Lesson Four Foreign Exchange and Foreign Exchange Control
Learning Objectives
Foreign exchange (FX)
Foreign exchange market (FX Market)
FX quotations
Exchange Control
China’s FX System
USD
EUR
JPY
Foreign Exchange is the process by which the currency of one country is exchanged for that of another.
FX
Meaning: currency and bank deposits that are denominated in foreign money
The currency of a country other than one’s own
The exchanging of the currency of one country for that of another
The practice of buying and selling the money of other countries
FX
Examples are:
Telegraphic transfers (T/T); Bank transfers made by cable；电汇
Mail transfers (M/T)；Bank transfers made by mail；
Bills (bills of exchange)汇票
demand drafts (or bills)即期汇票=sight drafts
checks: written order to a bank to pay money
banker’s drafts: a cheque payable on demand drawn by a bank 银行汇票
Examples continued
Coupons: one of a serious of promissory notes of consecutive maturities attached to a bond or other debt certificate and to be detached and presented on their respective due dates for payment of interest 息票
Traveler's checks: a special kind of check issued by a bank to a traveler who can get payment at sight at a bank, store, hotel,etc. almost everywhere.
Foreign notes and coins
FX Basics
Convertibility – the degree that one currency can be exchanged for another one without difficulty
Hard Currency – is a currency that is convertible and is supported by a strong economy
Soft ( lessor traded) Currencies- are officially tradable currencies, but are often illiquid and difficult to trade.
Non-tradable Currencies- are restricted by their governments.
FX Rate
a. Exchange Rates
The rate at which monies of different countries are exchanged
b. Exchange rate changes and international trade
A currency appreciates in value when its value rises in relation to another currency
A currency depreciates in value when its value falls in relation to another currency
c. Case study 1
FX Rate Basics
Bid price (buying rate)– the price the dealer is willing to buy a currency at
Offer price/ ask price (selling rate)– is the price the dealer sells currency for
Spread – is the difference between the buy and sell price from the dealer’s point of view.
Foreign Exchange
Transactions
Banks provide foreign exchange services for a fee: the bank’s bid (buy) quote for a foreign currency will be less than its ask (sell) quote. This is the bid/ask spread.
bid/ask % spread = ask rate – bid rate
ask rate
Example: Suppose bid price for £ = $, ask price = $.
bid/ask % spread = (–)/ = 5%
Foreign Exchange Market
Meaning
Place of Foreign Exchange Transaction
Mechanism (System) of Foreign Exchange
The FX market
no single, physical location
computer/telephone network
London, NY, Tokyo, Singapore, HK
Eurocurrency market
Foreign Exchange Market
Players in the foreign exchange market
Commercial banks, large corporations, non-bank financial institutions, central banks
Commercial banks are by far the largest players in the foreign exchange market. However large corporations like IBM and GE also engage in significant transactions. Another groups of important players are central banks
FX Market
Spot vs Forward Markets
Spot:
market for immediate transaction
technically, two-day settlement
Forward:
market for definite transaction in future
settlement occurs on specified date
forward price may differ from the spot price
Foreign Exchange Market
Volume
Huge! $ Trillion/day
87% of trades involve US$
Mostly Capital Account Trading (over 90%)
Mexico
China
Korea
Hong Kong
Singapore
.
Germany
Japan
USA
% of GDP
Daily Trading(bil USD)
Exchange Rate Quoting
An exchange rate can be quoted in two ways
Direct (American) terms and indirect (European) terms
Direct Terms
Price of foreign currency in terms of national currency
How many units of national currency do we need to buy a unit of foreign currency
Example $/€, $/¥
Last Friday’s dollar-euro exchange rate is
??
Indirect Terms
Price of national currency in terms of foreign currency
How many units of foreign currency do we need to buy a unit of national currency
Example €/$, ¥/$
Last Friday’s euro-dollar exchange rate is ？
Foreign Exchange Quotations
A cross exchange rate reflects the amount of one foreign currency per unit of another foreign currency.
Value of 1 unit of currency A in units of currency B = value of currency A in $
value of currency B in $
Determination of the Spot Exchange Rate
What determines the exchange rate?
Demand and supply
List 3 reasons individuals or businesses, at home or abroad, would demand foreign currency in exchange for Canadian currency (each reason should be a different type of activity)
List 3 reasons individuals or businesses would supply foreign currency in exchange for Can $.
What factors might affect demand and supply?
Reasons to demand foreign currency
1. meet current need - buy imports of goods and services, send a gift or pay investment income
2. purchase foreign assets or financial products - stocks, bonds, direct investments
3. hedge or speculate - either buy currency to protect against possible future fluctuations, or to bet on results of future currency fluctuations
Reasons to supply foreign currency
buy exports of goods or services, or pay investment income to Canadians
invest in Canada or buy Canadian real or financial assets (stocks, bonds, bank deposits)
hedge against or speculate on an appreciation of the Canadian dollar
Note:
first reason relates to current account transactions
2nd reason relates to capital account transactions
Determination of the Spot Exchange Rate
A demand for dollars is generated when foreigners want to buy dollars to acquire . goods, services or . assets
A supply of dollars is generated when holders of dollars want acquire foreign goods, services or assets
Foreign Exchange
rate (Yen per dollar)
Dollars (Millions
per Day)
120
Supply
Demand
Other Factors Affecting Exchange Rates
Inflation Differential
Income Differential
Gov’t Trade Restrictions
Interest Rate Differential
Capital Flow Restrictions
. Demand
For Foreign Goods
Foreign Demand
For . Goods
. Demand
For FC
Supply of FC
For Sale
. Demand
For Foreign Securities
Foreign Demand
For . Securities
. Demand
For FC
Supply of FC
For Sale
Exchange Rate
Between the
Foreign Currency
And the Dollar
Changes in the Exchange Rate
Factors that cause a currency to depreciate:
A rapid growth of income (relative to trading partners) that stimulates imports relative to exports.
A higher rate of inflation than one's trading partners.
A reduction in domestic real interest rates (relative to rates abroad).
Changes in the Exchange Rate
Factors that cause a currency to appreciate:
A slower growth rate relative to one’s trading partners.
A lower inflation than one's trading partners.
An increase in domestic real interest rates (relative to rates abroad).
Questions for Thought:
“A ‘weaker’ RMB benefits all Chinese people”? What is meant by a “stronger dollar”? Would all Americans benefit from it?
Exchange Control
Government rules limiting freedom of movement of money to other countries and on the buying and selling of foreign currencies, in order to prevent an outflow of capital to other countries and to protect the external value of the country’s currency.
Useful Websites
country’s fx reserves
is under pressure of appreciation ---news item
2
莱昂纳多的新电影 catch me if you can
Also other names: stronger national currency or weaker national currency
An appreciation of a nation’s currency will make foreign goods cheaper.
A depreciation of a nation’s currency will make foreign goods more expensive.
importers/exporters, investors, tourists, banks, dealers, brokers, speculators
Settlement-For “spot” deals:
2 Business Days for most currencies
1 Business Day for Canada
Inflation rates?
Trade deficits?
Demand for assets?
国家外汇管理局state administry of foreign exchange
