UNITTHREE

FOREIGN EXCHANGE TRADING

Pre-text assignment

Special Terms

A. Match these terms with their definitions

Floating exchange rale, discount, Central Bank, hedging, foreign exchange, speculation, gold standard, forward transaction, fixed exchange rate, premium, ar­bitrage, spot transaction

a) money or currency of a foreign country.

b) a monetary system used in the nineteenth and partly twentieth centuries
whereby the value of currencies could, on request of the owner (holder) be converted
into gold at a country's central bank. As all currencies had a gold value, they also had
a certain value in relation to each other. This was the beginning of a foreign exchange
system.

c) a country's chief bank, which is government owned. It regulates the com­
mercial banks and holds gold and foreign currency reserves. It actively intervenes by
buying and selling its own currency in the foreign exchange markets so that the cur­
rency will keep a certain value.

d) a system whereby central banks are required by international agreements to
maintain their currency at a relatively fixed value. This is achieved by buying the cur­
rency when it reaches its low point and by selling when it reaches its high point.

e) a system in which currencies have no specific par value; value is normally
determined by supply and demand. Central banks are not required to intervene but
they often do to avoid wild fluctuations.

f) currency bought or sold today with delivery two business days later.

g) to buy or sell a currency in the future, with payment and delivery at the fu­
ture date.

h) to offset a "buy" contract with a "sell" contract and vice versa, matching the amounts and the time span exactly.

i) when dealers do not offset a "buy" contract with a "sell" contract. This means that their position is left open.

j) the additional amount it will cost to buy or sell a currency at a given future dale (relative to the spot or today's price),

k) the lesser amount it will cost to buy or sell a currency at a given future date (relative to the spot or today's price).

1) the transfer of funds from one currency to another to benefit from currency dif­ferentials or disparities in interest rates. In arbitrating, at least two markets are entered,

B. Vocabulary Practice 1. What is foreign exchange¹^

?.. Explain how the gold standard represented the beginning of a foreign ex­change s>stem.

3. Name three functions of a country's central bank. Who owns it?

4. Under •& floating exchange rate system, what normally determines the value
of currencies?

5. Under what circumstances is an exchange rate system fixed?

6. What is a spot transaction? When does delivery take place?

7. On a forward transaction, when is the payment made? When is the delivery
of funds made?

8. Define hedging.

9. What does premium mean? How is it determined? What is the opposite of
premium?

10. What is involved in arbitraging? How many markets are entered?

Foreign Exchange Trading

Without foreign exchange trading, international trade itself could not exist. In former times trade was based on bartering - goods were exchanged for other goods. The introduction of precious metals (i.e., gold and silver) to pay for goods can be considered the forerunner of the foreign exchange market.

The Creeks and Romans commonly used gold as a medium of exchange. Most world trade continued to be based on gold until the nineteenth century. By then in­dustrialization in Western Europe and the United States had boosted world trade to such an extent that gold reserves were no longer adequate to meet the requirements. Governments introduced a par value of their respective local currencies in gold. Thus, the currencies were related to one another through a system called the gold standard. The United States joined this system in 1879. The gold standard system determined the value of all currencies based on gold. This meant the values of different curren­cies could be compared in terms of one another.

The system worked well until World War 1 when trade was interrupted. After the war, currencies fluctuated widely in terms of gold and, thus, in relation to each other. The value of currencies was meant to be regulated by supply and demand (the market mechanism), but speculators often interfered with this mechanism. So in an effort to create more stable exchange markets, some countries, notably the United States, England and France, returned to the gold standard. Except for a brief period in the early 1930s, the United States stayed on the gold standard. By 1971 it was the only country whose currency remained converted into gold, and so, by declaring the dollar inconvertible, the gold standard was finally abolished. This meant that holders of United States dollars could no longer exchange their dollars for gold at par value.

In 1944 toward the end of World War II, the Western industrialized nations re­alized that foreign trade would be necessary to quickly and effectively heal the wounds of war. To create a calm and stable foreign exchange market, the United

States government called for a conference in the summer of 1944. It was held in Brctton Woods. New Hampshire. At this conference, both the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development were established.

The Bretton Woods Agreement stipulated that all member countries would ex­press the value of their currencies in gold. However, only the United States dollar was convertible into gold at the price of S35 an ounce.

Central banks of the member countries were required to intervene in the for­eign exchange markets to keep the value of their currencies within 1 percent of the par value. This intervention was achieved by actively buying or selling foreign ex­change or gold. A given currency could, therefore, never rise above nor fall below fixed points, which are called intervention points. These are the prices beyond which the central bank intervenes. This is called the system affixed exchange rales

The system of fixed exchange rates worked well until the late 1960s and early 1970s. At that time a number of countries devalued their currencies. This meant that their currencies were now worth less in terms of gold. England in 1967, France in 1969, and the United States in 1971 and 1973, devalued their currencies. This caused an almost unprecedented turbulence in the foreign exchange markets. In addition, countries such as West Germany and Holland revalued their currencies (increased the par value of their currencies in terms of gold). Intervention by central banks became very costly. Foreign currency and gold reserves were drained. Countries had to buy their own currency with gold and foreign exchange in order to keep its value above the minimum intervention point, as agreed at Bretton Woods.

It is not surprising, then, that the world saw a return to a floating exchange rate system. Central banks were no longer required to support their own currencies. Eng­land, France (only temporarily), Italy. Japan, and the United States all floated their currencies. Western Europe, united in the Common Market, moved to preserve the fixed-rate system but allowed a widening of the intervention points to within 2.25 percent of the par value of the currencies. This system became known as the snake since these currencies move up and down together against currencies outside the snake.

The foreign exchange market is the mechanism through which foreign curren­cies are traded. It is not an actual marketplace but a system of telephone, fax and e-mail communications between banks., customers, and middlemen (foreign exchange brokers, acting for a client, vis-a-vis the bank).

Most banks have a special foreign exchange trading department which consists of foreign exchange dealers and an administrative staff. Customers trade with banks, banks trade among themselves, and brokers often trade on behalf of banks or corpo­rations. Active participants in the foreign exchange market include tourists, investors, exporters and importers, and governments, whose central banks intervene in the mar­kets to minimize fluctuations in their currencies.

The market consists of spot and forward transactions. When an Italian father transfers money to his son in New York, a typical spot transaction occurs. The Italian

механізм; скасувати систему золотого стандарту, щоб захистити себе від коли­вань курсу валюти при продажу; вводити номінал конвертованої валюти, доро­гоцінні метали, перетворювати в золото, оголосити золото необіговим, засіб обміну, це викликано безпрецедентні хвилювання, відповідати вимогам, держа­ва втручається, для того щоб утримати валюту вище номінальної точки втру­чання, провісник валютного ринку, за винятком короткого періоду, стимулюва­ти торгівлю до такого рівня, валюта коливалася відносно одна одної, тому, на­магаючись створити більш стабільний ринок.

В. Find in the text and give the translation

To avoid fluctuations, currencies were related to one another, to introduce a par value, disparities in interest rates, currency differentials, to offset, intervention points, a system of fixed exchange rates, floating exchange rate system, forward rates can be quoted either outright or in terms of premium or discount, a bid is the price dealers will pay to acquire pounds, arbitrage is the practice of transferring, funds from one currency to another to benefit from rate differentials, parity of currencies, to interrupt trade, with deliveiy two business days later, to match the amounts and the time span exactly, at least two markets are entered, maturity of currencies, to reduce the risk of fluctuating exchange rates, a snake system, the late 1960s and the early 1970s, West­ern Europe moved to preserve the fixed-rate system, the government called for a con­ference, it was the only country, to heal the wounds of war, to express the value of the currency in gold.