Unit 8 The Foreign Exchange Market

Any country’s currency is a legal tender only within its national boundaries. The trade beyond these boundaries involves exchange of currencies. They can be bought and sold in the Foreign Exchange Market, which performs two major functions: it facilitates the foreign exchange needs of exporters and importers, and it enables individuals, corporations and governments to obtain a desired currency mix of their portfolios.

Trading in the market occurs 24 hours a day in various centers around the world. Deals are concluded over telecommunication network by different counterparties, some of whom work as dealers.

The exchange market is global, it doesn’t have one centralized location. The great majority of trading takes place between those who represent large commercial banks or other financial institutions. Foreign exchange departments of banks are linked across the world through a sophisticated network of communication system.

The market consists of three major sectors: the spot market, the futures market and the currency options market.

Somewhat more than half of all transactions are spot deals. In other words, they are transactions that are settled within two business days.

Trading may occur at any future day. This transaction results in a futures contract. The businessman who signs a contract for the future delivery of machines may wish to settle the cost in his own currency immediately by signing a futures contract with his bank (he hedges his position). No matter what happens to the fluctuation in the foreign exchange rate between now and the settlement day, the businessman’s exchange rate is set.

In the currency option markets a company or a bank can buy the right, but not the obligation, to sell or buy currency forward, if required. This option, to decide whether to buy or sell currency, is particularly important when the firm is unsure about the timing or size of foreign currency receipts or payment. To purchase an option, the buyer has to pay a premium.

Prices in the exchange market depend on the volume of transactions, exchange rate volatility, the availability of relevant information and the strength of competition in the market. The basic idea of foreign exchange dealing is making profit on selling and buying currencies. Dealers and brokers usually quote not one, but two exchange rates for each pair of currencies: a bid (buy) price and an asked (sell) price. The bid-asked spread constitutes the dealer’s profit, though this spread is normally very small. As prices are different in different countries, professional dealers take advantage of it buying, say, US dollars for yen in Singapore and selling them in London for sterling and then back into yen in New-York – all for a profit. This operation is called currency arbitrage.

The delivery of the individual currencies involved in a foreign exchange transaction typically takes place through the payment systems of the two countries whose currencies are traded.

Words and expressions

boundary (n) - граница

currency mix- структура денежной массы

counterparty(n) - сторона при заключении сделки

spot market- рынок наличной валюты (на котором сделки совершаются в течение двух дней)

futures market- фьючерский рынок (срочных сделок – договоров о покупке или продаже фиксированного количества определенного товара, валюты или ценных бумаг для их поставки в оговоренную дату в будущем по согласованной цене)

options market- рынок опционов (разновидностей срочных сделок, которые необязательно выполнять)

somewhat(adv) - отчасти, до некоторой степени

hedge(v) - страховать себя от возможных потерь

fluctuation(n) - качание, колебание

obligation(n) - обязательство

to undertake obligations, assume obligations - принимать обязательства

to feel an obligation - чувствовать себя обязанным

to fulfill, meet an obligation - выполнять, исполнять долг

e.g.We have an obligation to help them. - Мы обязаны им помогать.

volatility(n) - изменчивость, непостоянство

quote(v) - котировать, назначать цену

quotation (n) - котировка

asked quotation - курс продавца

bid quotation - курс покупателя

spread (n) - разница, маржа

to narrow the spread -сократить разрыв в ценах

to profit from the spread -получить прибыль от разрыва в ценах

relevant (adj) - релевантный; значимый; существенный; важный

currency arbitrage- скупка и продажа валют, учитывающая разность курсов разных валют на различных валютных рынках

Exercises

1. Answer the questions.

1. What involves the exchange of currencies?

2. What are the functions of the Foreign Exchange Market?

3. How are deals concluded?

4. How is the exchange market organized?

5. What sectors does the exchange market consist of?

6. What are spot deals?

7. What is a futures or forward contract?

8. What does “to hedge the position” mean?

9. When do companies use options?

10. What do prices on the exchange market depend on?

11. What is the basic idea of foreign exchange dealing?

12. What prices do brokers and dealers quote?

13. What is currency arbitrage?

14. How does the delivery of currencies take place?

2. Translate into English.

Законное платежное средство; в рамках государственных границ; за пределами; обмен валюты; валютный рынок; способствует удовлетворению потребностей в иностранной валюте; позволяет добиться желаемой структуры денежной массы своего портфеля; торговля происходит круглосуточно; сделки заключаются с использованием телекоммуникационных систем; кто представляет крупные коммерческие банки или финансовые учреждения; сделка заключается в течение двух рабочих дней; сделка заканчивается заключением фьючерского контракта; установить стоимость; обменный курс определен; купить право, но не обязательство; время или размер валютных поступлений; покупателю приходится платить премию; зависеть от объема сделок, изменчивости валютного курса; разница между ценой покупателя и ценой продавца; поставка валюты обычно происходит через … .

3. Match the words with their definitions.

1. Exchange rates - a) the interest rate difference

2. The spot market - b) the simultaneous buying and selling of the same currency

in different markets to profit from rate difference

3. The futures market - c) the right but not the obligation to buy or sell currency at a

fixed price on a particular day

4. Option - d) the prices of foreign currencies expressed in terms of other

currencies

5. Hedging - e) deals in contracts to hedge against future changes in foreign

exchange rates

6. To fluctuate - f) deals in currency for immediate delivery

7. Spread - g) reducing the risk of unfavourable exchange rates by way of

future contracts

8. Arbitrage - h) to go up and down

4. Complete the text using the words:

currency rate, substantial, futures, foreign exchange markets, fluctuation, risks, traders

Knowledge of how the 1) … works and the ways in which 2) … can be reduced is important for business managers today. Of course, the problem of 3)… of currency value is not so serious if payment is made right away. But if payment must be made in weeks or months in the future, there is considerable uncertainty as to what spot 4) … will be on any given future date. When 5) … sums of money are involved, the rational 6) … will try to guarantee the future price at which currency can be purchased. This is the function of the 7) … exchange market.

5. Match the questions on the left with the answers on the right.

Exchange Rates

1. Is it true that there was a time when a) Because in reality, they are often determined

you could go to a bank in the USA by a massive amount of currency speculation

and demand gold in exchange for that goes on.

your dollar?

2. Who was he? 　b) Only if they were officially devaluated or

revaluated by the government or the central .　　

bank.

3. So could they never change? c) Not who, what or where. It was an international

conference held in New Hampshire in 1944. It

fixed the value of the US dollar at 1/35 of an

ounce of gold, and “pegged” or fixed most other

major currencies against the dollar.

4. But is it all different now? d) Oh sure, they can try to intervene on currency

markets by buying or selling billions of dollars

or pounds. But the speculators have much more

money than governments.

5. So, how does it work now? e) We have floating exchange rates, determined by

supply and demand. Theoretically, the rates

should reflect purchasing power.

6. Why “theoretically”? f) Well, in theory, yes. That was the result of

Bretton Woods.

7. So is there anything governments can g)Yes, the Bretton Woods system collapsed in

do? early 1970s because of inflation. There were

too many dollars and not enough gold, so

President Nixon ended gold convertibility.

6. Read the text and translate it into Russian.

Eurocurrencies

A Eurocurrency is any currency held outside its country of origin, such as US dollars in France (called Eurodollars) or Yen in the USA (called Euroyen). Thus Eurocurrencies do not necessarily have anything to do with Europe, so the name is not a very good one.

The Euromarket developed during the Cold War in the early 1950s, to finance international trade. The largest Euromarket is concentrated in London because there are fewer governmental regulations there than in most other financial centers, and because the European time-zone is half-way between those of Japan and the USA. Since banks are not obliged to deposit any of their Eurocurrency assets at zero interest with the central bank they can give better interest rates to both borrowers and depositors.

The Eurocurrency market there is organized by the large international banks and operates at two levels. Firstly, banks sell their funds to each other at the London Inter Bank Offering Rate (Лондонская ставка предложения по межбанковским депозитам - LIBOR). Secondly, smaller banks, corporate borrowers, national governments can borrow loans from this market.

The Eurocurrency markets perform three basic functions. Firstly, they are extensively used for foreign exchange hedging purposes. Banks take positions in the Eurocurrency market to fulfill the commitments they have with their customers. Secondly, Eurocurrency markets can at times bypass (обходить) domestic channels of financial intermediation, especially when governments impose tight credit restrictions. For example, US corporations can have Eurodollars in London. These deposits may be US domestic dollar deposits that have been transferred abroad, during US credit squeeze («сжатие кредита» - мероприятия государства по ограничению кредита потребителям). The third function is the full international intermediation role of channeling surplus liquid resources from, say, OPEC countries to those countries or corporations who need to borrow.

7. Summarize the information of the unit and speak on the topic: The Foreign Exchange Market