Foreign Exchange (FX) Exchange rates are one of the key linkages between a country and the rest of the world, both in goods/services and financial and capital markets Exchange rates are important because they enable us to translate different countries prices into comparable terms

Import and Export Import and export demands are influenced by the exchange rate. Appreciation of a country’s currency –Raises the price of exports –Lowers the price if imports Depreciation of a country’s currency –Lowers the price of its exports –Raises the price of its imports

The Market: –The place where money denominated in one currency is bought and sold with money denominated in another currency

International Trade and Capital Transactions Facilitated with the ability to transfer purchasing power between countries

Organization of the FX Market Wholesale (Majority) –Major Banks Retail –Banks doing it for customers

Types of Trades Spot Market –Immediate transaction, happens in 2 days Forward Market –At some time in the future

Forward Market Arbitrage – Purchase of securities on one market for immediate resale on another so as to profit Speculators – Betting that their currency will weaken or strengthen Hedgers – to protect what they have

Arbitrage Example London Frankfurt New York Strategy: 1.Use $ to buy DM in Frankfurt 2.With DM buy pounds in London 3.Sell pounds in NYC

Currency Arbitrage When rates differ from one financial center to another, profit opportunities exist Buy cheap in one int’l market, sell at a high price in another This is the importance of arbitrage The integration of financial centers make arbitrage more difficult.

The Euro - History of the In 2002 the Euro replaced the old national currencies of twelve of the 15 EU countries (Germany, France, Italy, Spain, Portugal, Belgium, Luxembourg, the Netherlands, Austria, Finland, Greece and Ireland).

The Euro As of 5/14/07 $1 USA Dollar buys.7383 Euro 1€ Euro buys dollars Example: 5 € x = $6.52 or add 30.3% to the amount of € $5 x.7383 = 3.69 €