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Foreign Exchange
and International
Financial
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Markets
Griffin & Pustay
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International Business, 6th Edition
chapter 8
Chapter Objectives
• Describe how demand and supply
determine the price of foreign exchange
• Discuss the role of international banks in
the foreign-exchange market
• Assess the different ways firms can use
the spot and forward markets to settle
international transactions
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Chapter Objectives (continued)
• Summarize the role of arbitrage in the
foreign-exchange market
• Discuss the important aspects of the
international capital market
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Foreign Exchange
Foreign exchange is a commodity
that consists of currencies issued by
countries other than one’s own.
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Figure 8.1 Demand for Yen
Demand for
Japanese yen is
derived from
foreigners’ demand
for Japanese
products
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Figure 8.2 Supply of Yen
Supply for
Japanese yen is
derived from
Japanese
demand for
foreign products
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Figure 8.3 The Market for Yen
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Foreign-Exchange Rates
• Direct exchange rate
– Direct quote
– Price of the foreign currency in terms of
home currency
• Indirect exchange rate
– Indirect quote
– Price of the home country in terms of the
foreign currency
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Figure 8.4 Direct and Indirect
Exchange Rates
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Structure of the Foreign-Exchange
Markets
The foreign-exchange market
comprises buyers and sellers of
currencies issued by the world’s
countries.
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Foreign-Exchange Trading
The largest center for foreign
exchange trading is London, followed
by New York and Tokyo.
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Figure 8.5 Currencies Involved in ForeignExchange Market Transactions
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The Role of Banks
• Buy or sell major traded currencies
• Markets
– Wholesale market
– Retail market
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Map 8.1 A Day of
Foreign-Exchange Trading
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Bank Foreign Exchange Clients
Commercial customers
Speculators
Arbitrageurs
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Foreign-Exchange Trading
The Tel Aviv
foreignexchange
trader is an
important link
in the $3.2
trillion-per-day
global
exchange
market.
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Spot and Forward Markets
• Spot Market: foreign exchange
transactions that are consummated
immediately
• Forward Market: foreign exchange
transactions that are to occur
sometime in the future
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Spot and Forward Markets
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Mechanisms for Future Foreign
Exchanges
• Currency future
• Currency option
– Call option
– Put option
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Arbitrage
Arbitrage is the riskless purchase of
a product in one market for
immediate resale in a second market
in order to profit from a price
discrepancy. There are two types of
arbitrage activities that affect the
foreign-exchange market: arbitrage
of goods and arbitrage of money.
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Arbitrage
Arbitrage
of Goods
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Arbitrage
of Money
Arbitrage of Money
Two-point
Three-point
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Covered-interest
Figure 8.6
Three-Point Arbitrage
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International Capital Market
• Major International Banks
• International Bond Market
• Global Equity Markets
• Offshore Financial Centers
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Table 8.1 The World’s Largest Banks
• ING Group
• BNP Paribas
• Fortis
• Credit Agricole
• Citigroup
• Deutsche Bank
• Dexia Group
• Bank of America
Corp.
• HSBC Holding
• HBOS
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Establishment of Overseas
Banking Operations
Subsidiary bank
Branch bank
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Affiliated bank
The Eurocurrency Market
• Originated in the early 1950s
• Eurodollars – U.S. dollars deposited in
European bank accounts
– Euroyen
– Europounds
• Eurocurrency – currency on deposit
outside in banks worldwide
• Euroloans quoted on basis of LIBOR
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The International Bond Market
• Major source of debt financing for:
– World’s governments
– International organizations
– Larger firms
• Two types of bonds
– Foreign bonds
– Eurobonds
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Figure 8.7 International Bond Issues
2007, by Currency (in billions of U.S. dollars)
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Global Equity Markets
• Start-up companies are no longer
restricted to raising new equity only
from domestic sources
• Development of country funds
– Mutual fund specializing in a given
country’s funds
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Offshore Financial Centers
• Focus on offering banking and other
financial services to nonresident
customers
• Locations
– Bahamas, Bahrain, the Cayman
Islands, Bermuda, the Netherlands
Antilles, Singapore, Luxembourg,
Switzerland
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Copyright © 2010 Pearson Education, Inc.
publishing as Prentice Hall