Foreign Exchange Markets

An American company that imports goods from Switzerland may need to exchange its dollars for Swiss francs in order to pay for its purchases. An American company exporting to Switzerland may receive Swiss francs, which it sells in exchange for dollars. Both firms must make use of the foreign exchange market, where currencies are traded.

The foreign exchange market has no central marketplace. All business is conducted by computer and telephone. The principal dealers are the large commercial banks, and

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any corporation that wants to buy or sell currency usually does so through a commercial bank.

Turnover in the foreign exchange markets is huge. In London alone about $640 billion of currency changes hands each day. That is equivalent to an annual turnover of $159 trillion ($159,000,000,000,000). New York and Tokyo together account for a further $500 billion of turnover per day. Compare this to trading volume of the New York Stock Exchange, where no more than $30 billion of stock might change hands on a typical day.

Suppose you ask someone the price of bread. He may tell you that you can buy two loaves for a dollar, or he may say that one loaf costs 50 cents. Similarly, if you ask a foreign exchange dealer to quote you a price for Ruritanian francs, she may tell you that you can buy two francs for a dollar or that one franc costs $.50. The first quote (the exchange rate number of francs that you can buy for a dollar) is known as an indirect quote of the ex-

Amount of one currency change rate. The second quote (the number of dollars that it costs to buy one franc) is needed to purchase one unit known as a direct quote. Of course, both quotes provide the same information. If you of another. can buy two francs for a dollar, then you can easily calculate that the cost of one franc is 1/2.0 = $.50.

Now look at Table 23.1, which has been adapted from the daily table of exchange rates in the London Financial Times. The first column of figures in the table shows the exchange rate for a number of countries on October 6, 1999. By custom, the prices of most currencies are expressed as indirect quotes. Thus you can see that you could buy 9.438 Mexican pesos for one dollar. However, to make things confusing, the price of the euro and the British pound are generally expressed as direct quotes. So Table 23.1 shows that it cost $1.0707 to buy one euro (€1).

table 23.1

Currency exchange rates on October 6, 1999

Forward Rate

Spot Rate

3 Months

1 Year

Europe

EMU (euro)

1.0707

1.0785

1.0979

Greece (drachma)

306.675

307.75

314.125

Sweden (krona)

8.1400

8.0875

7.988

Switzerland (franc)

1.4865

1.471

1.4331

U.K. (pound)

1.6566

1.6573

1.6535

Americas

Canada

1.4703

1.4662

1.4594

Mexico

9.4380

9.853

11.153

Asia/Pacific

Australia (dollar)

1.5148

1.5139

1.5133

Hong Kong (dollar)

7.7681

7.7687

7.896

Indonesia (rupiah)

7800.00

7952.5

8487.5

Japan (yen)

107.520

105.865

101.3

Singapore (dollar)

1.6790

1.665

1.6358

Note: Rates show the number of units of foreign currency per dollar (indirect quotes), except for the euro and the U.K. pound, which show the number of dollars per unit of foreign currency (direct quotes). Source: From Financial Times, October 7, 1999. Used by permission of Financial Times.

Note: Rates show the number of units of foreign currency per dollar (indirect quotes), except for the euro and the U.K. pound, which show the number of dollars per unit of foreign currency (direct quotes). Source: From Financial Times, October 7, 1999. Used by permission of Financial Times.

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