International Financial Markets
Motives for Using International Financial Markets
The markets for real or financial assets are prevented from full integration by barriers like tax
differentials, tariffs, quotas, labor immobility, communication costs, cultural, and financial reporting
differences. Yet, such market imperfections also create unique opportunities for specific geographic
markets, helping these markets attract foreign creditors and investors.
• Investors invest in foreign markets:
– to take advantage of favorable economic conditions;
– when they expect foreign currencies to appreciate against their own; and
– to reap the benefits of international diversification.
• Creditors provide credit in foreign markets:
– to capitalize on higher foreign interest rates
– when they expect foreign currencies to appreciate against their own, and
– to reap the benefits of diversification.
• Borrowers borrow in foreign markets:
– to capitalize on lower foreign interest rates, and
– when they expect foreign currencies to depreciate against their own.
Foreign Exchange Market
The foreign exchange market allows currencies to be exchanged in order to facilitate
international trade or financial transactions. The system for exchanging foreign currencies has evolved
from the gold standard to agreements on fixed exchange rates, to a floating rate system.
Foreign Exchange Transactions
The market for immediate exchange is known as the spot market. Trading between banks
occurs in the interbank market. Within this market, brokers sometimes act as intermediaries. The
forward market enables an MNC to lock in the exchange rate at which it will buy or sell a certain
quantity of currency on a specified future date. Customers in need of foreign exchange are concerned
with quote competitiveness, special banking relationship, speed of execution, advice about current
market conditions, and forecasting advice.
Banks provide foreign exchange services for a fee: a bank’s bid (buy) quote for a foreign
currency will be less than its ask (sell) quote.
, The spread on currency quotations is positively influenced by order costs, inventory costs, and
currency risk, and negatively influenced by competition, and volume. The markets for heavily traded
currencies like the €, £, and ¥ are very liquid.
Interpreting Foreign Exchange Quotations
The exchange rate quotations published in newspapers normally reflect the ask prices for
large transactions. Direct quotations represent the value of a foreign currency in terms of the home
currency (e.g. £ or euro), while indirect quotations represent the number of units of a foreign currency
per unit of home currency.
• Notation
“$1.6 to the ₤1” can be written as: $1.6/₤ or $1.6: ₤1 and treated as $1.6 = ₤1
A cross-exchange rate reflects the amount of one foreign currency per unit of another foreign currency.
Example:
Currency Futures and Options Market
Currency futures contracts specify a standard volume of a particular currency to be exchanged
on a specific settlement date. They are sold on exchanges, unlike forward contracts. Currency call (put)
Motives for Using International Financial Markets
The markets for real or financial assets are prevented from full integration by barriers like tax
differentials, tariffs, quotas, labor immobility, communication costs, cultural, and financial reporting
differences. Yet, such market imperfections also create unique opportunities for specific geographic
markets, helping these markets attract foreign creditors and investors.
• Investors invest in foreign markets:
– to take advantage of favorable economic conditions;
– when they expect foreign currencies to appreciate against their own; and
– to reap the benefits of international diversification.
• Creditors provide credit in foreign markets:
– to capitalize on higher foreign interest rates
– when they expect foreign currencies to appreciate against their own, and
– to reap the benefits of diversification.
• Borrowers borrow in foreign markets:
– to capitalize on lower foreign interest rates, and
– when they expect foreign currencies to depreciate against their own.
Foreign Exchange Market
The foreign exchange market allows currencies to be exchanged in order to facilitate
international trade or financial transactions. The system for exchanging foreign currencies has evolved
from the gold standard to agreements on fixed exchange rates, to a floating rate system.
Foreign Exchange Transactions
The market for immediate exchange is known as the spot market. Trading between banks
occurs in the interbank market. Within this market, brokers sometimes act as intermediaries. The
forward market enables an MNC to lock in the exchange rate at which it will buy or sell a certain
quantity of currency on a specified future date. Customers in need of foreign exchange are concerned
with quote competitiveness, special banking relationship, speed of execution, advice about current
market conditions, and forecasting advice.
Banks provide foreign exchange services for a fee: a bank’s bid (buy) quote for a foreign
currency will be less than its ask (sell) quote.
, The spread on currency quotations is positively influenced by order costs, inventory costs, and
currency risk, and negatively influenced by competition, and volume. The markets for heavily traded
currencies like the €, £, and ¥ are very liquid.
Interpreting Foreign Exchange Quotations
The exchange rate quotations published in newspapers normally reflect the ask prices for
large transactions. Direct quotations represent the value of a foreign currency in terms of the home
currency (e.g. £ or euro), while indirect quotations represent the number of units of a foreign currency
per unit of home currency.
• Notation
“$1.6 to the ₤1” can be written as: $1.6/₤ or $1.6: ₤1 and treated as $1.6 = ₤1
A cross-exchange rate reflects the amount of one foreign currency per unit of another foreign currency.
Example:
Currency Futures and Options Market
Currency futures contracts specify a standard volume of a particular currency to be exchanged
on a specific settlement date. They are sold on exchanges, unlike forward contracts. Currency call (put)
