted to b commercial customers Swap Rate: quoted in the interbank market as a discount or premium 35 THE FORWARD MARKET CALCULATING THE FORWARD PREMIUM OR DISCOUNT = F-S x 12 x 100 S n where F = the forward rate of exchange S = the spot rate of exchange n = the number of months in the forward contract 36 ... specific location Most trades by phone, telex, or SWIFT SWIFT: Society for Worldwide Interbank Financial Telecommunications PART II ORGANIZATION OF THE FOREIGN EXCHANGE MARKET I PARTICIPANTS... ff.55/US$ = dm3.636/ ff 24 THE SPOT MARKET E Currency Arbitrage If cross rates differ from one financial center to another, and profit opportunities exist 25 THE SPOT MARKET Buy cheap in one