Module EC290 Money and Banking Assessment component Team paper
Module EC290 Money and Banking
Assessment component Team paper (research, analysis, writing, presentation)
Weight in the OCG 20%
Max main text word count 2,000
Submission deadline 5 June 2018
Instructions You need to make research and analyze international foreign exchange market. The starting reference is a Triennial Central Bank Survey of foreign exchange and OTC derivatives markets (the most recent is from 2016). Your main objectives is to provide insights about size, structure, currencies, direction of trade, geographical distribution of global foreign exchange markets. Your value added would be to provide an analysis about main changes over the period 2007-2016 (since you can find reports from these two respective periods) and to describe them in your paper.
After submission, you will also have to make 15-minutes oral presentation and discussion in class (PP presentation is not mandatory).
Plagiarism – This is a serious offence. Plagiarism is detectable and rigorous checks are made. If proven, a fail grade may be awarded, which has serious implications for your Degree. Avoid this by attributing all ideas where necessary and sourcing all material.
Referencesshould be listed the alphabetical order. The Harvard style referencing should be used,
e.g. in the text: Lakonishok et al. (2007) document that in the equity option market, end users are net sellers;
In the reference list: Lakonishok, J., I. Lee, N. Pearson, and A. Poteshman (2007). Option market activity. Review of Financial Studies, Vol. 20, pp. 813–57.
Appropriate references are papers published in academic journals and working academic papers, i.e. unpublished papers.Textbooks are also acceptable, but Wikipedia, Investopedia, blogs etc. are not.
First Internal Examiner Amir Hadžiomeragi?First Internal Ex. Grade First Marker Comments Min 100 words
Second Internal Examiner Second Internal Ex. Grade Second Marker Comments Agreed Grade Student(s) Omari Abdullah, Serhan Arafat, Jusufovi? ZerinaTitle International Foreign Exchange Market
Foreign Exchange Market
The foreign exchange market (currency, Forex, or FX) market is where currency trading takes place. It is where banks and other official institutions that facilitate the buying and selling of foreign currencies. FX transactions typically involve one party purchasing a quantity of one currency in exchange for paying a quantity of another.
Today, the FX market is one of the largest and most liquid financial markets in the world, and includes trading between large banks, central banks, currency speculators, corporations, governments, and other institutions. The average daily volume in the global foreign exchange and related markets is continuously growing.
The purpose of FX market is to facilitate trade and investment. The need for a foreign exchange market arises because of the presence of multifarious international currencies such as US Dollar, Pound Sterling, etc., and the need for trading in such currencies.
Market size and liquidity
The foreign exchange market is unique because of
its trading volumes,
the extreme liquidity of the market,
its geographical dispersion,
its long trading hours: 24 hours a day except on weekends
the variety of factors that affect exchange rates.
the low margins of profit compared with other markets of fixed income (but profits can be high due to very large trading volumes)
the use of leverage
Foreign exchange trading increased by 38% between April 2005 and April 2006 and has more than doubled since 2001. This is largely due to the growing importance of foreign exchange as an asset class and an increase in fund management assets, particularly of hedge funds and pension funds. The diverse selection of execution venues such as retail trading platforms platforms offered by companies such as ParagonEX, First Prudential Markets and Saxo Bank have made it easier for retail traders to trade in the foreign exchange market. In 2006, retail traders constituted over 2% of the whole FX market volumes with an average daily trade volume of over US$50-60 billion (see retail trading platforms).5 Because foreign exchange is an OTC market where brokers/dealers negotiate directly with one another, there is no central exchange or clearing house. The biggest geographic trading centre is the UK, primarily London, which according to IFSL estimates has increased its share of global turnover in traditional transactions from 31.3% in April 2004 to 34.1% in April 2007. The ten most active traders account for almost 80% of trading volume, according to the 2008 Euromoney FX survey. These large international banks continually provide the market with both bid (buy) and ask (sell) prices. The bid/ask spread is the difference between the price at which a bank or market maker will sell (“ask”, or “offer”) and the price at which a market-maker will buy (“bid”) from a wholesale customer. This spread is minimal for actively traded pairs of currencies, usually 0–3 pips. For example, the bid/ask quote of EUR/USD might be 1.2200/1.2203 on a retail broker. Minimum trading size for most deals is usually 100,000 units of base currency, which is a standard “lot”.
Top 10 currency traders% of overall volume, May 2008
Rank Name Volume
1 Deutsche Bank21.70%
2 UBS AG15.80%
3 Barclays Capital9.12%
5 Royal Bank of Scotland7.30%
8 Lehman Brothers3.58%
9 Goldman Sachs3.47%
10 Morgan Stanley2.86%
Unlike a stock market, where all participants have access to the same prices, the foreign exchange market is divided into levels of access. At the top is the inter-bank market, which is made up of the largest investment banking firms. Within the inter-bank market, spreads, which are the difference between the bid and ask prices, are razor sharp and usually unavailable, and not known to players outside the inner circle. The levels of access that make up the foreign exchange market are determined by the size of the “line” (the amount of money with which they are trading).
The interbank market caters for both the majority of commercial turnover and large amounts of speculative trading every day. A large bank may trade billions of dollars daily. Some of this trading is undertaken on behalf of customers, but much is conducted by proprietary desks, trading for the bank’s own account.
2. Commercial companies
An important part of this market comes from the financial activities of companies seeking foreign exchange to pay for goods or services. Commercial companies often trade fairly small amounts compared to those of banks or speculators, and their trades often have little short term impact on market rates.
3. 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.
4. Hedge funds as speculators
About 70% to 90% of the foreign exchange transactions are speculative. In other words, the person or institution that bought or sold the currency has no plan to actually take delivery of the currency in the end; rather, they were solely speculating on the movement of that particular currency.
5. Investment management firms
Investment management firms (who typically manage large accounts on behalf of customers such as pension 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.
6. Retail foreign exchange brokers
There are two types of retail brokers offering the opportunity for speculative trading: retail foreign exchange brokers and market makers.
A spot transaction is a two-day delivery transaction), as opposed to the futures contracts, which are usually three months. This trade represents a “direct exchange” between two currencies, has the shortest time frame, involves cash rather than a contract; and interest is not included in the agreed-upon transaction.
In this transaction, money does not actually change hands until some agreed upon future date. A buyer and seller agree on an exchange rate for any date in the future, and the transaction occurs on that date, regardless of what the market rates are then. The duration of the trade can be a one day, a few days, months or years.
Foreign currency futures are exchange traded forward transactions with standard contract sizes and maturity dates — for example, $1000 for next November at an agreed rate. Futures are standardized and are usually traded on an exchange created for this purpose. The average contract length is roughly 3 months. Futures contracts are usually inclusive of any interest amounts.
The most common type of forward transaction is the currency swap. In a swap, two parties exchange currencies for a certain length of time and agree to reverse the transaction at a later date. These are not standardized contracts and are not traded through an exchange.
A foreign exchange option (commonly shortened to just FX option) is a derivative where the owner has the right but not the obligation to exchange money denominated in one currency into another currency at a pre-agreed exchange rate on a specified date. The FX options market is the deepest, largest and most liquid market for options of any kind in the world.
6. Exchange Traded Fund
Exchange-traded funds (or ETFs) are open ended investment companies that can be traded at any time throughout the course of the day. Typically, ETFs try to replicate a stock market index such as the S;P 500Exchange rate
In finance, the exchange rates (also known as the foreign-exchange rate, forex rate or FX rate) between two currencies specifies how much one currency is worth in terms of the other. It is the value of a foreign nation’s currency in terms of the home nation’s currency”
The spot exchange rate refers to the current exchange rate. The forward exchange rate refers to an exchange rate that is quoted and traded today but for delivery and payment on a specific future date.
An exchange system quotation is given by stating the number of units of “term currency” (or “price currency” or “quote currency”) that can be bought in terms of 1 “unit currency” (also called “base currency”). For example, in a quotation that says the EURUSD exchange rate is 1.4320 (1.4320 USD per EUR), the term currency is USD and the base currency is EUR.
Quotes using a country’s home currency as the price currency (e.g., EUR 1.00 = USD 1.58) are known as direct quotation or price quotation (from that country’s perspective) and are used by most countries.
Quotes using a country’s home currency as the unit currency (e.g., AUD 0.97 = USD 1.00) are known as indirect quotation or quantity quotation and are used in British newspapers and are also common in Australia, New Zealand and the eurozone.
direct quotation: 1 foreign currency unit = x home currency units
indirect quotation: 1 home currency unit = x foreign currency units
Free or pegged
If a currency is free-floating, its exchange rate is allowed to vary against that of other currencies and is determined by the market forces of supply and demand. Exchange rates for such currencies are likely to change almost constantly as quoted on financial markets.
Nominal and real exchange rates
The nominal exchange rate e is the price in domestic currency of one unit of a foreign currency.
The real exchange rate (RER) is defined as, where P * is the foreign price level and P the domestic price level. P and P * must have the same arbitrary value in some chosen base year. Hence in the base year, RER = e.
The RER is only a theoretical ideal. In practice, there are many foreign currencies and price level values to take into consideration. Correspondingly, the model calculations become increasingly more complex. Furthermore, the model is based on purchasing power parity (PPP), which implies a constant RER. The empirical determination of a constant RER value could never be realised, due to limitations on data collection. PPP would imply that the RER is the rate at which an organization can trade goods and services of one economy (e.g. country) for those of another.
Bilateral vs. effective exchange rate
Bilateral exchange rate involves a currency pair, while effective exchange rate is weighted average of a basket of foreign currencies, and it can be viewed as an overall measure of the country’s external competitiveness.
Uncovered interest rate parity
Uncovered interest rate parity (UIRP) states that an appreciation or depreciation of one currency against another currency might be neutralized by a change in the interest rate differential. If US interest rates increase while Japanese interest rates remain unchanged then the US dollar should appreciate against the Japanese yen by an amount that prevents arbitrage.
Brown, C.V. (1984); Forex Market ; Oxford: Basil Black Well (Ltd.)
Hamid Shahid, A. (2001); Data On Forex; Lahore: Manzoor Printing Press
Mc. Campbell R, Brue, Stanley L. (2002);
Sinclair, Peter. (1987);
Todaro, Micheal. L ;
www.pakistanecomomist.com ; Waheed, Abdul, Noreen, Mujahid ; “Industry and Economy”
www.nation.com ; Arif, Rauf, ”
International Finance by Maurice. D. Levi
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