Foreign exchange market (Иностранный обменный рынок)

Contents

I. Introduction 2

II. The structure of the foreign exchange market 3

1. What is the foreign exchange? 3

2. The participants of the foreign exchange markets 4

3. Instruments of the foreign exchange markets 5

III. Foreign exchange rates 6

1. Determining foreign exchange rates 6

2. Supply and Demand for foreign exchange 7

3. Factors affecting foreign exchange rates 11

IV. Conclusion 13

V. Recommendations 14

VI. Literature used 16

Introduction

Trade and payments across national borders require that one of the

parties to the transaction contract to pay or receive funds in a foreign

currency. At some stage, one party must convert domestic money into foreign

money. Moreover, knowledgeable investors based in each country are aware of

the opportunities of buying assets or selling debts denominated in foreign

currencies when the anticipated returns are higher abroad or when the

interest costs are lower. These investors also must use the foreign

exchange market whenever they invest or borrow abroad.

I’d like to add that the foreign exchange market is the largest market

in the world in terms of the volume of transactions. That the volume of

foreign exchange trading is many times larger than the volume of

international trade and investment reflects that a distinction should be

made between transactions that involve only banks and those that involve

banks, individuals, and firms involved in international trade and

investment.

The phenomenal explosion of activity and interest in foreign exchange

markets reflects in large measure a desire for self-preservation by

businesses, governments, and individuals. As the international financial

system has moved increasingly toward freely floating exchange rates,

currency prices have become significantly more volatile. The risks of

buying and selling dollars and other currencies have increased markedly in

recent years. Moreover, fluctuations in the prices of foreign currencies

affect domestic economic conditions, international investment, and the

success or failure of government economic policies. Governments,

businesses, and individuals involved in international affairs find it is

more important today than ever before to understand how foreign currencies

are traded and what affects their relative values.

In this work, we examine the structure, instruments, and price-

determining forces of the world's currency markets.

The structure of the foreign exchange market

What is the foreign exchange?

The foreign exchange markets are among the largest markets in the

world, with annual trading volume in excess of $160 trillion. The purpose

of the foreign exchange markets is to bring buyers and sellers of

currencies together. It is an over-the-counter market, with no central

trading location and no set hours of trading. Prices and other terms of

trade are determined by negotiation over the telephone or by wire,

satellite, or telex. The foreign exchange market is informal in its

operations: there are no special requirements for market participants, and

trading conforms to an unwritten code of rules.

You know that almost every country has its own currency for domestic

transactions. Trading among the residents of different countries requires

an efficient exchange of national currencies. This is usually accomplished

on a large scale through foreign exchange markets, located in financial

centers such as London, New York, or Paris—in order of importance—where

exchange rates for convertible currencies are determined. The instruments

used to effect international monetary payments or transfers are called

foreign exchange. Foreign exchange is the monetary means of making payments

from one currency area to another. The funds available as foreign exchange

include foreign coin and currency, deposits in foreign banks, and other

short-term, liquid financial claims payable in foreign currencies. An

international exchange rate is the price of one (foreign) currency measured

in terms of another (domestic) currency. More accurately, it is the price

of foreign exchange. Since exchange rates are the vehicle that translates

prices measured in one currency into prices measured in another currency,

changes in exchange rates affect the price and, therefore, the volume of

imports and exports exchanged. In turn the domestic rate of inflation and

the value of assets and liabilities of international borrowers and lenders

is influenced. The exchange rate rises (falls) when the quantity demanded

exceeds (is less than) the quantity supplied. Broadly speaking, the

quantity of U.S. dollars supplied to foreign exchange markets is composed

of the dollars spent on imports, plus the amount of funds spent or invested

by U.S. residents outside the United States. The demand for U.S. dollars

arises from the reverse of these transactions.

Many newspapers keep a daily record of the exchange rates in the

highly organized foreign exchange market, where currencies of different

nations are bought and sold. For instance, the Wall Street Journal shows

the price of a currency in two ways: first the price of the other currency

is given in U.S. dollars, and second the price of the U.S. dollar is quoted

in units of the other currency. Pairs of prices represent reciprocals of

each other. These rates refer to trading among banks, the primary

marketplace for foreign currencies.

2. The participants of the foreign exchange markets

The foreign exchange market is extremely competitive so there are many

participants, none of whom is large relative to the market.

The central institution in modern foreign exchange markets is the

commercial bank. Most transactions of any size in foreign currencies

represent merely an exchange of the deposits of one bank for the deposits

of another bank. If an individual or business firm needs foreign currency,

it contacts a bank, which in turn secures a deposit denominated in foreign

money or actually takes delivery of foreign currency if the customer

requires it. If the bank is a large money center institution, it may hold

inventories of foreign currency just to accommodate its customers. Small

banks typically do not, hold foreign currency or foreign currency-

denominated deposits. Rather, they contact large correspondent banks, which

in turn contact foreign exchange dealers.

The major international commercial banks act as both dealers and

brokers. In their dealer role, banks maintain a net long or short position

in a currency, and seek to profit from an anticipated change in the

exchange rate. (A long position means their holdings of assets denominated

in one currency exceed their liabilities denominated in this same

currency.) In their broker function, banks compete to obtain buy and sell

orders from commercial customers, such as the multinational oil companies,

both to profit from the spread between the rates at which they buy foreign

exchange from some customers and the rates at which they sell foreign

exchange to other customers, and to sell other types of banking services to

these customers.

Frequently, currency-trading banks do not deal directly with each

other but rely on foreign exchange brokers. These firms are in constant

communication with the exchange trading rooms of the world's major banks.

Their principal function is to bring currency buyers and sellers together.

Security brokerage firms, commodity traders, insurance companies, and

scores of other nonbank companies have come to play a growing role in the

foreign exchange markets today. These Nonbank Financial Institutions have

entered in the wake of deregulation of the financial marketplace and the

lifting of some foreign controls on international investment, especially by

Japan and the United Kingdom. Nonbank traders now offer a wide range of

services to international investors and export-import firms, including

assistance with foreign mergers, currency swaps and options, hedging

foreign security offerings against exchange rate fluctuations, and

providing currencies needed for purchases abroad.

In main all participants of an exchange market are usually divided on

two groups. The first group of participants is called speculators; by

definition, they seek to profit from anticipated changes in exchange rates.

The second group of participants is known as arbitragers. Arbitrage refers

to the purchase of one currency in a certain market and the sale of that

currency in another market in response to differences in price between the

two markets. The force of arbitrage generally keeps foreign exchange rates

from getting too far out of line in different markets.

3. Instruments of the foreign exchange markets

. Cable and Mail Transfers

Several financial instruments are used to facilitate foreign exchange

trading. One of the most important is the cable transfer, an execute order

sent by cable to a foreign bank holding a currency seller's account. The

cable directs the bank to debit the seller's account and credit the account

of a buyer or someone the buyer designates.

The essential advantage of the cable transfer is speed because the

transaction can be carried out the same day or within one or two business

days. Business firms selling their goods in international markets can avoid

tying up substantial sums of money in foreign exchange by using cable

transfers.

When speed is not a critical factor, a mail transfer of foreign

exchange may be used. Such transfers are written orders from the holder of

a foreign exchange deposit to a bank to pay a designated individual or

institution on presentation of a draft. A mail transfer may require days to

execute, depending on the speed of mail deliveries.

. Bills of Exchange

One of the most important of all international financial instruments

is the Bill of Exchange. Frequently today the word draft is used instead of

bill. Either way, a draft or bill of exchange is a written order requiring

a person, business firm, or bank to pay a specified sum of money to the

bearer of the bill.

We may distinguish sight bills, which are payable on demand, from time

bills, which mature at a future date and are payable only at that time.

There are also documentary hills, which typically accompany the

international shipment of goods. A documentary bill must be accompanied by

shipping papers allowing importers to pick up their merchandise. In

contrast, a clean hill has no accompanying documents and is simply an order

to a bank to pay a certain sum of money. The most common example arises

when an importer requests its bank to send a letter of credit to an

exporter in another country. The letter authorizes the exporter to draw

bills for payment, either against the importer's bank or against one of its

correspondent banks.

. Foreign Currency and Coin

Foreign currency and coin itself (as opposed to bank deposits) is an

important instrument for payment in the foreign exchange markets. This is

especially true for tourists who require pocket money to pay for lodging,

meals, and transportation. Usually this money winds up in the hands of

merchants accepting it in payment for purchases and is deposited in

domestic banks. For example, U.S. banks operating along the Canadian and

Mexican borders receive a substantial volume of Canadian dollars and

Mexican pesos each day. These funds normally are routed through the banking

system back to banks in the country of issue, and the U.S. banks receive

credit in the form of a deposit denominated in a foreign currency. This

deposit may then be loaned to a customer or to another bank.

. Other Foreign Exchange Instruments

A wide variety of other financial instruments are denominated in

foreign currencies, most of this small in amount. For example, traveler's

checks denominated in dollars and other convertible currencies may be spent

directly or converted into the currency of the country where purchases are

being made. International investors frequently receive interest coupons or

dividend warrants denominated in foreign currencies. These documents

normally are sold to a domestic bank at the current exchange rate.

Foreign exchange rates

1. Determining foreign exchange rates

As I’ve already mentioned the prices of foreign currencies expressed

in terms of other currencies are called foreign exchange rates. There are

today three markets for foreign exchange: the spot market, which deals in

currency for immediate delivery; the forward market, which involves the

future delivery of foreign currency; and the currency futures and options

market, which deals in contracts to hedge against future changes in foreign

exchange rates. Immediate delivery is defined as one or two business days

for most transactions. Future delivery typically means one, three, or six

months from today.

Dealers and brokers in foreign exchange actually set not one, but two,

exchange rates for each pair of currencies. That is, each trader sets a bid

(buy) price and an asked (sell) price. The dealer makes a profit on the

spread between the bid and asked price, although that spread is normally

very small.

2. Supply and Demand for foreign exchange

The underlying forces that determine the exchange rate between two

currencies are the supply and demand resulting from commercial and

financial transactions (including speculation). Foreign-exchange supply and

demand schedules relate to the price, or exchange rate. This is illustrated

in Figure 1, which assumes free-market or flexible exchange rates.

Figure 1

[pic]

Before examining this figure, we need to define two terms.

Depreciation (appreciation) of a domestic currency is a decline (rise)

brought about by market forces in the price of a domestic currency in terms

of a foreign currency. In contrast, devaluation (revaluation) of a domestic

currency is a decline (rise) brought about by government intervention in

the official price of a domestic currency in terms of a foreign currency.

Depreciation or appreciation is the appropriate concept to deal with

floating, or flexible, exchange rates, whereas devaluation or revaluation

is appropriate when dealing with fixed exchange rates.

In the dollar-pound exchange market, the demand schedule for pounds

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