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    Foreign Exchange Market

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    Mzee Mayse Codiers
    The foreign exchange market allows for the exchange of one country's currency for another. It operates globally 24/7. The largest trading centers are London, New York, and Tokyo. Daily trading volume exceeds $3 trillion US dollars. The market consists of banks and dealers exchanging currencies for clients and speculators. Transactions can occur on a spot basis, which settles in 2 days, or on a forward basis, which settles on a future date. Exchange rates are quoted using either the direct method of a home currency price of foreign currency or the indirect method of a foreign currency price of home currency. Quotes contain both bid and ask prices for buying and selling currencies.

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    Foreign Exchange Market

    Uploaded by

    Mzee Mayse Codiers
    107 views10 pages
    The foreign exchange market allows for the exchange of one country's currency for another. It operates globally 24/7. The largest trading centers are London, New York, and Tokyo. Daily trading volume exceeds $3 trillion US dollars. The market consists of banks and dealers exchanging currencies for clients and speculators. Transactions can occur on a spot basis, which settles in 2 days, or on a forward basis, which settles on a future date. Exchange rates are quoted using either the direct method of a home currency price of foreign currency or the indirect method of a foreign currency price of home currency. Quotes contain both bid and ask prices for buying and selling currencies.

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    The foreign exchange market allows for the exchange of one country's currency for another. It operates globally 24/7. The largest trading centers are London, New York, and Tokyo. Daily trading volume exceeds $3 trillion US dollars. The market consists of banks and dealers exchanging currencies for clients and speculators. Transactions can occur on a spot basis, which settles in 2 days, or on a forward basis, which settles on a future date. Exchange rates are quoted using either the direct method of a home currency price of foreign currency or the indirect method of a foreign currency price of home currency. Quotes contain both bid and ask prices for buying and selling currencies.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as DOC, PDF, TXT or read online from Scribd
    Download as doc, pdf, or txt
    107 views10 pages

    Foreign Exchange Market

    Uploaded by

    Mzee Mayse Codiers
    The foreign exchange market allows for the exchange of one country's currency for another. It operates globally 24/7. The largest trading centers are London, New York, and Tokyo. Daily trading volume exceeds $3 trillion US dollars. The market consists of banks and dealers exchanging currencies for clients and speculators. Transactions can occur on a spot basis, which settles in 2 days, or on a forward basis, which settles on a future date. Exchange rates are quoted using either the direct method of a home currency price of foreign currency or the indirect method of a foreign currency price of home currency. Quotes contain both bid and ask prices for buying and selling currencies.

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    Attribution Non-Commercial (BY-NC)
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    Introduction

    The foreign exchange market provides the physical and institutional structure through which the money of one country is exchanged for that of another country, the rate of exchange between currencies is determined, and foreign exchange transactions are physically completed. A foreign exchange transaction is an agreement between a buyer and a seller that a given amount of one currency is to be delivered at a specified rate for some other currency.

    Geographical Extent of the Foreign Exchange Market


    Geographically, the foreign exchange market spans the globe, with prices moving and currencies traded somewhere every minute, every hour of every business day. The market is deepest, or most liquid, early in the European afternoon, when the markets of both Europe and the U.S. East coast are open. The market is thinnest at the end of the day in California, when traders in Tokyo and Hong Kong are just getting up for the next day. In some countries, a portion of foreign exchange trading is conducted on an official trading floor by open bidding. Closing prices are published as the official price, or 'fixing' for the day and certain commercial and investment transactions are based on this official price.

    The Size of the Market


    According to the Bank for International Settlements, as of April 2010, average daily turnover in global foreign exchange markets is estimated at $3.98 trillion, a growth of approximately 20% over the $3.21 trillion daily volume as of April 2007. Some firms specializing on foreign exchange market had put the average daily turnover in excess of US$4 trillion. This is about 5 to 10 times the daily volume of international trade in goods and services. The market is dominated by trading in US Dollars, Euro and Japanese Yen respectively. Trading in the United Kingdom accounted for 36.7% of the total, making it by far the most important center for foreign exchange trading. Trading in the United States accounted for 17.9%, and Japan accounted for 6.2%.

    BBM 300. Qn: Describe Foreign Exchange Market. By: Kodia, Irene, Pascal, Sylvia & Anthony.

    Functions of the Foreign Exchange Market


    The foreign exchange market is the mechanism by which a person of firm transfers purchasing power from one country to another, obtains or provides credit for international trade transactions, and minimizes exposure to foreign exchange risk. Transfer of Purchasing Power: Transfer of purchasing power is necessary because international transactions normally involve parties in countries with different national currencies. Each party usually wants to deal in its own currency, but the transaction can be invoiced in only one currency. Provision of Credit: Because the movement of goods between countries takes time, inventory in transit must be financed. Minimizing Foreign Exchange Risk: The foreign exchange market provides "hedging" facilities for transferring foreign exchange risk to someone else.

    Market Participants
    The foreign exchange market consists of two tiers: the inter-bank or wholesale market, and the client or retail market. Individual transactions in the inter-bank market usually involve large sums that are multiples of a million USD or the equivalent value in other currencies. By contrast, contracts between a bank and its client are usually for specific amounts, sometimes down to the last penny. Foreign Exchange Dealers Banks, and a few non-bank foreign exchange dealers, operate in both the inter-bank and client markets. They profit from buying foreign exchange at a bid price and reselling it at a slightly higher ask price. Worldwide competitions among dealers narrows the spread between bid and ask and so contributes to making the foreign exchange market efficient in the same sense as securities markets.

    BBM 300. Qn: Describe Foreign Exchange Market. By: Kodia, Irene, Pascal, Sylvia & Anthony.

    Dealers in the foreign exchange departments of large international banks often function as market makers. They stand willing to buy and sell those currencies in which they specialize by maintaining an inventory position in those currencies. Participants in Commercial and Investment Transactions: Importers and exporters, international portfolio investors, multinational firms, tourists, and others use the foreign exchange market to facilitate execution of commercial or investment transactions. Some of these participants use the foreign exchange market to hedge foreign exchange risk. Speculators and Arbitragers: Speculators and arbitragers seek to profit from trading in the market. They operate in their own interest, without a need or obligation to serve clients or to ensure a continuous market. Speculators seek all of their profit from exchange rate changes. Arbitragers try to profit from simultaneous exchange rate differences in different markets. Central Banks and Treasuries: Central banks and treasuries use the market to acquire or spend their country's foreign exchange reserves as well as to influence the price at which their own currency is traded. In many instances they do best when they willingly take a loss on their foreign exchange transactions. As willing loss takers, central banks and treasuries differ in motive and behavior form all other market participants. Foreign Exchange Brokers: Foreign exchange brokers are agents who facilitate trading between dealers without themselves becoming principals in the transaction. For this service, they charge a small commission, and maintain access to hundreds of dealers worldwide via open telephone lines. It is a broker's business to know at any moment exactly which dealers want to buy or sell any currency. This knowledge enables the broker to find a counterpart for a client quickly without revealing the identity of either party until after an agreement has been reached.

    BBM 300. Qn: Describe Foreign Exchange Market. By: Kodia, Irene, Pascal, Sylvia & Anthony.

    Transactions in the Inter-bank Market


    Transactions in the foreign exchange market can be executed on a spot, forward, or swap basis. Spot Transactions: A spot transaction requires almost immediate delivery of foreign exchange. In the inter-bank market, a spot transaction involves the purchase of foreign exchange with delivery and payment between banks to take place, normally, on the second following business day. The date of settlement is referred to as the "value date." Spot transactions are the most important single type of transaction which 37 % of all transactions. Outright Forward Transactions: A forward transaction requires delivery at a future value date of a specified amount of one currency for a specified amount of another currency. The exchange rate to prevail at the value date is established at the time of the agreement, but payment and delivery are not required until maturity. Forward exchange rates are normally quoted for value dates of one, two, three, six, and twelve months. Actual contracts can be arranged for other lengths. Outright forward transactions only account for about 12% of all foreign exchange transactions. Swap Transactions: A swap transaction involves the simultaneous purchase and sale of a given amount of foreign exchange for two different value dates. The most common type of swap is a spot against forward, where the dealer buys a currency in the spot market and simultaneously sells the same amount back to the same back in the forward market. Since this agreement is executed as a single transaction, the dealer incurs no unexpected foreign exchange risk. Swap transactions account for about 1% of all foreign exchange transactions.

    BBM 300. Qn: Describe Foreign Exchange Market. By: Kodia, Irene, Pascal, Sylvia & Anthony.

    Foreign Exchange Rates and Quotations


    A foreign exchange rate is the price of a foreign currency. A foreign exchange quotation or quote is a statement of willingness to buy or sell at an announced rate. Inter-bank Quotations: The most common way that professional dealers and brokers state foreign exchange quotations, and the way they appear on all computer trading screens worldwide, is called European terms. The European terms quote shows the number of units of foreign currency needed to purchase one Kenya Shilling (KES): KES 96.5770 / USD An alternative method is called the American terms. The American terms quote shows the number of units of USD needed to purchase one unit of foreign currency: USD 0.0104 / KES Clearly, those two quotations are highly related. Define the price of a USD in KES to be S (KES / USD) Also, define the price of a KES in USD to be S (USD / KES) USD0.0104 / KES Then, it must be that S (KES / USD) 1 S (USD / KES) KES 96.5770 / USD

    Because KES 96.5770 / USD = 1 / {USD 0.0104 / KES}. These rules also apply to forward rates as well. We will denote an outright forward quote using the following notation: F (KES / USD) Direct and Indirect Quotations: A direct quote is a home currency price of a unit of foreign currency.
    BBM 300. Qn: Describe Foreign Exchange Market. By: Kodia, Irene, Pascal, Sylvia & Anthony.

    An indirect quote is a foreign currency price of a unit of home currency. In the US, a direct quote for the KES is USD 0.0104 / KES This quote would be an indirect quote here in Kenya. Bid and Ask Quotations: Inter-bank quotations are given as "bid" and "ask". A bid is the exchange rate in one currency at which a dealer will buy another currency An ask is the exchange rate at which a dealer will sell the other currency. Dealers buy at the bid price and sell at the ask price, profiting from the spread between the bid and ask prices: bid < ask. Bid and ask quotations are complicated by the fact that the bid for one currency is the ask for another currency: 1 S (KES / USD) 1 a S (USD / KES) b S (KES / USD) S (USD/KES)
    b a

    Example

    A dealer provides you the following quote: USD 0.0254 - 0.0312/ KES. This suggests that the bid price for the KES is USD 0.0254/KES and that the ask price is USD 0.0312/KES. The indirect version of this quote would be KES 1.5750 - 1.5790/USD

    Clearly, a dealer willing to purchase KES at a price of USD 0.6333/USD is implicitly willing to sell USD at the reciprocal price of KES 1.5790/USD. The spread between bid and ask prices exists for two reasons: 1. Transaction costs and dealers as financial intermediaries and 2. Profits.

    The Law of One Price and Cross Rates


    The law of one price states that homogenous goods and assets should have the same price everywhere (efficient markets and free trade). Cross Rates: Many currency pairs are only inactively traded, so their exchange rate is determined through their relationship to a widely traded third currency (generally the USD): For example, imagine that an investor in Zambia would like to purchase some Kenya shillings (KES). As both currencies are quoted against the USD, the investor can figure out the price of the Zambian Kwacha (ZMK) against the KES. Assuming that the exchange rates are: Quotations: Zambian ZMK: Kenyan KES

    ZMK 0.6982/USD KES 0.0116/USD

    The cross rate is ZMK/KES is: ZMK 0.6982/USD KES 0.0116 / USD In general, the formula for cross rate is: S (i / j) S (i / USD) S(j/ USD) S (i / USD) S (USD / J ) ZMK60.1896 / BBD

    Conclusion The Foreign exchange market has grown from the April 1992 Bank of International Settlement (BIS) estimated daily trading volume of USD 1 Trillion, to April 2010 estimated volume of USD 4 Trillion. The Financial Market has thus become vital enabling component in international trade with every country dependent. As international trade grows, the Foreign exchange Market too, will grow. References:
    Foreign Exchange Market, by Dun And Bradstreet 2007 Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity in 2010 - Final results Bank of International Settlements Website http://www.bis.org/publ/rpfxf10t.htm Foreign Exchange http://en.wikipedia.org/wiki/Foreign_exchange_market

    The Foreign Exchange. http://zinepedia.com

    MASINDE MULIRO UNIVERSITY OF SCIENCE AND TECHNOLOGY CAMPUS. BUNGOMA

    QUESTION: Describe the Foreign Exchange Market

    PRESENTED BY:

    REG No.BBM/0781/11 REG No.BBM/1510/11 REG No.BBM/1517/11 REG No: BBM/1523/11 REG No: BBM/1541/11

    Kodia Edwin Mmaitsi Omondi Pascal Omondi Wandaka Sylvia

    Omukata Jecinta Irene Bunyolia Wanyonyi Anthony

    DEPARTMENT COURSE COURSE CODE COURSE TITLE

    : : : :

    BUSINESS MANAGEMENT BACHELOR OF BUSINESS MANAGEMENT BBM 300 FINANCIAL INSTITUTIONS AND MARKETS

    PRESENTED ON: LECTURER :

    4th. DECEMBER 2011 MR. OSENO BEN

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