1、CHAPTER 3,THE FOREIGN EXCHANGE MARKET,3-2,Foreign Exchange,Foreign exchange is the act of trading different nations moneys. Demand deposits in banks Paper moneys Coins Foreign exchange rate is the price of one nations money in terms of another nations money.,3-3,Foreign Exchange Market,The foreign e

2、xchange market is the market in which national moneys are traded for other national moneys. 24-hour market / geographic dispersion Enormous trading volumes ($3.2 trillion on Forex vs. $100 billion on NY Stock Market per day,2007) Most trading involves U.S. dollars Retail vs. Interbank part of the ma

3、rket,3-4,24-Hour Market,Sidney 7:00-12:00 Tokyo 8:00-14:00 Hong Kong/Singapore 9:00-16:00 Frankfurt Summer 14:00-23:00 Winter15:00-0:00 London Summer 15:00-23:30 Winter 16:00-0:30 New York Summer 20:30-3:00 Winter 21:30-4:00 West Coast Summer 21:30-4:00 Winter 22:30-5:00,In Beijing Time, the followi

4、ng markets are most active in FX trading,3-5,Geographical Dispersion,3-6,Market Size,Main FX market average daily turnover, 1988 - 2007, in billions of USD,Source: Bank for International Settlements (December 2007),3-7,Market Size,As of Apr.2010, average daily turnover is estimated at $3.98 trillion

5、.,3-8,Market Size,Source: Bank for International Settlements ,2010,3-9,Most traded currencies,Source: Bank for International Settlements,3-10,Most traded currencies,Source: Bank for International Settlements , 2010,3-11,Top 10 currency traders,Source: Euromoney FX survey FX Poll. It is the largest g

6、lobal poll of foreign exchange service providers.,3-12,Levels of Access,Stock market vs. Forex market: No central exchange: OTC market Forex market is divided into levels of access. Retail parts vs. Interbank parts Trading volume Difference in spreads : difference between bid and ask price,EUR/USD：

7、0.7150/0.7153 for interbank market 0.7100/0.7200 for banknotes or travelers checks,3-13,Retail Markets,British firm,U.S. producer,A jet plane,Bank in London,Ask its bank to convert pounds into dollars,Bank in New York,Instruct to take dollars from its demand deposit account and pay to the U.S. produ

8、cer,Transfer dollars to its account,3-14,Inter-bank Market,The inter-bank market accounts for more than 40% of all transactions. Participants in inter-bank market: commercial banks and investment banks Active participants in retail part of the market: smaller investment banks, multi-national corpora

9、tions, hedge funds, pension funds, insurance companies, mutual funds, other institutional investors,3-15,Exchange Rates,An exchange rate is the price of one currency in terms of another currency. Two currencies involved Timing of delivery 1. Spot 2. Forward (An other rate is the future spot rate.),3

10、-16,Exchange Rates,As a U.S. dollar price of the other currency. $1.7621/ $0.1462/rmb As the price of the U.S. dollar in units of the other currency. 0.5675/$ rmb6.8406/$ The reciprocals of each other.,3-17,Direct vs. Indirect Quotation,Direct Quotation: Rates quoted in terms of a variable number of

11、 home currency per fixed foreign currency unit. rmb6.2725/$ Vice Versa $0.1594/rmb,3-18,Spot Exchange Rate,Source: Bank of China, www. boc. cn,The price of the other currency in units of RMB,3-19,Spot Exchange Rate,Source: Bank of China, www. boc. cn,3-20,Cross Rates in Spot Market,Source: ,3-21,The

12、 New York foreign exchange selling rates below apply to trading among banks in amounts of $1 million and more, as quoted at 4 p.m. Eastern time by Dow Jones and other sources. Retail transactions provide fewer units of foreign currency per dollar. For Late New York Trading Friday, October 22, 2010,K

13、ey Currency Cross Rates,Source: Wall Street Journal,3-22,What makes the ER rise or fall?,All the transactions create supply and demand for foreign currencies, which determine the exchange rate, within certain foreign exchange system.,3-23,Demand & Supply,Imports of goods and services and capital out

14、flows (as well as income payments to foreigners) create a demand for foreign currency.(debit items) Exports of goods and services and capital inflows (as well as income received from foreign sources) create a supply of foreign currency. (credit items),Balance of Payments and the Exchange Rate,Q,P,As

15、 U.S. citizens import, they supply dollars to the FOREX market.,Exchange rate $,S,D,($15.9),Balance of Payments and the Exchange Rate,Q,P,As U.S. citizens export, others demand dollars at the FOREX market.,S,D,($15.9),Exchange rate $,3-26,Demand and Supply Curves,3-27,Why Does Demand Curve Slope Dow

16、nward?,When the pound declines from $1.98 to $1.6, the Americans will find more use of it., 50,$1.98/ 50 = $99 $1.60/ 50 = $80,Made in Britain,3-28,Why Does Supply Curve Slope Upward?,When the pound declines from $1.98 to $1.6, the British will be reluctant to buy American goods.,$ 99,$99 $1.98/ = 5

17、0 $99 $1.60/ = 61.87,Made in U.S.A,3-29,Why Does Demand Curve Shift？,The following will drive it to the right: Increase in demand for U.K. products. (caused by forces other than changes in the exchange rate) A rise in U.S. residents willingness to invest in pound-denominated financial assets,3-30,Wh

18、y Does Supply Curve Shift？,The following will drive it to the right: Increase in U.K. residents demand for U.S. products (caused by forces other than changes in the exchange rate) . A rise in U.K. residents willingness to invest in U.S. dollar-denominated financial assets.,3-31,Floating Exchange Rat

19、es,The simplest system The formation of exchange rates is market-driven, purely by the interaction of private demand and supply for that currency. No intervention by government or currency authority.,3-32,Figure 3.2,3-33,Figure 3.3,Consider: A demand-side force other than changes in exchange rates d

20、rives the demand curve upwards.,3-34,Fixed Exchange Rates,Heavy intervention by government or currency authority. A fixed exchange rate is maintained even if this rate the government chooses differs from the current equilibrium rate.,3-35,Figure 3.2A,In this case, British officials are forced to int

21、ervene in the market, buying 50bn Pound to fill the gap AB.,2.00,2.02,Par value,3-36,Figure 3.2B,Now, Swiss government must sell 100bn SFr to defend the fixed exchange rate of 0.505.,3-37,Changes in Exchange Rates,Appreciation vs. depreciation under floating exchange rate regime Revaluation vs. deva

22、luation under fixed exchange rate regime.,Case 2 In April 21, 2008, Rmb/Dollar=7.00 In April 22, 2008, Rmb/Dollar=6.89,Case 1 In 1994, Rmb/Dollar=5.70 went to: Rmb/Dollar=8.30,USDCNY,3-38,Depreciation vs. Appreciation,3-39,3-40,Can these happen?,$1.7/ in New York while $1.6/ in London $1.7/, SFr3/Po

23、und & $0.50/SFr exist at a point in time?,3-41,Arbitrage in the spot market,Arbitrage is a process of buying and selling to make a (nearly) riskless pure profit, which ensures the rates in different locations essentially the same.,London,$1.40/Pound,$1.30/Pound,New York,3-42,Arbitrage in the Spot Market,Citibank HSBC Bid Price for HKD $0.1288 $0.1298 Ask Price for HKD $0.1293 $0.1303,If you have HKD10,000 in hand and would exchange them for USD, which bank would you go to? If yo