International Finance

Chapter 6

The Foreign Exchange Market

■ Questions

6-1.

Definitions. Define the following terms:

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Foreign exchange transaction. A foreign exchange transaction is an agreement between a buyer and

seller that a fixed amount of one currency will be delivered for some other currency at a specified rate.

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6-2.

Foreign exchange market. The foreign exchange market provides the physical and institutional

structure through which the money of one country is exchanged for that of another country, the rate of

exchange between currencies is determined, and foreign exchange transactions are physically

completed.

Foreign exchange. Foreign exchange means the money of a foreign country; that is, foreign currency

bank balances, bank notes, checks, and drafts.

Functions of the Foreign Exchange Market. What are the three major functions of the foreign exchange

market?

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To finance goods in transit. Typical parties would be importers and exporters.

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6-3.

To transfer purchasing power from one country and its currency to another. Typical parties would be

importers and exporters, investors in foreign securities, and tourists.

To provide hedging facilities. Typical parties would be importers, exporters, and creditors and debtors

with short-term monetary obligations.

Market Participants. For each of the foreign exchange market participants, identify their motive for

buying or selling foreign exchange.

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Foreign exchange dealers are banks and a few non-bank institutions that “make a market” in foreign

exchange. They buy and sell foreign exchange in the wholesale market, and resell or re-buy it from

customers at a slight change from the wholesale price.

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Foreign exchange brokers (not to be confused with dealers) act as intermediaries in bringing dealers

together, either because the dealers do not want their identity revealed until after the transaction, or

because the dealers find that brokers can “shop the market,”...