- •Chapter 3. The international financial marketplace key chapter concepts
- •Glossary of new terms
- •Financial challenge
- •Introduction
- •The global economy and multinational enterprises
- •Table 3—1
- •Table 3—1
- •Foreign currency markets and exchange rates
- •The Eurocurrency Market
- •Direct and Indirect Quotes
- •Table 3 — 2 Spot Foreign Exchange Rates
- •Spot Rates
- •Forward Rates
- •Table 3 — 3. Forward Foreign Exchange Rates
- •Foreign Currency Futures
- •Table 3-4. Futures Contract Quotations
- •Foreign Currency Options
- •Factors that affect exchange rates
- •Covered Interest Arbitrage and Interest Rate Parity
- •Purchasing Power Parity
- •Expectations Theory and Forward Exchange Rates
- •The International Fisher Effect
- •An Integrative Look at International Parity Relationships
- •Figure 3—1. International Parity Conditions: An Integrative Look
- •Forecasting future exchange rates
- •Using Forward Rates
- •Using Interest Rates
- •Foreign exchange risk
- •Transaction Exposure
- •Table 3-5. Example of Transaction Exchange Rate Risk
- •Economic Exposure
- •Translation Exposure
- •Table 3 – 6. Effect of a Decrease in the Exchange Rate on American Products' Balance Sheet
- •International finance and the practice of financial management
- •Ethical issues: payment of bribes abroad
- •Summary
- •Questions and topics for discussion
- •Self test problems
- •Problems
- •Solutions to self test problems
Direct and Indirect Quotes
Exchange rates can be expressed either as direct quotes or indirect quotes. A direct quote is the home currency price of one unit of foreign currency. For example, from the perspective of a U.S. firm a quote of $0.58 per Deutsche mark (DM) would be a direct quote. An indirect quote is the foreign currency price of one unit of the home currency. A quote of DM1.7241/$ would be an indirect quote from the perspective of a U.S. firm. Direct quotes and indirect quotes have a reciprocal relationship. Accordingly, the indirect quote was derived by taking the reciprocal (1÷$0.58/DM) of the direct quote
Table 3 — 2 Spot Foreign Exchange Rates
Source: Wall Street Journal (March 4, 1986 and December 2, 1991)
|
Country |
Currency |
EXCHANGE RATE (U.S. DOLLARS) | |
|
|
|
March 3, 1986 |
December 1, 1993 |
|
Australia |
Dollar |
$0.6955 |
$0.6588 |
|
Britain |
Pound |
1.4465 |
1.4775 |
|
Canada |
Dollar |
0.701 5 |
0.7500 |
|
France |
Franc |
0.1467 |
0.16829 |
|
Germany |
Mark |
0.4517 |
0.5807 |
|
India |
Rupee |
0.0810 |
0.0312 |
|
Italy |
Lira |
0.000664 |
0.0005816 |
|
Japan |
Yen |
0.005571 |
0.009191 |
|
Netherlands |
Guilder |
0.3987 |
0.5178 |
|
South Africa |
Rand |
0.020 |
0.2967 |
|
Sweden |
Krona |
0.1395 |
0.1177 |
|
Switzerland |
Franc |
0.5330 |
0.6658 |
|
— |
ECU |
0.9667 |
1.11620 |
Spot Rates
Exchange rates between U.S. dollars and the currencies of most countries are reported daily in the Wall Street Journal. Table 3-2 lists the (direct quote) exchange rates between U.S. dollars and various currencies as of March 3, 1986, and December 1, 19931. These quotes are for trades made among banks in amounts of $1 million or more. Smaller, retail transactions, usually result in fewer units of a foreign currency per dollar. The quotes in table 3-2 are known as spot rates. Spot rates represent the rate of exchange for currencies being bought and sold for immediate delivery2.
Banks profit from their foreign currency transactions by buying currencies at one rate (bid) and selling them at another, higher rate (ask or offer). For example, a bank may quote the Deutsche Mark at $0.5795 bid, and $0.5807 offer. This quote is often written simply as 0.5795-07. The spread between bid and offer for widely traded currencies is likely to be in the range of 0.1 to 0.5%