Expository Essay on International Foreign Exchange Market

2021-05-31 11:14:21
7 pages
1677 words
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Vanderbilt University
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Course work
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Question#1a

International foreign exchange market all started in the year 1973. Since then the fluctuation rates in some countries was limited due to the domination of the central bank when it comes to fluctuation rate. According to Bodie et al. (2014), many dealers at that time joined this market of currency trade with the aim of making profit basing their expectations on how rates were fluctuating. Foreign exchange markets started all the way from the Middle East where brokers started to exchange money. The main cause of the establishment of foreign exchange market was due to the fear of heavyweight, theft of coins and insecurity. As a result, foreign brokers invented paper money which came out to be much flexible in carrying out transactions. However, in the 20th century, the foreign exchange market became stable as foreign exchange rate stability and large fluctuations became compatible. It is believed the First World War was synchronized due to excessive speculations and fluctuations. By the end of 1931, there was a revolution in gold standard foreign exchange. This resulted in a decrease in foreign exchange markets. That is why up to date every currency in the world is measured in terms of its strength in comparison to the U.S dollar. Later, British pound seemed to dominate in foreign exchange and commercial trading.

Over the years, foreign exchange markets have experienced a number of changes due to various ups and down in the currency rate. This has been facilitated by the collapse of the standard gold system and also the Berton Woods monetary system. Other changes that happened in the international foreign market is the weakening of the value of gold and monetary system. Foreign exchange was affected by free fluctuations among other changes. Nowadays considerable foreign exchange rates are known since the collapse Berton Woods system as most of the companies have practiced many foreign exchange rate orders. As a result, trade volumes has improved at the same time experiencing bigger fluctuations since the world economy is growing accordingly. However, developing countries look forward in adopting better exchange rates. In addition, they are looking forward to benefiting from this stable exchange rates towards economic development.

Question#1b

The different types of an institution who trade in the international foreign market include the central banks, internet based trading platforms, commercial and investments banks, online retail broker-dealers and business and corporations. Having a look at the commercial and investments banks, not only do banks participate in currency markets to increase the wealth of their stakeholders but also to regulate foreign exchange risks. There is always a specific desk which deals with profit trading currency through the different array of strategies, arbitrage, and hedging. Central banks play a role of holding foreign currency deposits. The amount held by the central bank indicates the ability of a country to pay foreign debts. In addition, they are used in foreign relation policies. There exist different reserve currencies including the Swiss franc, euro and US dollar which are used to stabilize the country's currency. On the other hand, the central bank does hold foreign currency as a way of raising the value of the own. It is the role of the central bank to ensure that the amount in hold keeps in changing have a relationship between supply and demand forces and monetary policies (Neely, 2015).

When it comes to business and corporation, they are involved in foreign trade. Most of the times they are forced to carry out transactions using a foreign currency. No transaction can ever be carried with having in possession of a currency of the partner trading with. The internet based trading platforms resulted due to the great challenges being experienced in the forex market. In addition, how different related business is handled has also lead to the same. Such platforms have helped in systemizing the task of order/customer matching as they serve as access points of a pool of liquidity. The other participants in the international foreign market are the online retail broker-dealers. They play the role of enabling an individual to exchange currency with another at the same time making some profit out of it. This is made possible through availing of the current pricing available. The same brokers help other in participation in the interbank market (Hodrick, 2014).

Question#2a

The structure of the future markets involves an agreement between a buyer and a seller regarding a particular asset. It may constitute of an agreement to buy now and the time it will take to be delivered. Furthermore, it also has to do with an agreement to sell and the time to take to make that delivery. On the other hand, it is composed of buying and selling certainly given assets in coming future. This has to be transacted at an agreed price. Agreeing to sell a future means selling the underlying at a specific time at an agreed price. Any conditions and terms of payments to be made in future are agreed in advance. There are two ways of settling future contracts. One of them is physical delivery while the other one is the cash settled. However, cash settled apply to equity futures. On the other hand, future contracts can be sold before the expiry time and be freely bought (Course manual, 2017).

All this future traded contracts have to act on the basis of contract terms, delivery date and the respective amount of the underlying they relate to. Regarding how the basis is calculated, we just get the difference between the cash price of an asset and its future price at all times the basis are usually negative since the future price is always higher than the current price. This is caused by the costs of carrying that involved all through that duration. When calculating the future fair value, we see that is always equal to costs of carrying adding the cash price. In any case where the future is based on the cash price of the asset which is based on is what we refer to as the contango. It always indicates that the basis is negative. Backwardation refers to valuing the future below the cash price of which is impossible and unusual. Has the role of indicating that the basis is positive.

Question#2b

Since futures have a relationship with the basis, futures are used for speculative purposes. Any changes in between the future price and the cash price are used by the trader attempting to make the profit. A good example is that of a zinc having a cash price of $4 per tonne, the trader is likely to short on zinc if the future price rises to $50 per ton. For any case where the base can be much stronger, profit can be made only when the future position is closed and subsequently sold. If any case the basis is expected to weaken in future, it would be advisable to buy zinc future and sell cash future (Course manual, 2017).

Question#3a

According to Rogers et al., (2016), an example of an international stock exchange that deals with equities is the London stock exchange. An institution deals with the same is the National Bank Market deals perfectly with the other countries in the equity market. The bank is widely equipped with ideas that are innovative that in turns help one unique needs. Furthermore, the bank is in a position to offer services in sales and trading and a complete line-up of equity products. On the other hand, it has equipped with research capabilities hence having a wider knowledge about the equity market. Furthermore, they offer services in trading and sales, electronic execution, and prime services among others.

Question#3b

One international stock exchange is the Intercontinental Exchange that deals with commodities such as electricity, natural gas, and crude oil. An institution that deals with commodity exchange are the Chicago Board of Trade only to create the standardization of derivative contract. On the other hand, it aims at allowing investors including the hedge funds to build non-conventional investment procedures. Furthermore, it plays the role of a clear house as well as giving licenses to certain investors to occupy given speculative positions.

Question#3c

The New York stock exchange is an example of an international bond exchange. On the other hand, a good example of an institution participating in the bond market is the Investment Bank. This bank has a capability of helping other corporations be issued with new bonds and stock. In addition, the government benefits as the banks contribute in the issue of new bonds. On the hand, new securities use it as a market agent.

In conclusion, International foreign exchange market all started not long time ago. Since then the fluctuation rates in some countries was limited due to the domination of the central bank when it comes to fluctuation rate. Many dealers at that time joined this market of currency trade with the aim of making profit basing their expectations on how rates were fluctuating. Foreign exchange markets started all the way from the Middle East where brokers started to exchange money. The main cause of the establishment of foreign exchange market was due to the fear of heavyweight, theft of coins and insecurity. In addition, the structure of the future markets involves an agreement between a buyer and a seller regarding a particular asset. It may constitute an agreement to buy now and the time it will take to be delivered. Furthermore, it also has to do with an agreement to sell and the time to take to make that delivery. As we have seen, futures are widely used by traders for speculative purposes to predict the future price.

 

References

Bodie, Z., Kane, A., & Marcus, A. J. (2014). Investments, 10e. McGraw-Hill Education.

Course Manual (2017). Introduction to futures and options trading. London Academy of Trading.

Hodrick, R. (2014). The empirical evidence on the efficiency of forward and futures foreign exchange markets (Vol. 24). Routledge.

Neely, C. J. (2015). Unconventional monetary policy had large international effects. Journal of Banking & Finance, 52, 101-111.

Rogers, J. H., Scotti, C., & Wright, J. H. (2016). Unconventional monetary policy and international risk premia.

 

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