exchange markets and exchange rates

Exchange markets and rates1

Exchange markets and exchange rates

Suggested Reading from Textbook Chapter 7 (Foreign Exchange Market : Operation and Mechanics)


The foreign exchange market

●A 24-hour market●Moves from Tokyo in the far east to Hong Kong, Singapore, Bahrain, Frankfurt, Zurich, London, New York and Los Angeles ●No Physical, individual market place. Banks and dealers carry out transactions



Heavy use of technologyThe resulting electronic infrastructure melds the world into a global market for ideas, data and capital, all moving virtually at the speed of light to any part of the world The Inter-bank foreign exchange markets are arguably the most efficient markets in the world



●Today, there are more than 200,000 computer terminals, in hundreds of trading rooms, in scores of countries around the world, that light up to display an unending flow of news●Less than two minutes elapse between the time a president, a prime minister or a central banker makes a statement and the time markets buy or sell currency, stocks or bonds, according to their evaluation of the policy's effect on the market



●The result is a continuing global referendum on a country's economic policies, which are the final determinant of the value of its currency●In a sense, the financial market represents a form of economic free speech. Although many politicians do not like what it is saying, the market presents judgments that are generally clear-eyed and hard-nosed



●The foreign exchange market is by far the largest financial market in the world ●Daily trading volume of close to $ 6 trillion

QuestionWhich are the major centres of foreign exchange trading in the world?


Major centres of forex trading

Singapore has outstripped Tokyo by a tiny margin

London (41% ofVolume)

New York ( 19%Of volume)

Tokyo ( 6% of Volume )

Substantial overlap Between American and European markets

Some overlap between European and Asian markets

No overlap between American and Asian markets


Question

●After peaking in 1998, daily trading volumes in foreign exchange markets fell sharply to about a trillion dollars in the late nineties

●How would you explain this sharp fall in volumes?



●Volume fell largely because of the replacement of 12 European currencies with the euro .

●And also the rise of electronic trading (traders entering their buy and sell orders directly into their terminals on an anonymous basis, and these prices are visible to all market participants. Another trader, anywhere in the world can execute a trade by simply pressing a button)

Question : Have you heard of “high-frequency trading? What is it ? Why is the SEC worried about it ?


Question

●How would you explain the following, rather startling position? Does it bother you in terms of how it might affect the global financial system?

●Trade accounts for less than 5% of all foreign exchange transactions ( in other words about $ 300 billion as compared with say $ 6 trillion a day of forex transactions )

The data on the next slide might help in forming a view on the above question

Global Foreign Exchange Market Turnover ( USD Billions) ( Source : Bank for International Settlements, database)Transaction Type 1998 200

12004 200

72010

2013

Spot 568 386 631 1005

1488

2048

Outright forwards

128 130 209 362 475 680

Forex swaps 734 656 954 1714

1759

2226

Currency Swaps

10 7 21 31 43 54

Derivatives (mainly options)

87 60 119 212 207 447

Total 1527 1239

1934 3324

3971

5435



●There could be two major reasons:

The foreign exchange market is very largely an inter-bank market, with banks having to cover every one of their transactions

Portfolio investments, and, to some extent, speculation

Speculation in currency marketsGeorge Soros, Thailand, mid 1997Current Account Deficit 8.5% of GDPBut Thai Baht pegged to the US DollarUS Dollar began risingPeg became difficult to maintainEnter George SorosSpeculates heavily against THBTHB crashesSo-called East Asian crisis begins

QuestionWho are the major participants in

the foreign exchange market ?



Market participants

●Commercial banks●Individuals●Central banks●Speculators●Arbitrageurs

QuestionWhy do central banks get involved in forex markets?

QuestionWhat are the different types of

transactions in the foreign exchange market?



Types of transactions

●Commercial●Arbitrage●Speculation●Intervention

Question: What is the difference between arbitrage and speculation?

QuestionWhat are some of the major quoting

conventions in the foreign exchange market?



Rates and quoting conventions

●Tomorrow (“Tom”) - value tomorrow or the next trading day●Spot: value two business days after the trading date (one business day for Canadian/US dollar transactions)●Forwards – Trade at a pre-specified price and on a pre-specified future date ( any value date beyond spot )



●Direct quote: expresses the foreign currency in local currency terms (say $ 1 = Rs. 60.00)●Indirect quote: Expresses the local currency in foreign currency terms (say Rs 100 = $ 1.6667)



●Cross rates (Example: If $ quotes at Rs 60 and Pound sterling quotes at Rs 120, then we can work out the Pound dollar rate by crossing these two rates. We get one Pound = 120 / 60 = $2.00)

●Two-way quotes (buy and sell rates) For example, a bank might buy dollars from you at Rs 60 and sell it at Rs. 61


Question

●What are the major sources of supply of foreign exchange?


Sources of supply of foreign exchange

●Exporters (goods and services)●NRI deposits and remittances●FDI (foreign direct investment)●FPI (foreign portfolio investment)●Euro issues (GDRs, euro-convertibles, euro-bonds)●Euro loans●Aid (bilateral, multilateral)


Question

●What are the major sources of demand for foreign exchange?


Sources of demand for foreign exchange

●Importers (goods)●Central bank●Investors●Loan repayers●Unilateral transfers (eg. gifts)●Speculators

QuestionWhat is the US Dollar Index ?


UD Dollar Index ( USDX)Started by New York Board of Trade (NYBOT), renamed ICE Futures USEstablished in 1973 to track the Dollar’s value against a basket of currencies ( major trading partners at the time )Began with 17 currencies, now down to 6 with euro launch Current weights : Euro (57%), JPY ( 14%), GBP (12%), CAD (9%), Swedish Krone (4%), CHF (4%)Index has traded as high as 165, but also into the low seventies ( Currently , on 9 January 2016 , quoting at 98.45)

exchange markets and exchange rates

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