1. ©2004 Prentice Hall8-1 Chapter 8: Foreign Exchange and International Financial Markets International Business, 4 th Edition Griffin & Pustay

2. ©2004 Prentice Hall8-2 Chapter Objectives_1  Describe how demand and supply determine the price of foreign exchange  Discuss the role of international banks in the foreign-exchange market  Summarize the role of arbitrage in the foreign-exchange market

3. ©2004 Prentice Hall8-3 Chapter Objectives_2  Assess the different ways firms can use the spot and forward markets to settle international transactions  Discuss the important aspects of the international capital market

4. ©2004 Prentice Hall8-4 Foreign Exchange A commodity that consists of currencies issued by countries other than one’s own

5. ©2004 Prentice Hall8-5 Figure 8.1 Demand for Japanese Yen is Derived from Foreigner’s Demand for Japanese Products

6. ©2004 Prentice Hall8-6 Figure 8.2 Supply for Japanese Yen is Derived from Japanese Demand for Foreign Products

7. ©2004 Prentice Hall8-7 Figure 8.3 The Market for Yen

8. ©2004 Prentice Hall8-8 Foreign Exchange Rates  Direct exchange rate –Direct quote –Price of the foreign currency in terms of home currency  Indirect exchange rate –Indirect quote –Price of the home country in terms of the foreign currency

9. ©2004 Prentice Hall8-9 Figure 8.4 Direct and Indirect Exchange Rates

10. ©2004 Prentice Hall8-10 The Role of Banks  Wholesale market for foreign exchange  Retail market for foreign exchange  Clients –Commercial customers –Speculators –Arbitrageurs

11. ©2004 Prentice Hall8-11 Map 8.1 A Day of Foreign-Exchange Trading

12. ©2004 Prentice Hall8-12 Figure 8.5 Currencies Involved in Foreign-Exchange Market Transactions

13. ©2004 Prentice Hall8-13 Tokyo is the third largest center for foreign- exchange trading, trailing only London and New York

14. ©2004 Prentice Hall8-14 Spot and Forward Markets  Lending and Purchasing on credit  Spot market: foreign-exchange transactions that are to be consummated immediately  Forward market: foreign exchange transactions that are to occur at some time in the future  Swap transaction: same currency is bought and sold simultaneously with delivery at different points in time

15. ©2004 Prentice Hall8-15 Mechanisms for Future Foreign Exchanges  Currency future  Currency option –Call option –Put option

16. ©2004 Prentice Hall8-16 Figure 8.6 Foreign-Exchange Options on the Chicago Mercantile Exchange

17. ©2004 Prentice Hall8-17 Arbitrage and the Currency Market  Arbitrage: the riskless purchase of a product in one market for immediate resale in a second market in order to profit from a price discrepancy –Arbitrage of goods –Arbitrage of money

18. ©2004 Prentice Hall8-18 Theory of Purchasing Power Parity (PPP)  The prices of tradable goods, when expressed in a common currency, will tend to equalize across countries as a result of exchange rate changes  Occurs because process of buying goods in a cheap market and reselling them in expensive market affects demand for (and price of) the foreign currency and the market price of the good in the two product markets in question

19. ©2004 Prentice Hall8-19 The prices these Mexican shoppers pay for foreign-made goods are affected by fluctuations in the value of the peso in the foreign-exchange market

20. ©2004 Prentice Hall8-20 Arbitrage of Money  Two-point (geographic arbitrage)  Three-point  Covered interest

21. ©2004 Prentice Hall8-21 Figure 8.7 Three-Point Arbitrage

22. ©2004 Prentice Hall8-22 Importance of Arbitrage Activities  Constitutes a major portion of $1.2 trillion currencies traded globally each working day  Ties together the foreign-exchange markets  Overcomes differences in geography, currency type, time

23. ©2004 Prentice Hall8-23 Table 8.1 The World’s 10 Largest Banks RankCompanyCountryAssets ($ Mil) 1Mizuho HoldingsJapan1,148,917 2CitigroupUS1,051,450 3Sumitomo Mitsui BankingJapan820,083 4Deutsche BankGermany813,619 5Mitsubishi Tokyo Financial GroupJapan755,481 6UBSSwitzerland752,332 7BNP ParibasFrance733,423 8HSBC HoldingsUK694,238 9J.P. Morgan ChaseUS693,575 10Bayerische Hypo BankGermany647,926

24. ©2004 Prentice Hall8-24 Establishment of Overseas Banking Operation  Subsidiary bank  Branch bank  Affiliated bank

25. ©2004 Prentice Hall8-25 The Eurocurrency Market  Originated in the early 1950s  Eurodollars – U.S. dollars deposited in European bank accounts –Euroyen –Europounds  Eurocurrency – currency on deposit outside in banks worldwide  Euroloans quoted on basis of LIBOR

26. ©2004 Prentice Hall8-26 The International Bond Market  Major source of debt financing for –World’s governments –International organizations –Larger firms  2 types of bonds –Foreign bonds –Eurobonds

27. ©2004 Prentice Hall8-27 Figure 8.8 International Bond Issues, 2001, by Currency (in billions of U.S. dollars)

28. ©2004 Prentice Hall8-28 Hong Kong residents seeking to buy shares in the Web portal firm tom.com

29. ©2004 Prentice Hall8-29 Global Equity Markets  Start-up companies are no longer restricted to raising new equity only from domestic sources  Development of country funds –Mutual fund specializing in a given country’s funds

30. ©2004 Prentice Hall8-30 Offshore Financial Centers  Focus on offering banking and other financial services to non-resident customers  Locations –Bahamas, Bahrain, the Cayman Islands, Bermuda, the Netherlands Antilles, Singapore, Luxembourg, Switzerland