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Market
Location
1. OTC-type: no specific location
2. Most trades by phone, telex, or
SWIFT
SWIFT: Society for Worldwide
Interbank Financial
Telecommunications
Nature of foreign
exchange
Volatile, affected by hedger, arbitrager, speculator.
Affected by demand and supply.
Affected by rate of interest.
Affected by balance of payment surplus and deficit.
Affected inflation rate.
Spot and forward rates are different.
Affected by the economic stability of the country.
Affected by the fiscal policy of the government.
Affected by the political condition of the country.
It can be quoted directly or indirectly
Participants by Market
Spot Market
a.commercial banks
b.Brokers
c.customers of commercial and central banks
. Forward Market
a. arbitrageurs
b. traders
c. hedgers
d. speculators
CLEARING SYSTEMS
A. Clearing House Interbank Payments
System (CHIPS)
- used in U.S. for electronic fund
transfers.
B. FedWire
- operated by the Fed
- used for domestic transfers
ELECTRONIC TRADING
A. Automated Trading
- genuine screen-based market
B. Results:
1. Reduces cost of trading
2. Threatens traders oligopoly of
information
3. Provides liquidity
commercial banks:
the most important group of foreign
exchange market participants
they buy and sell foreign currencies for their
clients and trade for themselves
central banks:
arbitragers:
they want to earn a profit without
taking any kind of risk (usually
commercial banks):
try to profit from simultaneous exchange
rate differences in different markets
making use of the interest rate differences
that exist in national financial markets of
two countries along with transactions on
spot and forward foreign exchange market
at the same time (covered interest parity)
Swap Transactions
simultaneous purchase and sale of a given
amount of foreign exchange for two different
value dates:
spot against forward swaps:
Hedging
the act of reducing exchange rate risk
b) Swap Rate:
quoted in the
interbank
market
as
a
discount or premium.
Futures positions
Futures are similar to forwards
First, futures positions require a margin deposit to be
posted and maintained daily.
If a loss is taken on the contract, the amount is debited
from the margin account after the close of trading.
In other words, these futures are cash settled and no
underlying instruments or principals are exchanged.
Secondly, all contract specifications such as expiration
time, face amount, and margins are determined by the
exchange instead of by the individual trading parties.
Futures
basic characteristics of futures:
the amount of the currency that is being traded
type of currency quotation
contract expiration
last day of trading with the contract
settlement day
margin requirements
Options
Options are a way of buying or selling a
currency at a certain point in the future.
An option is a contract which specifies the
price at which an amount of currency can
be bought at a date in the future called the
expiration date.
Unlike forwards and futures, the owner of
an option does not have to go through with
the transaction if he or she does not wish
to do so.
Forward Contract
an agreement between a bank and a
customer to deliver a specified
amount of currency against another
currency at a specified future date
and at a fixed exchange rate.