Chapter Eleven Foreign Exchange

The Market The foreign exchange market is international, open 24 hours a day, adjusts prices constantly and deals in huge sums ‘Five’ always means 5 million, whether dollars, yen or sterling, and yards is a billion According to the BIS Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity (2010), daily turnover had reached $3.981 trillion – a huge increase even from 2004, when daily turnover stood at $1.9 trillion London is by far the largest foreign exchange market, trading $1,854bn daily (36.7% market share), followed by New York ($904bn) (17.9% share) and Tokyo ($312bn) (6.2% share)

Buyers and Sellers Importers/exporters Tourists Government spending, for example for troops abroad Speculators Banks and institutions

Top 10 Traders by % Share of Foreign Exchange Market Rank Bank % share ____________________________________________________________ 1 Deutsche 15.64 2 Barclays Capital 10.75 3 UBS 10.59 4 Citi 8.88 5 JP Morgan 6.43 6 HSBC 6.26 7 RBS 6.20 8 Credit Suisse 4.80 9 Goldman Sachs 4.13 10 Morgan Stanley 3.64 __________________________________________________ Source: Euromoney, May, 2011

What Determines Exchange Rates? Purchasing power parity Inflation Balance of payments Sheer psychology of the market

Bretton Woods In the postwar period up to the early 1970s, currencies did not fluctuate as they do today but operated on a fixed basis The system was set up at a conference in Bretton Woods (New Hampshire, U.S.) in 1944 It set up: A system of exchange rate stability The International Monetary Fund The World Bank

Foreign Exchange Risk For Corporates Transaction risk Translation risk Economic risk

Foreign Exchange Risk Hedging Forward rates Options Break forward Participating forward Cylinder or collar Swaps

Foreign Exchange Dealing The foreign exchange dealer is surrounded by computer terminals giving exchange rates quoted by banks all over the world An exchange rate between two currencies, neither of them the dollar, is a cross-rate Extensive use is made of brokers who may not wish to reveal their position to others Getting paid is, naturally, crucially important. Doing the deal on the telephone is called ‘front office’. Getting paid, reconciling accounts and so on is ‘back office’

Central Bank Foreign Exchange Surveys: Daily Foreign Exchange Dealing in 2004 and 2010 2004 2010 Centre Amount Share Amount Share $bn % $bn % _____________________________________________________________________ UK 753 31.3 1,854 36.7 US 461 19.2 904 17.9 Switzerland 79 3.3 263 5.2 Japan 199 8.3 312 6.2 Singapore 125 5.2 266 5.3 Hong Kong 102 4.2 238 4.2 Australia 81 3.4 192 3.8 Germany 118 4.9 109 2.1 ______________________________________________________________ Source: BIS, Triennial Central Bank Survey, 2010