1. International Business Environments & Operations
Daniels ● Radebaugh ● Sullivan
International Business Environments and Operations 15e by Daniels, Radebaugh, and Sullivan
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2. Global Foreign-Exchange Markets
Chapter 8
Global Foreign-Exchange Markets
Chapter 8: Global Foreign Exchange Markets
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Learning Objectives
Learn the fundamentals of foreign exchange
Identify the major characteristics of the foreign-exchange market and how governments control the flow of currencies across national borders
Describe how the foreign-exchange market works
Examine the different institutions that deal in foreign exchange
Understand why companies deal in foreign exchange
The Learning Objectives for this chapter are
To learn the fundamentals of foreign exchange
To identify the major characteristics of the foreign-exchange market and how governments control the flow of currencies across national borders
To describe how the foreign-exchange market works
To examine the different institutions that deal in foreign exchange
To understand why companies deal in foreign exchange
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4. What Is Foreign Exchange?
Discussion of foreign exchange involves the currency, market, rate and players in the market. Each institution has a specific role.
Foreign exchange currency: money denominated in the currency of another nation or group of nations
Foreign exchange market: where foreign exchange transactions take place
Exchange rate: the price of a currency
Players in the foreign exchange market include
Reporting dealers
Financial institutions
Nonfinancial institutions
What is foreign exchange? It’s money denominated in the currency of another nation or group of nations. It can be in the form of cash, funds available on credit and debit cards, traveler’s checks, bank deposits, or other short-term claims.
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5. Size, Composition, and Location of the Foreign Exchange Market
Market size is $4 trillion daily and the U.S. dollar is the most important currency on the foreign-exchange market
The most commonly traded currency pairs are EUR/USD and USD/JPY
London is the largest foreign exchange market (followed by New York, Tokyo, and Singapore) because of its strategic location between Asia and the Americas.
Market activity first heightens when Europe and Asia are open and again when Europe and the United States are open.
Electronic platforms made foreign currency transactions easier.
Bank of International Settlements (BIS) plays a critical role in managing FX transactions worldwide
Estimated daily foreign exchange turnover in 2010 was $4 trillion - up 20 percent from Almost 85 percent of all transaction involve the U.S. dollar.
In fact the dollar fill many roles: it’s an investment currency in many capital markets, a reserve currency held by many central banks, a transaction currency in many international commodity markets, an invoice currency in many contracts, and an intervention currency employed by monetary authorities in market operations to influence their own exchange rates.
Because of the importance of the U.S. dollar as the currency through which most foreign exchange trades take place, the exchange rate between two currencies other than the U.S. dollar is known as a cross rate.
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6. The Circadian Rhythms of the Foreign Exchange Market

7. Size, Composition, and Location of the Foreign Exchange Market
Foreign Exchange Markets: Average Daily Volume
This Figure shows the average daily volume in the foreign exchange market from 1998 to 2010.
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8. Size, Composition, and Location of the Foreign-Exchange Market
Global Foreign Exchange: Currency Distribution
This Table shows the currency distribution in global foreign exchange.
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9. Size, Composition, and Location of the Foreign Exchange Market
Foreign Exchange Markets: Geographic Distribution
This Figure shows the geographical distribution of foreign exchange markets. Notice the dominance of the United Kingdom. More dollars are traded in London than in New York.
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10. Why U.S. Dollar is so widely traded
It is an investment currency in many capital markets
It is a reserve currency held by many central banks
It is a transaction currency in many international commodity markets
It is an invoice currency in many contracts
It is an intervention currency employed by monetary authorities in market operations to influence their own exchange rates

11. Global Over The Counter (OTC) Foreign Exchange Instruments
Spot transactions are for immediate delivery of the currency, within two days maximum.
Forward transactions involve currency exchange beyond three days at a fixed rate, known as the forward rate.
FX Swaps is exchange of currencies in the spot market with agreement to reverse the transaction in the future. It is a combination of spot and forward transaction at the same time.
Options are contracts specifying the right to buy or sell foreign exchange within a specific period or on a specific date.
Futures are contracts for forward delivery of currency for specific amounts with specific maturity dates, not as flexible as a forward contract
The spot rate is the exchange rate quoted for transactions that require delivery within two days.
Outright forwards involve the exchange of currency beyond three days at a fixed exchange rate, known as the forward rate.
An FX swap is a simultaneous spot and forward transaction - one currency is swapped for another on one date and then swapped back on a future date. Currency swaps deal more with interest-bearing financial instruments like bonds, and involve the exchange of principal and interest payments.
Options are the right, but not the obligation, to trade foreign currency in the future.
Finally, a futures contract is an agreement between two parties to buy or sell a particular currency at a particular price on a particular future date, as specified in a standardized contract to all participants in that currency futures exchange.
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12. Global OTC Foreign Exchange Instruments
Foreign Exchange Markets: Turnover by Instrument
This Figure shows the turnover in foreign exchange by each of the instruments.
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FX Terms and Quotes
Foreign exchange dealers quote rates
Bid (buy) rate: the rate at which traders buy foreign exchange
Offer (sell) rate: the rate at which traders sell foreign exchange
Spread: the difference between bid and offer rates
Direct quote (the number of dollars per unit of foreign currency) and Indirect Quote (the number of units of foreign currency per dollar)
Cross rate determines the rate between two foreign currencies
Rates in the foreign exchange market are quoted by dealers.
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Banks And Exchanges
The top banks in the inter-bank market in foreign exchange can
trade in specific market locations
engage in major currencies and cross-trades
deal in specific currencies
handle derivatives
forwards, options, futures, swaps
conduct key market research
The largest volume of foreign exchange activity takes place with the big money center banks. While these banks all typically have the ability to trade in specific market locations, engage in major currencies and cross-trades, deal in specific currencies, handle derivatives like forwards, options, futures, and swaps, and also conduct key market research, most large companies usually use several banks.
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15. Banks And Exchanges
Foreign Exchange Trades: Top Commercial Banks, 2012
Ranked by Overall Market Share
This Table shows the top banks in the world in terms of foreign exchange trading.
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16. FX Fluctuation and Trade
Assume that current U.S. Dollar and Japanese Yen exchange rate is $ 1 = ¥ 105. Japanese Yen appreciates against U.S. Dollar, and, the new market rate is to $ 1 = ¥ 95. How will this affect U.S.-Japan trade?
Japanese exports to U.S. …. Will it increase or decrease?
U.S. Exports to Japan…. Will it increase or decrease?
Because Japanese can buy the same dollar with a smaller quantity of Yen (95 now, instead of 105 before) their purchasing power has increased against the Americans. To them, imports from USA is now cheaper. This means that they will import more from USA. In other words, U.S. exports to Japan will increase.
On the contrary, Americans are getting less Yen for the same dollar, so they will buy less from Japan. Thus Japanese exports to the U.S. will decrease.
Policy question: can a strong yen reduce the U.S. trade deficit with Japan?

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Future of FX Market
More efficient markets
create more opportunities for foreign exchange trading
lower costs
Financial crisis in Europe
future of the euro
Rise of the Chinese yaun and Brazilian real
Technology developments
more electronic trades
What is likely to happen to foreign exchange markets in the future? Well, they will almost certainly be more efficient which should not only create more opportunities for foreign exchange trading, it should also lower the cost of transactions for companies. Similarly, developments in technology will prompt more electronic trades rather than traditional phone trades.
The financial crisis in Europe will also have an impact on the future of foreign exchange markets. If the situation stabilizes, the euro could take on a dominant role. However, if the crisis deepens, the very existence of the euro could be in jeopardy. In either case, both the Chinese yuan and the Brazilian real are likely to become bigger players.
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18. Chapter 8: Discussion Questions
What is a foreign exchange market? Explain the role each institution plays in the FX market.
Why U.S. dollar is the most traded currency in the world?
Define the following Global Over The Counter (OTC) Foreign Exchange Instruments: spot rate, forward rate, options, futures and swap.
Define the following terms and distinguish their differences: bid, offer, spread, and cross rate.
How does the fluctuation of exchange rate affect trade? For example, if Yen appreciates against Dollar, how will this affect U.S.-Japan trade? I can ask similar question with any currency.

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