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FMI week 10 Foreign exchange market - Coggle Diagram
FMI week 10 Foreign exchange market
Foreign exchange market
Why FX market : Australian firms engage into international trade
Exchange rate in indirect quote:
AUD/USD = 0.75. 1 AUD exchanges for 0.75 USD. increase means appreciation.
always think about base currency for deals, if sell USD, then means buy AUD.
ER are determined by supply and demand.
operations of FX market
Fixed exchange rate:
constant rate of exchange between currencies, require a lot of interventions.
Floating exchange rate:
purely determined by supply and demand.
Managed exchange rate:
allow to float, but with bands relative to another currency.
pegged exchange rate:
tied to the value of another/basket of currency
Crawling peg
: managed float where exchange rate is allowed to appreciate in controlled steps.
AUD used to peg =>GBP =>USD => basket => float
Government intervention
if lower than target,
support
currency by selling domestic assets to foreigners.
if higher than target,
depress
currency by buying domestic assets from abroad.
reserve assets
as a key indicator for stable ER.
if
no reserves
, then
economic policy
, relaxed MP/lower IR => higher inflation => price to raise in AU relative to others => higher supply of AUD => AUD falls
Structure:
OTC market, transaction at anytime, no rules governing
Participants:
individual&corporations, large multinational banks, investment banks, central banks. mediated by FX broker.
Types of transactions
Spot market:
sold and purchase on spot(T+2)
Forward market
: trade currency at predetermined rate in forward.
Functions
payment
hedging
provision of credit
Balance of Payments
set of accounts summaries country's international balance of trade
two accounts
the current account:
summaries foreign trade plus investment income or gift to other countries. AU is current account deficit due to net borrowing for cheaper interest rate.
the financial account:
measures capital flows in and out of the country. AU maintain a positive financial account due to excess investment in AU from other countries.
five factors changes demand for export and import
Relative prices
Barriers to trade
Resources endowments
taste
productivity
Purchasing power parity(PPP):
purchasing power should equal in all countries if no friction to trade
Capital flows
Investment capital flows: chase in different interest rate
Political capital flows: instability leads to outflows
central bank's operation: stablize currency
Interest rate parities
Uncovered interest rate parity (UIP)
Violation leads to
carry trade
: borrow from country with low interest rate and invest in high interest paying country
profit from
dividend yield
and
capital gains
Covered interest rate parity(CIP)
Chinese Currency market
One currency two rates
CNY as onshore RMB: allow to trade with 2% band
CNH as offshore RMB: floating
Eurocurrency and Eurobond
functions
source of working capital for multinational firms at competitive rate
storehouse for liquidity with competitive rate of return
facilitate international trade