Finance- Advance II PDF

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TABLE OF CONTENTS

Executive Summary Introduction Chapter I 1. Concept of currency 1.1 Currency 1.2 Explanatory Models of Foreign Exchange Markets Chapter II 2. Currency Market 2.1 Explanatory Models of Foreign Exchange Markets 2.2 Demand and Supply of Foreign Exchange Chapter III 3. Characteristics of Forex Chapter IV 4. Participants of the foreign currency market 4.1 Direct interbank market 4.1.1. Traditional Users 4.1.2. Commercial Banks 4.1.3. Commercial companies 4.1.4. Central Banks 4.1.5. Speculators 4.2. Indirect interbank market 4.2.1 Brokers Chapter V 5. Functions of foreign Exchange market 5.1 Function Liquidity 5.2 Credit Function 5.3 Function insurance exchange

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Chapter VI 6. Forex Market Segments 6.1 For the delivery 6.1.1 Spot market (SPOT) 6.1.1.1 Exchange differences 6.1.2 Future market (FORWARD) 6.1.3 Market options (OPTIONS) 6.1.3.1 Call opcion 6.1.3.2 Put opcion 6.2 For the size of a transaction 6.2.1 Retail market 6.2.2 Wholesale market 6.3 Interbank Market 6.3.1 Direct interbank market 6.3.2 Indirect interbank market Chapter VII 7. Currency arbitrage Conclusions Bibliography Annexes List of acronyms

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EXECUTIVE SUMMARY

Currently, We have a lot of commercial transactions worldwide, which is conducted the exchange, sale and purchase of goods, services or goods by the buyers who demand the goods and have the ability to buy and few vendors offering the same. The foreign exchange market or currency market in which the individual foreign currencies traded is an important market in the world, which have participants that do an important role in the international finances. The forex market allows an impersonal and efficient way to purchase foreign exchange, facilitated with this international trade, so can the agents of a country making sales, purchases and other business with the agents of other nations. Thus, resort to foreign exchange market exporters, importers, domestic tourists abroad, foreign tourists in Peru, investors, etc. In recent years seen in Peru and other countries, a sharp depreciation of the dollar. In this research, we want to show how domestic and international factors affect the exchange rate and that in an increasingly global economy, risk management exchange is of growing importance to the company and as demonstrated both the strategies followed by most multinational companies such as the growing number of academic studies on the issue. Given the current trend to internationalize the production and marketing processes, and integrate with the business of financial management, knowledge of the forex market is growing.

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INTRODUCTION This report is divided into 8 chapters all about of the FOREX market. In this preliminary report we are going to find a small introduction of any point of the table of contents. Each of one chapter has examples in order to make more understandable and dynamic for the future users of this report. The first, second and third chapter is about an introduction of the currency and how is used in all the world. The chapter describes many characteristics of this market and the parts that are involved in the FOREX market. The followings chapter describes the development of the forex market and how is divided this market. This report could be an help tool for any others investigation for students in order to make simple and accessible information.

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CHAPTER I CONCEPT OF CURRENCY

Forex is a term that comes from the Latin divide (divide) and is used to refer to any currency used in a country or region. The value of a currency is on the value of another and fluctuates in the foreign exchange market (forex). The currency exchange rate is constantly changing depending on many economic variables such as inflation, domestic consumption and economic growth of a country but also geopolitical variables. It is worth mentioning the difference center the term currency and the term currency. The coin refers only to metal or paper money used as an object for exchange for goods, products or services. The relative value of the currency of one country over the other depends on trade and financial flows between the country and other countries. Thus, imports of goods and services and investment overseas demand determines that the country has foreign exchange, while exports and foreign investment in the country determines the supply of own currency. Dollar, euro, pound sterling and Swiss franc: The most common and biggestcirculation worldwide currencies. Las monedas de mayor transacción4 Distribución de divisas por volumen de negocios en el mercado FX

Rango 1

Divisa Dólar estadounidense

Código ISO 4217 % Porcentaje (Símbolo) (Abril de 2013) Source: USD ($)

87%

2

Euro

EUR (€)

33.4%

3

Yen japonés

JPY (¥)

23.0%

4

Libra esterlina

GBP (£)

11.8%

5

Dólar australiano

AUD ($)

8.6%

6

Franco suizo

CHF (Fr)

5.2%

7

Dólar canadiense

CAD ($)

4.6%

8

Peso mexicano

MXN ($)

2.5%

9

Yuan chino

CNY(yn)

2.2%

10

Dólar neozelandés

NZD ($)

2%

11

Corona sueca

SEK(kr)

1.8%

12

Rublo ruso

RUB (руб)

1.6%

12

Wŏn surcoreano

KRW (₩)

1.4%

13

Dólar de Singapur

SGD ($)

1.4%

Otras

36%

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CHAPTER II CURRENCY MARKET

CHAPTER I CONCEPT OF CURRENCY

2. Currency Market The foreign exchange market or FOREX allows banks to companies and other institutions easily buy and sell currencies. The purpose of the forex market is to facilitate international trade and investment. A foreign exchange market helps businesses convert one currency into another. For example, it permits a US business amount of European goods and pay Euros, even though the company's revenues are in US dollars The modern foreign exchange market started forming during the 1970s when countries gradually began to have floating exchange rates from the previous exchange rate regime, which remained fixed by the Bretton Woods system. The foreign exchange market is unique because of the trading volumes, extreme liquidity of the market, its geographical dispersion, its long trading hours: 24 hours 8

a day except on weekends (from 22:00 UTC on Friday through Sunday 22:00 UTC) and the variety of factors that affect exchange rates. Profit margins are low compared with other markets of fixed income (but profits can be high due to the volume of transactions that are large) due to the use of leverage. As such, it has been referred to as the closest to the ideal of perfect competition, notwithstanding market manipulation by central banks market. According to the Bank for International Settlements, average daily turnover in global foreign exchange markets is estimated at 3.98 billion. THE amount contracted in the major financial markets of the world accounted for 3.21 trillion. These approximately 3.21 billion turnovers in organized markets currency breaks down as follows: 

1.005 trillion in spot transactions



$ 362 billion in future



1,714 billion dollars in foreign exchange swaps

2.1 Explanatory Models of Foreign Exchange Markets The following theories explain the fluctuations in exchange rates in a floating exchange rate (in a fixed exchange rate regime, FX rates are decided by the government): International parity conditions ie the purchasing power parity, the parity of interest rates and the Domestic Fisher effect. Although to some extent the above theories require logical explanation for the fluctuations in exchange rates, yet these theories fail because they are based on challengeable assumptions (for example, the free movement of goods, services and capital), rarely once it's true in the real world. 

Model balance of payments. This model, however, focuses mainly on goods and services, ignoring the increasing role of global capital flows. He 9

could not give any explanation for continuous appreciation of dollar during 1980s and most of 1990, compared to the sharp current account deficit of US. 

The asset market model. Consider the coin as a kind of important for building investment portfolios asset. The asset prices are influenced mainly by expectations of investors, which in turn depend on their expectations on the future worth of these assets, "the exchange rate between two currencies represents the price that just balances the relative supplies this and the demand for assets denominated in those currencies.”

None of the models developed so far have been successful to explain FX rates levels and volatility in the longer time ranges.

2.2 Demand and Supply of Foreign Exchange a. When the supply of currency increases

Source: Forextime 0

Increasing the Offer (more foreign investment, more loans, more exports, more money transfers from abroad), low price. b. When the supply of low currency

Lowering the offer (minus foreign investment, loans, exports, money transfers from abroad), increases quote. Source: Forextime

c. when the demand for currency increases

Increasing demand (increased: imports, foreign transfers, interest payments on debt, Source: Forextime s to foreign companies, loans to countries around the world, flight of capital out of foreign investments, etc.) , ups quote. d. when demand low currency

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Source: Forextime

CHAPTER III CHARACTERISTICS OF FOREX

CHAPTER II CURRENCY MARKET

The (Foreign Exchange) Foreign Exchange or Forex has some features that make it unique in its kind. The main features include: Market liquidity: Liquidity is an important factor to operate and feature of the Forex market is said to be the most liquid market in the world. It operations are performed consistently and trading volumes are absorbed by the market at the desired price. This liquidity is especially true when the major markets are open (London, USA and Tokyo). Open 24 hours: The forex market is a global market, which is open 24 hours. This means we can operate at any time of day, although obviously there will be times when there is less liquidity and volatility. Transparency: Being the most liquid market where large volumes are traded capital is very difficult to exist in the forex market manipulation by some agent. Anywhere: The forex market is a global, decentralized market without physical presence, as in other markets. This allows us to operate from anywhere in the world with a simple internet connection, no physical headquarters. Relationship of currencies: Each currency is related to the country he represents. Therefore, currency fluctuations are linked to the policies of their respective countries, especially monetary policy. Huge volume transaction:

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CHAPTER IV PARTICIPANTS OF THE FOREIGN CURRENCY MARKET

The forex market is structured by the next way:

The forex market has 2 levels: Source: own

4.1 Direct interbank market Direct interbank market is Decentralized, continuous, open-bid, double auction market. The bid is open because anyone can ask for quote. The auction is double because each market maker is listed on both the purchase price and the selling price.

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Participants are forming direct interbank market or market-makers. Listed together the buy and sell prices and maintain a position on one or more currencies. For that, they need to maintain stocks of currency trading, and are always willing to buy and sell the quoted price. They are comprised of: 4.1.1. Traditional Users Individuals hold a wide range of non-trading operations in the sphere of foreign tourism, transfers of salaries, pensions, royalties, buying and selling of currency. And in 1986 with the introduction of margin trading Individuals Have the opportunity to invest idle funds in the FOREX market for profit. 4.1.2 Commercial Banks Commercial banks carry the main volume of trading. They are Involved in taking deposits from Individuals and legal entities and operating according to their goals with subsequent return of money to the owners. 4.1.3 Commercial companies An Important part of the foreign exchange market comes from the financial activities of companies seeking foreign exchange to pay for goods or services. Commercial companies trade fairly small Amounts Often Compared to Those of banks or speculators, and their trades often have little short term impact on market rates. Nevertheless, trade flows are an important factor in the long-term direction of a currency's exchange rate. Some multinational corporations (MNCs) Can Have an unpredictable impact when very large positions are covered due to exposures that are not Widely Known by other market Participants. Mainly transnational corporations and governments. These actors enter the forex market only if they need to buy or sell a specific currency, do not make the market. 16

4.1.4 Central Banks National central banks play an important role in the foreign exchange markets. They try to control the money supply, inflation, and/or interest rates and often have official or unofficial target rates for their currencies. They can use their often substantial foreign exchange reserves to stabilize the market. Nevertheless, the effectiveness of central bank "stabilizing speculation" is doubtful because central banks do not go bankrupt if they make large losses, like other traders would, and there is no convincing evidence that they do make a profit trading. These institutions can acquire foreign currencies for themselves or for their governments. They also have the power to increase or spending their international reserves. Finally, central banks can invest in the foreign exchange market with the explicit aim of affecting the exchange rate. Interventions can generate losses for central banks themselves without any important objective is achieved. When the Central Bank wants to strengthen the national currency sells foreign currency. To prevent the domestic currency to appreciate in an exaggerated manner, the central bank buys foreign currency. 4.1.5 Indirect interbank market Investment management firms (who manage large accounts typically on Behalf of customers: such as board funds and endowments) use the foreign exchange market to Facilitate transactions in foreign securities. For example, an investment manager bearing an international equity portfolio needs to purchase and sell several pairs of foreign currencies to pay for foreign securities purchases.

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Some investment management firms also have more speculative specialist currency overlay operations, which manage clients' currency exposures with the aim of generating profits as well as limiting risk. While the number Title body of specialist firms is quite small, many have a large value of assets under management and, hence it can generate large trades.

4.2 Brokers The brokers prepare transactions as promoters; facilitate them without directly participating in them. Brokers do not make the market do not maintain inventories or take currency positions. They act on the behalf of others. They charge a small share both sellers and buyers. Its function is to match sales orders to purchase orders. A broker receives limit orders to buy or sell a specific currency at a specified price. Each seller tries to find a buyer or group of buyers. All direct market participants may use the services of brokers if they wish to remain anonymous. In some cases banks and treasuries of large enterprises do not want to disclose their identity, particularly if transactions are large.

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CHAPTER V FUNCTIONS OF FOREIGN EXCHANGE MARKET

The foreign exchange market is the mechanism, by which a person of firm transfers purchasing power form one country to another, obtains or provides credit for international trade transactions, and minimizes exposure to foreign exchange risk. 5.1. Transfer of Liquidity or Purchasing Power: Transfer of purchasing power is necessary because international transactions normally involve parties in countries with different national currencies. Each party usually wants to deal in its own currency, but the transaction can be invoiced in only one currency. 5.2. Provision of Credit: Because the movement of goods between countries takes time, inventory in transit must be financed. 5.3. Minimizing Foreign Exchange Risk: The foreign exchange market provides "hedging" facilities for transferring foreign exchange risk to someone else. Examples: Liquidity function the most important.

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For example if a Peruvian want to buy 2 products in Thailand. This employer has purchasing power in local currency but needs purchasing power in Thai currency (Thai Baht). In this case the bank scotiabank which has a presence in Thailand and Peru, using the foreign exchange market, pay the bill and bangckock bath in charge of the merchant's account in Peru.

Credit function. The second function relates to resolve the need to finance international trade transactions when the goods are in transit. The best example is the letter of credit. This document works efficiently thanks to global foreign exchange market. Minimizing risk The best examples are arbitration and speculation.

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CHAPTER VI FOREX MARKET SEGMENTS

The forex market is the financial market where foreign currency is freely convertible, or where the currency exchange market operates as an organizational framework in which banks, businesses and individuals buy and sell foreign currencies, providing currency conversion. The use of the dollar as a vehicle currency not only reduces the number of exchange that between every currency in the international system but it also increases the size and liquidity, simplifying procedures. The overall forex market is unique and is the most liquid in the world, but consists or consists of several time-related, transactions size segments.

6.1 FOR DELIVERY TIME 23

6.1.1 MARKET SPOT It is the spot market, which any asset or sold is compared immediate (or short time) and the current market price of delivery. A currency operations cash or spot is a purchase-sale liquidation or where actual delivery of the currencies is made within a period not exceeding two working days. Also called physical market or cash market, although in Spanish the term is used more spot market or current market. Market operations comprise 33% of Forex and can be distinguished by size in 3niveles: retail, wholesale, interchanged. An example: the students of the University Ricardo Palma, we can go to Lima stock exchange and buying shares of the Company PEPITO and owning those shares in a manner and immediately. But there are high transaction costs for market such as: •

The opportunity cost of holding inventories Currency

•

The risk for the variability of exchange

•

The risk of theft or receiving a counterfeit.

•

Little competition, allowing exchange houses charge monopoly rent.

•

There is a high administrative cost compared to the value of the transaction.

6.1.2 LONG- TERM MARKET (FORWARD) A currency forward is a contract between the bank and the company in the purchase / sale of foreign currency forward an agreed exchange rate is agreed in advance. To agree a forward the exporter company receives ass...