* Determination Of Foreign Exchange Rates * Factors Affecting Foreign Exchange Rates * Mechanics Of Foreign Exchange Market

* Determination Of Foreign Exchange Rates

* Factors Affecting Foreign Exchange Rates

* Mechanics Of Foreign Exchange Market

FOREIGN EXCHANGE MARKET

DETERMINATION OF FOREIGN EXCHANGE RATESAn exchange rate measures all the value of one unit of currency in terms of units of another currency.

Example:

RM3.74 / USD 1.00

USD 0.27 / RM 1.00

Demand for a Foreign CurrencyReferred also as supply of home currency.It would happen when home country people import/ buy good and services from foreign country.Example: Demand curve is a downward sloping because Malaysian would be encouraged to purchase more US goods when the US dollar is worth less in ringgit.

Supply for a Foreign CurrecnyReferred also as demand for home currency.Happens when foreigners import/buy goods and services from our country.Positive relationship with the value of USD in term of RM and the Quantity of USD being supplied.

Equilibrium of Foreign ExchangeWhen the demand and supply curves combined, it will give us the exchange rate or price of foreign currency against the home currency.The primary function of foreign exchange is to transfer purchasing power of one currency to another and thereby facilitate international trade and investment.

Factors Affecting FOREX RatesFactors Affecting FOREX RatesRELATIVE INFLATION RATESThe changes can affect international trade activities in the country.When Malaysia inflation demand for foreign products , hence the demand for foreign currencies.Ex: when Malaysia inflation increase, USD will appreciate (RM depreciate)Ex: USD1 = RM2.50 USD1 = RM2.70

RELATIVE INTEREST RATEAssume that Malaysia interest rate while US interest rate remain constantIn this case, Malaysian resident would desire less US bank deposits since Malaysia rate are now more attractive relative to US rate so, USD demand.Increase in Malaysia interest rate will invite foreign investment therefore supply of foreign currency will increase.Ex: RM appreciate ,USD depreciate.

USD AppreciateFactors Affecting FOREX RatesRELATIVE INCOME LEVELSAssume that Malaysia income level substantially rises while the US income level remains unchanged, we would expect the equilibrium exchange rate of USD rises.Because, Malaysia residents would demand for US goods, reflecting increase in Malaysia income therefore demand USD.Supply USD = unchangedDemand USD = because Malaysia demand more US goods

GOVERNMENT CONTROLSCan influence equilibrium exchange rate in many ways, include:The imposition of foreign exchange barriersThe imposition of foreign exchange trade barriersThe imposition of capital flows/fundIntervening (buying & selling currencies) in the forex market, bank negaraAffecting macro variable such as inflation, interest rate, income level, etc.

Factors Affecting FOREX RatesEXPECTATIONSForex market always react to any news that may have future effect.Ex: news of a potential increase in US inflation rate may cause currency traders to sell US dollars, anticipating a future decline in the dollars value.This response places immediate downward pressure on the US dollars.

Mechanics of Foreign Exchange MarketFOREX market is an over-the-counter (OTC) market because trading does not take place in a central market place where buyers and sellers congregate.Besides, FOREX market is a worldwide linkage of bank currency traders, non bank dealers and FOREX market brokers.FOREX market is the largest financial market in the world by virtually any standard. It is open somewhere in the world 365 days a year, 24 hours a day follows the sun around the globe!FOREX Market ParticipantsPRICE/RATE QUOTATIONIn FOREX market, there are 2 types of price rate. Which are:Spot PriceForward Price

This quotes are for traders among dealers in the interbank market.PRICE/RATE QUOTATIONAmerican Terms:number of U. S. $ per unit of foreign currencyExample: SFr 1 = $0.8672

PRICE/RATE QUOTATIONEuropean Terms:number of foreign currency units per U. S. $Example: $1 = SFr 1.1531Verify: $1 / 1.1531 = $0.8672

PRICE/RATE QUOTATIONAmerican Terms:Number of U. S. $ per unit of foreign currencyExample:SFr1 = $0.8672 European Terms:Number of foreign currency units per U. S. $Ex: $1 = SFr 1.1531PRICE/RATE QUOTATIONDirect Quotation:home currency price of foreign currencyExample: (France) FF 3.3862 = 1 DM(Germany) DM 0.29531 = 1 FF

PRICE/RATE QUOTATIONIndirect Quotation:value of one unit of home currency in the foreign currencyExample: (England) 1 = $ 1.6698THE BID-ASK SPREADBUY / BID price = price that banks willing to buySELL / ASK price = price that banks willing to sellExample : RM 3.6510 - 15

Thus, Bid=RM3.6510 Ask=RM3.6515

BID PRICEASK PRICETHE BID-ASK SPREAD RM 3.6510 - 15

REMEMBER!!Banks will always buy low and sell highAsk price always higher than Bid priceBanks always sell/buy foreign currency

Big figure2 digits of decimal is called small figureTHE BID-ASK SPREADBanks make profit from the spread between the buying and selling price that is known as bid-ask spreadAlso known of % cost of transferring

Percent spread = Ask Price Bid price Ask PriceX 100 CROSS RATECOMMON CURRENCY IS ON THE ONE UNIT SIDECOMMON CURRENCY IS ON THE MANY UNITS SIDECOMMON CURRENCY IS ON BOTH SIDESFOREX MarketThere are two types of FOREX market:The spot market currencies are traded for immediate delivery, which within 2 business days after the transaction has been concluded.

Percentage Change = New spot rate old spot rate old spot rate

The forward market contracts are made to buy/sell foreign currencies for future deliveryx 100