Foreign Exchange & Foreign Exchange Market

Chapter5ForeignExchange&ForeignExchangeMarketOverviewForeignExchange&ForeignExchangeRateForeignExchangeDeterminationsForeignExchangeMarketForeignExchangeTransactionsVocabularyWorkKeyConceptsSentenceUnderstandingCaseStudyPractice-ParagraphTranslation-TrueorFalse-PracticalWritingForeignExchange&ForeignExchangeRateVocabularyWorkforeignexchangeforeignexchangerateexchangeratequotationpricecurrency/unitcurrencydirect/indirectquotationmethodhomecurrency/foreigncurrencyKeyConcepts&CaseStudyForeignExchange&ForeignExchangeRateForeignExchange-currencyissuedbyforeigngovernment-topayforimportedgoods-tomeetforeigndebtrepaymentobligationsForeignExchangeRate-howmuchonecurrencyisworthintermsoftheother.-forexrate/FXrateQuotationExchangeQuotation-statingthenumberofunitsofapricecurrencythatcanbeboughtintermsofaunitcurrency.-e.g:Euro-UnitedStatesDollarexchangerate=1.2dollarspereuro-pricecurrency:dollar-unitcurrency:euroQuotationDirectQuotation-HomeCurrency=pricecurrency-ForeignCurrency=unitcurrencyIndirectQuotation-ForeignCurrency=pricecurrency-HomeCurrency=unitcurrencyCaseStudyDirectQuotation-Britishpounds:homecurrency-USdollars:foreigncurrency-ForeignExchangeRate:$1=£0.625-Britishpounds=pricecurrency-USdollars=unitcurrencyIndirectQuotation-GBP-USDExchangeRate:£1=$1.6--Britishpounds=unitcurrency-USdollars=pricecurrencyChinaisusingthedirectquotationmethod.-RMB/GBPExchangeRate:￥10.0039/£1=10.0039-RMB/USDExchangeRate:￥6.3815/$1=6.3815TypesofExchangeRateSystemVocabularyWorkfixedandfloatingexchangeratesinterveneexchangeratetargetsterlingtheEuropeanExchangeRateMechanism(ERM)marketdeterminedcommoncirculationmacroeconomicperformancerunupordowntheexchangeratetakepromptinterventionalactionextentoffluctuationputeconomicsecurityundermenacepermittedbandsoffluctuationTypesofExchangeRateSystemFixedandFloatingExchangeRatesFreeFloatingManagedFloatingExchangeRatesSemi-fixedExchangeRatesFully-fixedExchangeRatesFixedandFloatingExchangeRatesThegovernment(orthecentralbankactingonthegovernment’sbehalf)intervenesinthecurrencymarketsothattheexchangeratestaysclosetoanexchangeratetarget.Example:-BritainjoinedtheEuropeanExchangeRateMechanisminOct1990,itfixedsterlingagainstotherEuropeancurrencies.-ThepoundwaspermittedtovaryagainsttheGermanMarkbyonly6%eithersideofacentraltargetofDM2.95.-BankofEnglandhadnotintervenedinthecurrencymarketsforalongtimemeaningthatSterlinghasbeenmarket-determinedIn2002,12exchangeratedbecameonewhentheEuroenteredcommoncirculationthroughouttheEuroZone.FreeFloatingWithfloatingexchangerates,changesinmarketdemandandmarketsupplyofacurrencycauseachangeinitsvalue.Tradeflowsandcapitalflowsarethemainfactorsaffectingtheexchangerate.Inthelongrun,itisthemacroeconomicperformanceoftheeconomythatdrivesthevalueofcurrencyItisrareforpurefreefloatingexchangeratestoexist---mostgovernmentsatonetimeoranotherseekto“manage”thevalueoftheircurrencythroughchangesininterestratesandothercontrols.ManagedFloatingExchangeRatesDirtyFloatingGovernmentsinterveneintheexchangemarkettorunupordowntheexchangerateofthedomesticcurrencyaccordingtoitsnationaleconomicorpoliticalinterest.Inpractice,governmentswouldtakepromptinterventionalactionwhentheextentoffluctuationputitseconomicsecurityundermenace.Semi-fixedExchangeRatesThecurrencyisallowedtomovebetweenpermittedbandsoffluctuation,whichmakestheexchangerateisthedominanttargetofeconomicpolicy-making.Interestratesaresettomeetthetargetandtheexchangerateisgivenaspecifictarget.Re-valuationispossible,butseenaslastresort.Fully-fixedExchangeRatesCommitmenttoasinglefixedexchangerate,nofluctuationispermitted.Governmentsmayuseinternationalreservesforinterventionpurposeorputforeignexchangecontrolintopracticetomaintainthevalueofitscurrency.Somecountrieshavetoborrowconsiderableforeigndebtstobalanceitspaymentandeasethepressureonitsowncurrency.Theexchangeratestabilitymaybeachievedattheexpenseofdomesticeconomicstability.DeterminationsofExchangeRatesVocabularyWorkspotexchange/forwardexchangeexecutethedealonthespottradeataspecifiedratebesellingatadiscount/atapremiumSpotExchangeonthespottradesexecutethedealimmediatelyonaparticulardayexample:-marketopens:thespotUSD/GBPExchangeRate:$1=£0.7-bytheendoftheday:thespotexchangeratemightbe:$1=£0.73-theDollarhasappreciated,andthePoundhaddepreciatedproblematicforaninternationalbusinessForwardExchangeTwopartiesagreetoexchangecurrencyataspecifiedrateexecutethedealatsomespecificdateinthefuture30days/90days/180daysintothefutureForwardExchangeExample:-USimportinglaptopsfromJapan,JPY200,000foreach-thecurrentdollar/yenspotexchangerate:$1=￥120-thecostsinUSD=￥200,000/120=$1,667-thegrossprofit=thesellingpriceof$2,000–thecost$1,667=$333-30dayslater-thedollar/yenexchangerate:$1=￥95(JPYappreciates)-thecostsinUSD=￥200,000/95=$2,105-anunprofitabledeal-30-dayforwardexchangerate:$1=￥110-thecostsinUSD=￥200,000/110=$1,818-thegrossprofit=thesellingpriceof$2,000–thecost$1,818=$182Discount&Premiumfuturecurrencymovementsforeignexchangedealersexpectedthedo