2. The Foreign Exchange Market9
chapter
The Foreign Exchange Market
McGraw-Hill/Irwin
Global Business Today, 5e
© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

3. Chapter 9: The Foreign Exchange Market
INTRODUCTION
This chapter:
Explains how the foreign exchange market works
Examines the forces that determine exchange rates
Discusses the degree to which it is possible to predict exchange rate movements
Maps the implications for international business of exchange rate movements and the foreign exchange market

4. Chapter 9: The Foreign Exchange Market
THE FUNCTIONS OF THE FOREIGN EXCHANGE MARKET
The foreign exchange market serves two main functions:
to convert the currency of one country into the currency of another
to provide some insurance against foreign exchange risk

5. Chapter 9: The Foreign Exchange Market
Currency Conversion
Insuring Against Foreign Exchange Risk

6. THE NATURE OF THE FOREIGN EXCHANGE MARKET
The foreign exchange market is a global network of banks, brokers, and foreign exchange dealers connected by electronic communications systems.
Two significant features of the market are:
It never sleeps
High-speed computer linkages between trading centers around the globe have effectively created a single market

7. Chapter 9: The Foreign Exchange Market
ECONOMIC THEORIES OF EXCHANGE RATE DETERMINATION
Exchange rates are determined by the demand and supply for different currencies.
Three factors impact future exchange rate movements:
A country’s price inflation
A country’s interest rate
Market psychology

8. Chapter 9: The Foreign Exchange Market
Prices and Exchange Rates
Interest Rates and Exchange Rates
Investor Psychology and Bandwagon Effects
Summary

9. EXCHANGE RATE FORECASTING
Is it worthwhile for a company to invest in exchange rate forecasting services to aid decision-making?

10. Two schools of thought address this issue:
the efficient market school argues that forward exchange rate do the best possible job of forecasting future spot exchange rates, and, therefore, investing in forecasting services would be a waste of money
the inefficient market school, argues that companies can improve the foreign exchange market’s estimate of future exchange rates by investing in forecasting services

11. Chapter 9: The Foreign Exchange Market
The Efficient Market School
The Inefficient Market School
Approaches to Forecasting

12. Chapter 9: The Foreign Exchange Market
CURRENCY CONVERTIBILITY
A currency is said to be freely convertible when a government of a country allows both residents and non-residents to purchase unlimited amounts of foreign currency with the domestic currency.
A currency is said to be externally convertible when non-residents can convert their holdings of domestic currency into a foreign currency, but when the ability of residents to convert currency is limited in some way.
A currency is nonconvertible when both residents and non-residents are prohibited from converting their holdings of domestic currency into a foreign currency.

13. Chapter 9: The Foreign Exchange Market
IMPLICATIONS FOR MANAGERS
It is absolutely critical that international businesses understand the influence of exchange rates on the profitability of trade and investment deals.
Transaction Exposure
Translation Exposure
Economic Exposure

14. Chapter 9: The Foreign Exchange Market
IMPLICATIONS FOR MANAGERS
Reducing Translation and Transaction Exposure
Reducing Economic Exposure
Other Steps for Managing Foreign Exchange Risk