2Copy of 13 Forex MktBB.docx
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2Copy of 13 Forex MktBB.docx
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2Copyof13ForexMktBB
DepartmentofEconomics,NUICork
EC3202–InternationalMoneyandFinance
Lecturer:
StephanieSweeneyHandout2012/13No.3
TheForeignExchangeMarketTheforeignexchangemarketprovidesthephysicalandinstitutionalstructurethroughwhichthemoneyofonecountryisexchangedforthatofanothercountry,therateofexchangebetweencurrenciesisdeterminedandforeignexchangetransactionsarephysicallycompleted.Foreignexchangemeansthemoneyofaforeigncountrythatis,foreigncurrencybankbalances,banknotes,checksanddrafts.
Aforeignexchangetransactionisanagreementbetweenabuyerandsellerthatafixedamountofonecurrencywillbedeliveredforsomeothercurrencyataspecifiedrate.
TheSizeoftheMarket
Theforeignexchangemarketisuniquebecauseofitstradingvolume,theextremeliquidityofthemarket,thelargenumberoftradersandthegeographicaldispersion.AccordingtoaBISsurveyinApril2004theaveragedailyinternationalforeignexchangetradingvolumewas$1.9trillion.
FunctionsoftheForeignExchangeMarket
1)Transferpurchasingpowerbetweencountries
2)Obtainorprovidecreditforinternationaltradetransactions
3)Minimiseexposuretotheriskofexchangeratechanges
TheForeignExchangeMarketParticipants
1)ForeignExchangeDealers
2)Individualandfirmsconductingcommercialandinvestmenttransactions
3)SpeculatorsandArbitragers
4)CentralBankandTreasuries
5)ForeignExchangeBrokers
TransactionsintheForeignExchangeMarket
1)SpotTransactions现货交易:
Aspottransactionrequiresalmostimmediatedeliveryofforeignexchange.
2)OutrightForwardTransactions直接远期交易:
Aforwardtransactionrequiresdeliveryatafuturevaluedate,aspecifiedamountofonecurrencyforaspecifiedamountofanothercurrency.
3)SwapTransactions互换交易:
Aswaptransactioninvolvesthesimultaneouspurchaseandsaleofagivenamountofforeignexchangefortwodifferentvaluedates.
WhyareExchangeRatesImportant
1)Exchangeratesfeedinto:
a)Outlookfordomesticandglobaleconomy
b)Stockmarket
c)Industrialcompetitiveness(firm/industry.
2)Increasedglobalisation
a)Internationalisationofbusiness
b)Relativityofworldtradetodomesticdemand
c)Economicintegration(e.g.Europe)
d)Technologicaladvancesinmoneytransfer
BuyingvsSellingRatesAsinmanyothermarkets,mosttransactionsinvolveintermediaries,whoactastemporarybuyersforagentswishingtosellandastemporarysellersforagentswishingtobuySometimesintermediarieschargefeesMoreoften,theirprofitliesindifferencebetweenpriceatwhichtheybuycurrencyandpriceatwhichtheysellit.
BidrateforcurrencyAintermsofcurrencyBisrateatwhichdealersbuycurrencyA(sellcurrencyB).Offerrate(oraskrate)israteatwhichdealersellscurrencyA(buyscurrencyB).Bid/offerspreadisgapbetweenofferandbidrates.
Example:
Bid/offerspreadof€/£was0.03p,sodealerwouldmake£30,000ontransactionof£100m
Sincebuyingonecurrencyinvolvessellinganother,offerpriceforcurrencyA(intermsofcurrencyB)isreciprocalofbidpriceforcurrencyB(intermsofcurrencyA).
Inabsenceoftransactioncosts:
–S(€per£)=1/S(£per€)
Doesn’tholdwhenyouallowforbid/offerspread
ExchangeRates
Anexchangerateisbasicallyaprice
BilateralvsTradeWeightedExchangeRates
Abilateralexchangerateisanexchangeratebetweentwocountries.ThebilateralexchangeratebetweentheUKandtheUSAisthepriceofdollarsintermsofpounds.Achangeintheexchangerateinfavourofthedollarcouldbeindicativeofeitheradeclineintheinternationalvalueofthepoundorariseinthedollarorboth.
Across-exchangerateisanexchangeratebetweentwocurrencies,AandB,neitherofwhichis€.ItcanbecalculatedastheratioofexchangerateofAtothe€,dividedbyexchangerateofBtothe€.
Ifwelookatcross-ratesandseethat€hasdepreciatedagainst$butappreciatedagainst£,istheneteffectariseorfallinthevalueof€?
NostraightforwardanswerIfpricesofsomegoodsarerisingwhilepricesofothersarefalling,theoverallchangeinpricesiscalculatedusingindex
Effectiveortrade-weightedexchangerateofcurrencyAisaweightedaverageofitsexchangeratesagainstcurrenciesB,C,D,E,etc.TheweightsusedareusuallytheproportionofcountryA’stradewhichinvolvesB,C,D,E,etc.respectively.
Effectiveexchangerateismultilateral,ratherthanbilateral
Absolutevalueofindexhasnomeaning-dependsonbaseyear(sameasCPI).
E.g.ifeffectiveexchangerateof€is105today,itmeansthatitis5%aboveitsaveragelevelinbaseyear.
2.FOREXMarket–InstitutionsandOrganisation
164CurrenciesListedontheLondonInterbankMarket
QuotingConventions:
∙TheFXSymbolisdefinedinElectronicBankingSystemformatas"CCY1/CCY2".
oRatesareexpressedas"currency1incurrency2"(or"currency2percurrency1")andarecalculatedasCCY2dividedbyCCY1,NOTCCY1dividedbyCCY2
∙CCY1/CCY2=X
WhereX=numberofunitsofCCY2thatoneunitofCCY1isworth.
Impliesthat:
oCCY1Amount*Rate(X)=CCY2Amount(whentradingCCY1)
oCCY2AmountRate(X)=CCY1Amount(whentradingCCY2)
∙MarketConventiondeterminesCCY1andCCY2foranycurrencypairbasedonthevalueofeachcurrencywithahierarchyofexceptions.ThelessvaluablecurrencyistypicallyCCY2(givingarate>1),exceptforthe11currencieslistedbelowwhicharealwaysCCY1:
EUR;GBP;AUD;NZD;FJD;TOP;WST;PGK;BWP;SBD;USD.(Theorderofthislistisimportant!
)
Ifanyofthe12currenciesonour‘exceptions’listarequotedagainsteachother,thenthecurrencyhigherinthelistwillbeCCY1.
Examples:
∙AratebetweenSwissFranc(CHF)andJapaneseYen(JPY)willbequotedasCHF/JPYbecause1CHFisworthmorethan1JPYinthemarket.
(NB:
the‘/’signcanbeconfusing;itiseasytomistakeitforaratio–i.e.youmightbetemptedtoquotethenumberofSwissFrancstotheJapaneseYen.Rememberourrateis,infact,theopposite,quotingthenumberofYentotheSwissFranc.)
∙AratebetweenGBP(PoundSterling)andAUD(AussieDollar)willbequotedasGBP/AUDbecauseGBPappearsfirstintheabovelist.
∙Insomecaseswhereacurrency(notintheabovelist)withahighvalueisquotedagainstacurrencyinthelist,theratecanbelessthan1.Examplesare:
USD/BHD;USD/CYP;andUSD/KWD.
∙Incertainlocalmarkets,however,manycorporatesprefertheirowndomesticcurrencytoalwaysbeCCY1orCCY2.SwisscompaniesforexamplepreferCHFalwaystobeCCY2,sotheyasktheirbanktoquoteaJPY/CHFrateratherthanaCHF/JPYrate.Thisisnotinterbankmarketconventionbutlocalmarketpractice.
∙Untilrecently,GBPwasalwaysquotedCCY1becauseoneunitofGBPwasworthmorethanoneunitofanyothermajorcurrency.Likewise,forsomeothercurrencieswithstronghistoricalconnectionstoGBPsuchastheAUDandNZD.
Withtheadventoftheeuroonthein1998,theECBstipulatedthatEURshouldalwaysbeCCY1,evenagainstGBP.Therewassomeoppositiontothis,particularlyfromLondonBanks.WhentradinginEURbeganonJan4th,1999,automatedbrokerssuchasReuters3000Spotmatching,supportedbothEUR/GBPandGBP/EURsothatmarketcoulddecidewhichwouldemergeasmarketstandard.EUR/GBPwasveryquicklyestablishedasacceptedmarketconvention.
∙CCY1isalsoknownas‘basecurrency’andCCY2isknownas‘terms’currency.‘Basecurrency’,however,isoftenusedtodescribeabanksdomesticoraccountingcurrency.Becarefulwhenusingtheterm‘base’intrading.Forexample,ifaBritishBankwhoseaccounting/basecurrencyisGBP,istradingEUR/GBP,thebasecurrencyofthetrade(CCY1)isneverthelessEUR.
∙ThereisnoorganisationthatdecideswhatmarketconventionshouldbeforanyaspectofForextrading.Thisexplanationismerelystatingpracticesthatarefollowedbytheinterbankmarket.
SpotFXTrading
∙Foreignexchange(oftenabbreviatedtoFXorforex)meansthebuyingandsellingofcurrenciesagainstothercurrencies.Amassive1.5trillionUSDollarsistradedeverydayinthewholesaleforeignexchangemarket.Thatequatesto1billionUSDollarsperminute.
∙FXspotpricesareusuallyquotedtobetween4and6significantfigures.Forexample,EUR/USD,themostfrequentlytradedcurrencypair,hasseenratessuchas0.8225,1.0015or1.4628.Thenumberofdecimalsdoesnotvaryforaparticularcurrencypairaccordingtomovementsintherate,exceptinthecaseofdevaluations.
FXspotpriceshaveabidpriceandanofferprice,forexample:
Bid
Offer
EUR/USD
1.0345
1.0347
∙ThebidpriceiswherethebankiswillingtobuyCCY1andtheofferpriceiswherethebankiswillingtosellCCY1.Inthiscase,thebankiswillingtobuyEURagainstUSDat1.0345andiswillingtosellEURagainstUSDat1.0347.Thedifferencebetweenthebidandtheofferiscalledthespread.ItismarketconventionalwaystotalkaboutwhatyouaredoingwithCCY1.Forexample,ifsomeoneis"buyingUSD/JPY",theyarebuyingUSDandsellingJPY.
Marketparticipantsaregenerallyexpectedtoknowwhatthefirstpartoftheratewillbe(inthiscase1.03..),andthispartisknownasthe"bigfigure".Becausethecurrentbigfiguredoesnotusuallyvaryfromoneminutetothenext,tradersnormallyquoteonlythelast2digitsoftherate(3digitsforsomecurrencypairs),andthesedigitsareknownasthe"pips".Atraderwouldthereforequotethebidandofferinthisexampleas"4547".Whentradingoverthephone,itiscommontoquoteonlythepips,whereaselectronicsystemsgenerallydisplaytheentirerate(althoughthepipsmaybegivenmorep
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