International Financial Markets

Foreign Exchange Market Eurocurrency market Eurocredit Market Eurobond Market International Stock Markets Foreign Exchange Market. The foreign exchange market allows currencies to be exchanged in order to facilitate international trade or financial transactions.

Foreign Exchange Market

Spot Market Inter-bank Market Forward Market Currency Futures Options Market Spot Market. The most common type of foreign exchange transaction is for immediate exchange at the so-called spot rate. The market in which these transactions occur is known as the spot market.

Forward Contracts
There are also forward contracts available which allow for the purchasing or selling of currencies in future periods. Within the forward contract, a forward rate is specified. This represents the exchange rate at which currencies will be exchanged at a future point in time.
When MNCs anticipate future need or future receipt of a foreign currency, they can set up forward contracts to lock in the rate at which they can purchase or sell a particular foreign currency. Virtually all MNCs use forward contracts.

Forward Contracts
Premium or Discount on the Forward Rate: If the forward rate exceeds the existing spot rate, it contains a premium. If it is less than the existing spot rate, it contains a discount.
The above premium or discount is normally computed an annual basis. Ex. Rate for British Value Maturity Forward Premium Or Discount Spot rate $1.8632 30-day FR $1.8621 30 days $1.8621 - $1.8632/$1.8632 x 360/30 = -.71% 90-day FR $1.8586 90 day $1.8586 1.8632/$1.8632 x 360/90 = -.99%

Computation of Forward Rate Premium or Discount

A commercial bank quotes a spot rate of $1.90 for the French frank and a 90-day forward rate of $1.88. Determine the forward premium (or discount) of the French frank on an annualized basis.
Forward dis. for the French frank = $1.88 - $1.9/1.9 x 360/90 = -4.21%

Problems
1. The $:DM exchange rate is DM 1 = $0.35, and DM:FF exchange rate is FF 1 = DM 0.31. What is the FF:$ exchange rate? Suppose the direct quote for sterling in New York is 1.1110-5. What is the direct quote for dollars in London? Suppose the spot quote on the Deutsche mark is $0.3302-10, and the spot quote on the FF is $0.1180-90.

2. 3.

a. what is the direct spot quote for the franc In Frankfurt? b. compute the percentage bid-ask spreads on the DM and franc. 4. The spot and 90-day forward rates for the pound are $1.1376 and $1.1350, respectively. What is the forward premium or discount on the pound?

Currency Futures and Options Markets

Futures Contracts. A currency futures contract specifies a

standard volume of a particular currency to be exchanged on a specific settlement date. Futures contracts are somewhat similar to forward contracts , except that they are sold on an exchange while forward contracts are offered by commercial banks.Profit & losses of futures contracts are paid over every day at the end of trading, a practice called marking to market.
Currency futures are currently available for the British pound, Canadian dollar, Deutsche mark, Swiss Frank, French frank, Japanese yen, Australian dollar, and European Currency unit. Contracts sizes are standardized according to amount of foreign currency for example, 62,500, C$100,000, A$100,000, DM125,000, FF250,000, SF125,000

Currency Futures Contracts Traded on CME

Currency Australian dollar Units per Contract 100,000

British pound Canadian dollar German mark Japanese yen Swiss franc

62,500 100,000 125,000 12,500,000 125,000

Comparison of the Forward and Futures Markets

Forward
Size of contract Delivery date Participants Tailored to individual needs Tailored to individual needs Banks, brokers, and MNCs. Public speculation not encouraged Security deposit None as such, but compensating bank balance required Market place Over the phone worldwide Daily settlement Not possible Transaction costs Set by spread between banks buy and sell prices.

Futures
Standardized Standardized Banks, brokers, and MNC. Qualified public speculation encouraged. Small security deposit required. Central exchange floor ww. Daily settlement practiced. Negotiated brokerage fees.

Availability of Currency Options

Currency options are presently available for seven currencies on the Philadelphia exchange: 1. British pound 2. Canadian dollar 3. German mark 4. Japanese yen 5. Swiss franc 6. French franc 7. Australian dollar

Currency Options Contracts

An option is a financial instrument that gives the holder the right but not the obligation to sell (put) or buy (call) another financial instrument at a set price and expiration date. A currency call option provides the right to buy a specific currency at a specific price (called the strike price or exercise price) within a specific period of time. It is used to hedge future payables. A currency put option provides the right to sell a specific currency at a specific price within a specific period of time. It is used to hedge future receivables.

Numerical Example on Option Contract

Suppose that Jim is a speculator who buys a Sterling pound option with a strike price of $1.40 and a December settlement date. The current spot price as of that date is about $1.39. Jim pays a premium of $.012 per unit for the call option. Assume there are no brokerage fees. Just before the settlement date, the spot rate of reaches $1.41. At this time Jim exercises the call option and then immediately sells the pounds at the spot rate to a bank.Determine Jims profit or loss. Assume one option contract specifies 31,250 units. Per Unit Per Contract Selling price of $1.41 $44,063 ($1.41 x 31,250 units) - Purchase price of - $1.40 - $43,750 ($1.40 x 31,250 units) - Premium paid for option - $.012 - $375 ($.012 x 31,250 units) = Net profit - $.002 - $62 ($.002 x 31.250 units)

Euromarkets
Eurocurrency Market. A eurocurrency market deals in eurocurrency. A eurocurrency is a dollar or other freely convertible currency deposited in a bank outside its country of origin. The eurocurrency market consists of those banks called Eurobanks that accept deposits and make loans in foreign currencies (I.e., in dollars).

Euromarkets
Eurocredit Market. MNCs have access to mediumterm funds through Eurobanks located in foreign markets, called Eurocredit market. Loans of one year or longer extended by Eurobanks are commonly called Eurocredits or Eurocredit loans. Eurobond Market. The Eurobond market facilitates the international transfers of long-term credit in the form of Eurobonds, which enables government and large corporations to borrow funds from various countries.

Foreign Exchange Market

Inter-bank Market. If a bank begins to experience a shortage in a particular foreign currency, it can purchase that currency from other banks. This trading between banks occurs in what is often referred to as the inter-bank market.
Bid/Ask Spread of Banks.Commercial banks provide foreign exchange transactions for a fee. At any given point of time a banks bid (buy) quote for a foreign currency will be less than its ask (sell) quote. The bid/ask spread is intended to cover the costs involved in accommodating requests to exchange currencies.

Bid/Ask Spread

Bid/Ask Spread = Ask rate Bid rate/Ask rate

Currency British Bid/Ask Spread $1.60-$1.52/$1.60 = .05 or 5% Jap Yen $.0070 $.0074 $.0074-$.007/$.0074 = .054 or 5.4% A commercial bank quotes a bid rate of $.784 for the Swiss frank, and ask rate of $.80. What is the bid/ask % spread? Bid rate $1.52 Ask rate $1.60