CHAPTER - 3
INTERNATIONAL FINANCIAL MARKETS
FOREIGN EXCHANGE MARKET
• Allows the exchange of one currency for another.
• To facilitate international trade and financial transactions.
• Exchange rate is the rate at which one currency can be
exchanged for another.
TYPES OF MARKET
• Spot Market: Market for immediate exchange of currency.
• Forward Market: Market that enables to lock in the
exchange rate at which a certain amount of currency will be
bought or sold on a specified future date.
FOREIGN EXCHANGE MARKET
• Futures Market: Market that enables to lock in the
exchange rate at which a standardized amount of currency
will be bought or sold on a specified future date.
• Option Market: Market that provides the right to buy or
sell a specified amount of currency at a specific price within
a specified period.
– Call option, provides the right to buy a specific currency at
a specific price within a specific period of time.
– Put option, provides the right to sell a specific currency at
a specific price within a specific period of time.
• The price at which forward / future / option contracts are
executed is called strike price or exercise price.
FOREIGN EXCHANGE TRANSACTIONS
Foreign Exchange Quotation
• Bid Quote = Buy Price
Ask Quote = Sell Price
Bid/Ask spread = Difference between bid and ask quote.
Ask Rate – Bid Rate
Bid/Ask spread (%) = 100
Ask Rate
• Example:
Bid price for £ = $1.52,
Ask price for £ = $1.60.
Bid/Ask spread = (1.60–1.52)/1.60 = 5%
FOREIGN EXCHANGE TRANSACTIONS
Factors Affecting the Spread
• Order costs
• Inventory costs
• Competition
• Volume
• Currency risk
FOREIGN EXCHANGE TRANSACTIONS
Foreign Exchange Quotation
• Direct Quotations:
– Represent the value of per unit foreign currency in terms of
domestic currency.
– The amount of domestic currency required to buy or sell
one unit of foreign currency.
– $1 = Tk. 77
• Indirect Quotations,
– Represent the value of per unit of a domestic currency in
terms of foreign currency.
– The amount of foreign currency required to buy or sell one
unit of domestic currency.
– Tk. 1 = $ 0.013
FOREIGN EXCHANGE TRANSACTIONS
Foreign Exchange Quotation
• Cross Exchange Rate: The exchange rate between two
currencies, calculated by comparing them to third currency.
• Example:
– Peso 1 = $ 0.07
– C$ 1 = $ 0.70
• Assume, $1 = Tk. 78; £1 = Tk. 88. What is the exchange rate of
Dollar to Pound?
MOTIVES FOR BORROWING FROM FOREIGN MARKET
• First, Govt. / MNC may need to borrow funds to pay for
imports denominated in a foreign currency.
• Second, To support local operations, Govt. / MNC may
consider borrowing in a currency in which the interest
rate is lower.
• Third, Govt. / MNC may consider borrowing in a currency
that will depreciate against their home currency, as they
would be able to repay the loan at a more favorable
exchange rate over time.
MOTIVES FOR INVESTING IN FOREIGN MARKET
• First, Govt. / MNC would receive more interest from
investments denominated in foreign currencies than their
investments in home currency.
• Second, Investors may expect firms in a particular foreign
country to achieve more favorable performance than those
in the investor’s home country.
• Third, Govt. / MNC may consider investing in a currency that
will appreciate against their home currency because they
would be able to convert that currency into their home
currency at a favorable exchange rate at the end of the
period.