Chapter 7 - International Financial Markets and Institutions

Slide 7.
Chapter 7
International financial markets

and institutions
Rugman and Collinson, International Business, 6th Edition, Pearson Education Limited 2013
Slide 7.2
International financial
markets and institutions
Objectives
Introduction
Foreign exchange markets
Determination of the exchange rate
Protecting against exchange risk
Foreign money and capital markets
Regional money and capital markets
The IMF system.
Slide 7.3
Objectives
Review the basic characteristics of all the
financial markets that may be available to a firm
in international business.
Examine the foreign exchange market, its
operation and the main participants.
Explain the fundamental economic factors that
determine exchange rates.
Show how firms can operate successfully in
more than one currency without facing
unacceptable levels of exchange risk.
Slide 7.4
Objectives (Continued)
Give insights into domestic money and capital
markets that exist around the world.
Describe the functioning of the euromarkets, both
short term and long term.
Explain how the international monetary system
functions and how it relates to both private-sector
firms and governments.
Look at a countrys balance of payments and
show what lessons can be drawn from it.
Show how firms can take advantage of the
opportunities available in all of these markets.
Slide 7.5
Introduction
International financial markets are relevant to
companies, whether or not they become directly
involved in international business through exports,
direct investment and the like.
Purchases of imported products or services,
borrowing and investment in other countries or
currency, all involve exchange risk.
Exchange risk: The risk of financial loss or gain
due to an unexpected change in a currencys
value.
Slide 7.6
Introduction (Continued)
Foreign exchange: any financial instrument that
carries out payment from one currency to
another.
Exchange rate: the amount of one currency that
can be obtained for another currency.
Spot rate is the rate quoted for current foreign
currency transactions.
Forward rate is the rate quoted for the delivery of
foreign currency at a predetermined future date
such as 90 days from now.
Cross rate is an exchange rate that is computed
from two other rates.
Slide 7.7
Foreign exchange markets
Slide 7.8
The foreign exchange markets

The foreign exchange market is a mechanism
through which financial instruments (cash,
cheques or drafts, wire transfers telephone
transfers and contracts to sell or buy currency in
the future) that are denominated in different
currencies can be transacted.
Slide 7.9

(Continued)
There are four major ways of conducting foreign
exchange in the US:
Between banks: the interbank market for foreign
exchange involves transactions between banks.
Brokers: the brokers market consists of a small
group of foreign exchange brokerage companies
that make markets in foreign currencies. These
brokers do not take currency positions. They
simply match buyers and sellers and charge a
commission for their services.
Slide 7.10

(Continued)
Forward transaction: lets a customer lock in an
exchange rate and thus be protected against the risk
of an unfavorable change in the value of the
currency that is needed. This exchange market is
very important to firms that are doing business
overseas and dealing in foreign currency.
Futures market: is very similar to the forward
foreign exchange market except in that the amount
of currency transacted is fixed to be transferred at a
future date at a fixed exchange rate.
Slide 7.11
Figure 7.2
US foreign exchange markets
Source: Adapted from Robert Grosse, St. Louis Fed Review, March 1984, p. 91
Slide 7.12
Determination of the exchange rate
Slide 7.13
Activities of various actors

Traders work in commercial banks where they buy and
sell foreign currency for their employer.
Brokers work in brokerage firms where they often deal in
both spot rate and forward rate transactions.
A speculator is a participant who takes an open position.
This means that the individual either has foreign
currency on hand (called a long position) or has
promised to deliver foreign currency in the future and
does not have it on hand (called a short position).
Hedgers limit their potential losses by locking in
guaranteed foreign exchange positions.
Arbitrageurs are individuals who simultaneously buy and
sell currency in two or more foreign markets and profit
from the exchange rate differences.
Governments.
Slide 7.14
Figure 7.1
Foreign exchange market for euros in New York

Slide 7.15
Economic relationship
for exchange rate determination
Exchange rates are determined by the activities
of the groups discussed above, as well as
through two fundamental economic relationships
that underlie exchange rate determination:
Purchasing power parity
The international Fisher effect.
Slide 7.16
Purchasing power parity

PPP theory states
that the exchange
rate between two
currencies will be
determined by the
relative purchasing
power of these
currencies.
Infl = Inflation
XR = Exchange Rate
t = time
Slide 7.17
The international Fisher effect

Fisher effect: describes
the relationship between
inflation and interest rates
in two countries and holds
that as inflation rises, so
will the nominal interest
rate.
The Fisher effect holds
that the interest rate
differential between two
countries is an unbiased
predictor of future
exchanges in the spot
market.
i = interest rate
XR = exchange rate
t = time
Slide 7.18
Combined equilibrium
The future exchange rate, XRt+1, will be partially
determined by both of the above factors (PPP
and IFE) in the absence of government
intervention.
Slide 7.19
Figure 7.3
Exchange rate determination

Slide 7.20
Slide 7.21

Alternatives to minimize exchange risk
Risk avoidance: avoid foreign currency
transactions.
Risk adaptation: this strategy includes all
methods of hedging against exchange rate
changes.
Risk transfer: the use of an insurance contract or
guarantee that transfers the exchange risk to the
insurer or guarantor.
Diversification: spreading assets and liabilities
across several currencies.
Slide 7.22
Slide 7.23

The MNE will generally utilize local markets to
perform local financial transactions and often to
hedge its local asset exposure through local
borrowing (or its local liability exposure through
local deposits or investments).
The MNE can also utilize local financial markets
to obtain additional funding (or place additional
funds) for its nonlocal activities.
Slide 7.24
Slide 7.25

The eurocurrency market
A eurodollar is a dollar-denominated bank deposit
located outside the United States.
Eurobonds are financial instruments that are
typically underwritten by a syndicate of banks from
different countries and are sold in countries other
than the ones in which their currency is
denominated.
Euroequities are shares of publicly traded stocks
traded on an exchange outside of the issuing firms
home country.
Slide 7.26
The IMF system
Slide 7.27
The international monetary system

International monetary system: The
arrangement between national
governments/central banks that oversee the
operation of official foreign exchange dealings
between countries.
International Monetary Fund (IMF): The
international organization, founded at Bretton
Woods, NH, in 1944, that offers balance of
payments support to countries in crisis along with
financial advising to central banks.
Slide 7.28
The International Monetary Fund (IMF)

The goals of the IMF include
facilitating the balanced growth of international
trade;
promoting exchange stability and orderly exchange
arrangements and to discourage competitive
currency depreciation;
seeking the elimination of exchange restrictions
that hinder the growth of world trade;
making financial resources available to members,
on a temporary basis and with adequate
safeguards, to permit them to correct payment
imbalances without resorting to measures
destructive to national and international prosperity.

Chapter 7 - International Financial Markets and Institutions

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Slide 7.

International financial markets

Foreign exchange markets

The foreign exchange markets

The foreign exchange markets

The foreign exchange markets

US foreign exchange markets

Determination of the exchange rate

Activities of various actors

Foreign exchange market for euros in New York

Purchasing power parity

The international Fisher effect

Exchange rate determination

Protecting against exchange risk

Protecting against exchange risk

Foreign money and capital markets

Foreign money and capital markets

Regional money and capital markets

Regional money and capital markets

The IMF system

The international monetary system

The International Monetary Fund (IMF)

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