PART FOUR WORLD FINANCIAL ENVIRONMENT International Business Chapter Nine Global Foreign Exchange and Capital Markets

2 Chapter 9 Objectives How does the foreign exchange work? Why do companies deal in foreign exchange? Who are the different institutions that deal in foreign exchange? How do companies make payment for international transactions?

3 The Foreign Exchange includes... Foreign exchange (Fx): money denominated in the currency of another nation or group of nations Exchange rate: the price of one currency expressed in terms another currency What do you think causes the values of currencies to change daily?

4 Where do people go to exchange their currency? The Foreign Exchange Market  Most are Over-the-counter (OTC) market through commercial and investment banks  The Exchange-trade market specializes in securities, futures and options  to learn how to do-it-yourself

5 Top OTC Banks ESTIMATED BEST IN BEST IN BEST IN BEST IN TRADING BANK MKT.SHARE LONDON NEW YORK EURO/US$ US$/YEN 1. Deutsche Bank 19.75% UBS Warburg 11.61% Citigroup 7.33% HSBC 6.64% Barclays 6.41% 4 — JP Morgan 5.38% ABN Amro 4.57% Merrill Lynch 4.45% — —— — 9. Goldman Sachs 4.38% Morgan Stanley 4.20% — 9— — Source: “2005 Euromoney Foreign Exchange Poll,” Euromoney (May 2005).

6 Which currency is the most actively traded? CURRENCY U.S. Dollar Euro — — — — Japanese Yen Pound Sterling Swiss Franc All others Source: Bank for International Settlements, Central BankSurvey of Foreign Exchange and Derivatives Market Activity, Why do you think these currencies so popular?

7 The stability of the U.S. dollar has made it the most widely traded in the world Dollars are invested in many capital markets Dollars are used as a reserve currency for many governments’ central banks Dollars are a transaction currency in many international commodity markets Dollars are an invoice currency Dollars are an intervention currency used by monetary authorities to influence their own exchange rates

8 Why do you think the U.K. has the most Fx market activity?

9 Location of the 4 Biggest Foreign Exchange Market London is the largest foreign exchange market (followed by New York, Tokyo, and Singapore) because of its strategic location between Asia and the Americas.  1st peak when Asia & Europe are open  2nd peak when Europe and U.S. are open The most frequently traded currency pairs are:  U.S. Dollar/Euro (28%)  U.S. Dollar/Yen (17%)

10 The Circadian Rhythms of the Foreign Exchange Market

11 What are Futures & Options? Futures: a contractual agreement to buy or sell a given currency at a negotiated price on a specified future date. Option: gives the buyer the right (but not the obligation) to buy or sell a certain amount of foreign currency at a specified exchange rate “strike price” within a specified amount of time.  more flexible & expensive than forward contracts  Premium: the fee paid to the writer of the option

12 Foreign Exchange Markets: Thursday, April 28, 2005 US$ EQUIVALENT CURRENCY PER US$ COUNTRYTHURWEDTHURWED Brazil (Real) Canada (Dollar) India (Rupee) Japan (Yen) Russia (Ruble) South Africa (Rand) Switzerland (Franc) U.K. (Pound) Special Drawing Right Euro Special Drawing Rights (SDRs) are based on exchange rates for the US dollar, the euro, the Japanese yen, and the British pound. Sources: International Monetary Fund; Wall Street Journal, 2005.

13 Is ALL currency convertible? Convertibility: How easy/hard it is to purchase foreign currency with a domestic currency without government restrictions  Hard currencies are fully convertible with no govt restrictions on trade  External convertibility: Govt. limits non-resident trading  Soft currencies are non-convertible because of total govt. restriction on trading

14 Currency As a Trade Barrier A government currency restrictions include:  licensing  a multiple exchange rate system  advance import deposits  quantity controls Currency controls add to the cost of doing business and thus serve as serious impediments to trade and investment.

15 Why do Businesses Fx? 1.To covert currency for trade transactions 2.hedging [risk reduction through loss protection] 3.speculation [currency trading on expectations of future prices] 4.arbitrage [risk-free profit based on price differentials]  interest arbitrage

16 Structure of Foreign Exchange Markets

17 Global Capital Markets: International Bonds Companies borrow money in the international bond market to diversify funding sources.  Foreign bonds: sold outside of home country but denominated in the currency of the country of issue.  Eurobonds: sold in countries other than the one in whose currency the bond is denominated; usually underwritten  Global bond: registered in different national markets according to the registration requirements of each market

18 Equity Capital Markets = Stock Market The growth of emerging stock markets has been very sensitive to global economic conditions and events.

19 Conclusions at least $1.2 trillion in foreign exchange is traded each day by banks and securities exchanges. The U.S. dollar is the most widely traded currency in the world. Currency is exchanged to  settle trade transactions  For direct investment  portfolio investment and speculation