Functions & Contribution of Foreign Exchange Market - Assignment Example

Question 1 In the United States of America, the spot currency market operates under a direct quotation so that the value of the American dollar is stated at a given unit-measure of a given foreign currency. A direct quotation in the United States of America focuses on portraying how much USD it would take in order to buy a single unit of another foreign currency (Investopedia, n,d). In Europe, the spot currency market operates under an indirect quotation. Indirect quotation result from a position; where the value of a given foreign currency is stated at a given unit of measurement of the overall US dollar (Investopedia, n, d). It shows the amount of foreign currency it would take to buy a one USD (Investopedia, n, d). This also goes for Australia that also uses the indirect quotation just like Europe since it is one of the Commonwealth currencies. Question 4 Functions & Contribution of Foreign Exchange Market It is important to note that the foreign exchange market avails the physical and institutional structures for which the money resource is a single country is exchanged for another country; a place where the determination of the rate of exchange between countries is done and where foreign exchange transactions are physically done (King, Osler & Rime, 2011). The foreign exchange market conducts the following functions; first, it avails the transfer of purchasing power, which is a necessary phenomenon since international transactions basically involved parties in nations that possess different currencies. Secondly, it avails credit. This is because the movement of products between different nations would normally take lots of time, inventory in transit and should be financed at all times (King, Osler & Rime, 2011). Third, it results to the minimisation of foreign exchange risk to a different party so that there is minimal amount of losses incurred at any given period. Market Participants It can be noted that the foreign exchange market would normally be made up of two tiers; the interbank or wholesale market, the customer as well as the retail market. It is crucial to note that the individual set of transactions within the interbank markets would normally constitute an enormous amount of money that are multiples of millions in USD or even other popular currencies like the Yen and UK Pound (King, Osler & Rime, 2011). In most instances, the contrast that is made between a bank and its immediate clientele base is normally made for specific amounts of money. These participants would include; i) Foreign exchange dealers; that could involve banking institution and a few non-banking premises. These participants would profit from purchasing foreign currencies at specific bid price and resell at a slightly higher amount (King, Osler & Rime, 2011). ii) Participants in commercial and investment transactions; that would extend to importers and exporters, multinational companies and tourists. iii) Foreign exchange brokers; are agents that foster trading between dealers while not being perceived as principals within the transaction. They would normally charge a relatively smaller amount of commission and enjoy lots of access to international traders through their telephone lines (King, Osler & Rime, 2011). Transactions The transactions conducted within a given foreign exchange market can be done as a spot, forward or even swap. Spot transactions; is a form of transaction that would require an immediate delivery of foreign exchange. It normally constitutes foreign exchange with delivery and a subsequent delivery of payment between banks in the following business period (King, Osler & Rime, 2011). Outright forward transactions; would take place when the process related to delivery is undertaken at a future value date or a given level of amount of a given currency for a specified amount of another currency. For most cases, the forward exchange rates would be basically valued at the dates within a given predetermined period (King, Osler & Rime, 2011). Statistically, outright forward transactions cover at least 9% of overall foreign exchange transactions (King, Osler & Rime, 2011). Swap transactions; would normally involve buying and later selling of foreign exchange for a number of value dates. The most popular being the a spot against forward for where the dealer would purchase currency in the spot market and later engage in reselling the same amount back to the same back in the forward market. Question 5 There are a different number of reasons for which companies would make efforts to go global and thus, multinational. First, a company would go international for purposes of expanding its overall market growth. This helps a company to expand its reach thus enabling companies to explore and benefit from new growth market like the currently the boom being experienced in African and Asian economies (Federal Reserve Bank of St. Louis, 2015). This reason is in fact viable when the domestic demand for a given company products or services has remained stagnant for a long period. A perfect example would be Coca-Cola Company that has continued to expand into different international markets for purposes of securing demand for its own beverage-related products. Secondly, companies would opt to go international for purposes of reducing the level of costs involved in the production process (Federal Reserve Bank of St. Louis, 2015). It is safe to argue that the production costs of a given business would normally differ from one country to the next hence business would mostly opt to conduct their production processes as multinational and secure facilities in foreign economies in order to directly benefit from such aspects as cheap labour; land or even production resources (Federal Reserve Bank of St. Louis, 2015). A good example of a company that went multinational for this purpose is Google, which has continued to source for cheap labour in countries like India where IT experts are paid far much lower compared to those in the United States of America. On the contrary though, a company might opt to not go international at all despite the fact that it has the resources and has possible demand for its products and services in another country. One such reason relates to the localisation advantage. A company would focus on growing its local demand as opposed to international demands for purposes of cutting down on such costs as transportation costs or in cases where the products and services being offered can only be purchased and enjoyed at the local level in relation to the local tastes and preferences. In some instances, these companies would focus on enjoying benefits that can only found locally like lower energy and environmental requirements. A good example is the Polish affiliate of the Coca-Cola Company that only operates within the Beskidy Mountains that enjoys an enormous level of mineral water for making other notable beverages. Question 6 Purchasing Power Parity is a macroeconomic analysis that has been devised for purposes of comparing the economic productivity of and the underlying standards of living for people within a given country (Coakley et al, 2005). It is focused on making comparisons of different nations’ currencies through a given market ‘basket of goods’ model. The theory ascertains that any given two currencies would be at equilibrium or even at par when a market basket of products or services, while taking into consideration the underlying exchange rate, is positioned at a similar rate between two countries. An absolute Purchasing Power Parity indicates that the underlying buying power of a given unit of a local currency is positioned exactly the same within the foreign economy while one is being converted into notable foreign currency at the immediate absolute PPP exchange rate (Coakley et al, 2005). On the other hand, the relative PPP ascertains that the possible alterations experienced within the national price degree can be effectively countered by way of commensurate changes within the nominal exchange rates between relevant currencies. Indeed PPP is useful especially since the Big Mac Index can be used to measure the degree of purchasing power parity between two different countries while utilising the price of Big Mac as the benchmark (Coakley et al, 2005). The Big Mac Index ascertains that any given alterations that exists in exchange rates between currencies should be able to affect the price that customers would likely pay for a Big Mac within a given country thereby replacing the basket with hamburgers. References Coakley, J et al. (2005). Purchasing Power Parity and the theory general relativity; the first tests. Journal of International Money and Finance. 24, 293-316 Federal Reserve Bank of St. Louis. (2015). Why would a firm want to become a multinational’. Accessed from https://www.stlouisfed.org/on-the-economy/2015/april/why-would-a-firm-want-to-become-a-multinational Investopedia, (n, d). Indirect quote. Accessed from http://www.investopedia.com/terms/i/indirectquote.asp King, M,R Osler, C & Rime, D. (2011). Foreign exchange market structure, players and evolution. Working Paper. Accessed from https://www.unich.it/~vitale/Rime-2.pdf Read More