La Salle University

Ozamiz City
Bachelor of Science Business Administration Major in Accountancy
College of Business and Accountancy

FOREIGN EXCHANGE MARKET

Submitted by:

Desucatan, Ray Mart A.

Francisco, Christian P.
Godinez, Marian E.
Gonzaga, David Sabiston H.
Lledo, Rhea Doun Desserie B.
Repuela, Britney Love P.
Sarausa, Joy J.

Submitted to:

Ms. Aprilyn Alisna, CPA

EXPECTED LEARNING OUTCOMES

1. Understand what factors significantly influence the currency exchange rates of a country
2. Describe how foreign exchange market provides the mechanism for the transfer purchasing
power from one currency to another
3. Understand what exchange rate is
4. Distinguish between spot transactions and forward transactions
5. Distinguish between spot exchange rate and forward exchange rate
6. Understand what direct and indirect quotes are
7. Explain what cross rate is
8. Discuss what arbitrage is
9. Know the significance of foreign exchange risks
10. Understand how exchange rate risk in Foreign currency market can be avoided

Most countries in the world have different currencies;

COUNTRY CURRENCY

United States Dollar

France Euro

Brazil Real

India Rupee

Philippines Peso

FOREIGN EXCHANGE

Foreign exchange or forex is the exchange of money from one currency to another. It is the
buying and selling of money in foreign currencies.

FOREIGN EXCHANGE MARKET

 • A marketplace in which currencies are bought and sold purely to make profit via
speculation.
• It is a market where currencies are traded. It is the world’s largest financial market where
trillions are traded daily.
• Forex market is open 24 hours, 5 days a week.

RECENT HISTORICAL PERSPECTIVE OF EXCHANGE RATE

 End of World War – Early 70’s

 Fixed Exchange Rate System

- A system used by a government or central bank that links the official
exchange rate of a nation to the value of gold of another country’s
currency.
- Administered by International Monetary Fund (IMF)
- All countries were required to set a specific parity rate for their currency
vis-a-vis the United States dollar.
 1973 onwards
 Floating Rate International Currency System
- A system in which the forex market controls a country’s currency rate
based on supply and demand in relation to other currencies.

IMPORTANCE OF FOREX MARKET IN THE TRANSFER OF PURCHASING

POWER

 These markets allow firms making transaction in foreign currencies to convert the
currencies or deposits they have into the currencies or deposits they want.
 Because the market provides transactions in a continuous manner for a very large volume
of sales and purchase, the currencies are efficiently priced or the market is efficient.

EXCHANGE RATE

 the price of one’s country’s currency expressed in terms of another country’s currency.

Reference Exchange Rate Bulletin (October 19, 2022)

WHY ARE EXCHANGE RATES IMPORTANT?

It serves as the primary link between domestic and international markets for a wide range of
commodities, services, and financial assets. Using the exchange rate, we may compare the prices
of items, services, and assets offered in other currencies.

FACTORS INFLUENCING EXCHANGE RATES

1. Inflation. Inflation tends to deflate the value of a currency because holding the currency
results in reduced purchasing power.

2. Interest rates. If interest returns in a particular country are higher relative to other
countries, individuals and companies will be enticed to invest in that country. As a result,
there will be an increased demand for the country's currency.

3. Balance of payments. Balance of payments is used to refer to a system of accounts that

catalogs the flow of goods between the residents of two countries. For instance, if
Philippines is a net exporter of goods and therefore has a surplus balance of trade,
countries purchasing the goods must use the country's currency. This increases the
demand for the currency and its relative value.
 4. Government intervention. Through intervention (e.g., buying or selling the currency in
the foreign exchange markets), the central bank of a country may support or depress the
value of its currency.

5. Other factors. Other factors that may affect exchange rates are political and economic
stability, extended stock market rallies and significant declines in the demand for major
exports.

INTERACTION IN FOREIGN CURRENCY MARKETS

Exchange Rate Determination

Equilibrium exchange rate in floating markets are determined by the supply of and demand for
the currencies.

Fixed Exchange Rate

The value of the exchange rate is fixed to another currency. This means that the government
have to intervene in the foreign exchange market to maintain the fixed

Managed Float
Also known as “dirty float”, this is a system of floating exchange rates with central bank
intervention to reduce currency fluctuations.

WHAT ARE THE FOREIGN CURRENCY EXCHANGE RATE TRANSACTIONS ?

The two kinds of Foreign Exchange Rate Transactions are:

A. Spot Transactions
B. Forward Transactions

Spot Transactions

• Spot transactions or spot trades involve securities traded for immediate delivery in the
market on a specified date.
• The spot date is the transaction settles as opposed to the day the trade is executed.

Forward Transactions

• Forward transactions involve the exchange of bank deposits at some specified future date.
• Two people or other entities engage in a binding agreement to perform a trade in the
future, rather than at the present.
• Consists in buying or selling an asset for any different from the spot date.

SPOT EXCHANGE RATES

• It is the current exchange rate between two currencies.

• It is the price to be paid today for immediate settlement in an exchange of two currencies.
• The exchange rate at which the transaction is done is called spot exchange rate.

FORWARD EXCHANGE RATES

• The exchange rate at which the currency for future delivery is quoted.
• It deals with a future time, the expectations regarding the future value of that currency are
reflected in that forward rate.
• Forward rates may be greater than the current spot rate (premium) or less than the current
spot rate (discount).

ILLUSTRATIVE CASE
Illustrative case studies and reference to real-life business examples are used to bring the
technical information to life.

DIRECT QUOTES

Direct quotation is where the cost of one unit of foreign currency is given in units of local
currency.

INDIRECT QOUTES

Indirect quotation is where the cost of one unit of local currency is given in units of foreign
currency.

1
Indirect Quote¿
Direct Quote

Thus,

1
U S dollars= =0.0169 (dollar/P1)
58.9300
1
U K pounds= =0.0149 (pound/P1)
66.7559
1
EUeuros= =0.0172 (euro/P1)
58.1028

CROSS RATES

Indirect computation of the exchange rate of two currencies their exchange rate of a third
currency.

For example, we can infer the pound/euro exchange rate from the peso/pound and euro/pound
exchange rate.
P63.9424=€1
P58.1028=€1
P63.9424/P58.1028 = 1.1005 euro per 1 pound
Thus, the pound/euro exchange rate is:
P58.1028/P63.9424 = 0.908867 pound per 1 euro
ARBITRAGE

• is a trading that exploit the tiny differences in price between identical assets in two or
more markets.
• The arbitrage trader buys the asset in one market and sells it in the other market at the
same time in order to pocket the difference between the two prices.

FACTORS THAT AFFECT EXCHANGE RATES IN THE LONG RUN

Relative Price Levels

In the long run, a rise in a country's price level (relative to the foreign price level) causes its
currency to depreciate, and a fall in the country's relative price level causes its currency to
appreciate.

Trade Barriers
Increasing trade barriers causes a country's currency to appreciate in the long
run.
Preferences for Domestic Versus Foreign Goods
Increased demand for a country's exports causes its currency to appreciate in the long run;
conversely, increased demand for imports causes the domestic currency to depreciate.

Productivity
In the long run, as a country becomes more productive relative to other countries, its currency
appreciates.

EXCHANGE RATES IN THE SHORT RUN

• Recognize that an exchange rate is the price of domestic bank deposits (those dominated
in the domestic currency) in terms of foreign bank deposits (those dominated in the
foreign currency).
• Earlier approaches to exchange rate determination emphasized the role of import and
export demand.

MANAGING FOREIGN EXCHANGE RISK

Foreign Exchange risk

• refers to the possibility of a drop in revenue or an increase in cost in an international
transaction due to change in foreign exchange rates
• Importers, exporters, investors, and multinational firms are all exposed to “foreign
exchange risk”

To deal with this foreign currency exposure effectively, the financial manager must understand
foreign exchange rates and how they are determined.
Foreign exchange rates are influenced by differences in inflation rates among countries in
interest rates, government policies and the expectations of the participants in the foreign
exchange markets.

AVOIDANCE OF EXCHANGE RATE RISK IN FOREIGN CURRENCY MARKETS

The international financial manager can reduce the firm's foreign currency exposure by hedging
in the forward exchange markets, money markets and currency future markets.

1. The firm may hedge its risk by purchasing or selling forward exchange contracts. A firm
may buy or sell forward contracts to cover liabilities or receivables, respectively,
denominated in a foreign currency. Any gain or loss on the foreign payables or
receivables because of changes in exchange rates is offset by the loss or gain on the
forward contract.

2. The firm may choose to minimize receivables and liabilities denominated in foreign
currencies.
3. Maintaining a monetary balance between receivables and payables denominated in a
particular foreign currency avoids a net receivable or net liability position in that
currency. Monetary items are those with fixed cash flows. A firm may attempt to achieve
a net monetary debtor (creditor) position in countries with currencies expected to
depreciate (appreciate). Large multinational corporations have established multinational
netting centers as special departments to attempt to achieve balance between foreign
receivables and payables. They also enter into foreign currency futures contracts when
necessary to achieve balance.

4. Another means of managing exchange rate risk is by the use of trigger pricing. Under
trigger pricing, foreign funds are supplied at an indexed price but with an option to
convert to a future-based fixed price when a specified basis differential exists between
the two prices.
5. A firm may seek to minimize its exchange-rate risk by diversification. If it has
transactions in both strong and weak currencies, the effects of changes in rates may he
offsetting.
6. A speculative forward contract does not hedge any exposure to foreign currency
fluctuations, it creates the exposure.