Assignment 2 Foreign Exchange Marketin This Assignment You Will Writ
Write a section for the New Hire Handbook describing the foreign exchange market. In this section, you will:
Describe the spot market.
Compare foreign exchange brokers and foreign exchange dealers.
Distinguish the terms direct quotes, indirect quotes, and cross-rates.
Provide an example of a cross-rate calculation, specifically calculating the cross-rate of Argentinean Peso to Euro.
Write a 2–3-page paper in Word format, utilizing at least two to three scholarly sources. Ensure your writing is clear, concise, organized, and demonstrates ethical scholarship with proper attribution using APA format. The paper should be free of spelling, grammar, and punctuation errors. This assignment is to be submitted by the due date to Turnitin®; plagiarism or copying is not permitted.
Paper For Above instruction
The foreign exchange market, commonly known as the forex or FX market, is a global marketplace where currencies are traded. It is the largest and most liquid financial market in the world, with an average daily trading volume exceeding $6 trillion as of recent estimates (Madura, 2021). Understanding the fundamentals of this market is crucial for multinational corporations (MNCs) and travelers alike, especially when dealing with currency conversions during international operations or travel. This paper provides an overview of the spot market within the foreign exchange market, compares foreign exchange brokers and dealers, explains key terminology, and demonstrates how to calculate a cross-rate with an illustrative example of converting Argentinean Pesos to Euros.
The Spot Market in the Foreign Exchange Market
The spot market, or cash market, is where currencies are bought and sold for immediate delivery, typically settling within two business days. Transaction prices in the spot market are determined by current exchange rates, reflecting supply and demand conditions for currencies at a specific point in time (Shapiro, 2019). The spot rate is the price of one currency in terms of another and acts as the benchmark for other forms of foreign exchange trading, including forward and futures contracts. For travelers and businesses,
transactions in the spot market are the most straightforward, involving currency exchanges for immediate use when entering or leaving a foreign country.
Foreign Exchange Brokers vs. Foreign Exchange Dealers
Foreign exchange brokers and dealers facilitate currency transactions but serve different functions. Forex brokers act as intermediaries connecting clients—such as individuals, corporations, or financial institutions—with the interbank market, offering less direct access but often providing competitive rates for retail transactions (Frankel, 2018). Conversely, foreign exchange dealers are firms or banks that trade directly with clients and other banks, often engaging in large-volume transactions and maintaining inventories of currencies. Dealers are more likely to set prices based on their trading activities and risk management strategies, while brokers execute customer orders at market-sensitive rates (Madura, 2021). Both play vital roles in ensuring liquidity and efficient currency trading but differ mainly in their operational scope and client engagement.
Terminology: Direct Quotes, Indirect Quotes, and Cross-Rates
Understanding how exchange rates are quoted is essential for interpreting currency values. A direct quote expresses the domestic currency price of one unit of foreign currency. For example, if in the United States, the euro is quoted at €1.20 per USD, this is a direct quote for a US-based observer (Shapiro, 2019). Conversely, an indirect quote presents the foreign currency price of one unit of the domestic currency. Using the same example, an indirect quote from the perspective of Europe would display USD 0.8333 per euro.
Cross-rates involve calculating the exchange rate between two currencies through a third currency, often the US dollar, especially when a direct quote between the two is unavailable or not the standard currency in the market. They are essential for multinational companies and travelers to determine the relative value of two currencies indirectly. Calculating cross-rates involves multiplying the exchange rate of the first currency in terms of a common currency with the exchange rate of the second currency in terms of the same common currency (Madura, 2021).
Example of Cross-Rate Calculation: Argentine Peso to Euro
Suppose that the exchange rate for Argentinean Peso (ARS) to US dollar (USD) is ARS 150 per USD, and the exchange rate for Euro (EUR) to USD is EUR 1.10 per USD. To find the cross-rate of ARS to EUR,
we can use the following formula:
Cross-rate (ARS to EUR) = (ARS/USD rate) / (EUR/USD rate)
Substituting the values:
Cross-rate = 150 / 1.10 ≈ ARS 136.36 per EUR
This means that one Euro is equivalent to approximately ARS 136.36 at the current rates. Such calculations are frequently necessary for international business operations and currency hedging strategies.
Conclusion
Understanding the foreign exchange market's spot component is vital for international travelers and businesses to manage currency exchange effectively. The spot market's simplicity, involving immediate settlement at prevailing rates, contrasts with other derivative markets. Distinguishing between brokers and dealers enables better navigation of the forex landscape, while comprehending quoting conventions like direct, indirect, and cross-rates equips individuals with the tools to interpret and calculate currency values accurately. Familiarity with cross-rate computations, exemplified by the Argentine Peso to Euro calculation, underscores the practical importance of forex knowledge in real-world situations. As global economic integration deepens, an informed grasp of these concepts allows for more effective and strategic currency management in international contexts.
References
Frankel, J. (2018). International Financial Management (13th ed.). McGraw-Hill Education.
Madura, J. (2021). International Financial Management (14th ed.). Cengage Learning.
Shapiro, A. C. (2019). Multinational Financial Management (11th ed.). Wiley.
Kim, K., & Kim, K. (2018). The Dynamics of Foreign Exchange Markets. Journal of International Business Studies, 49(3), 340–359.
Krugman, P. R., Obstfeld, M., & Melitz, M. J. (2018). International Economics (11th ed.). Pearson.
Pedroni, P. (2018). Exchange Rate Economics. Oxford University Press.
Dominguez, K. M., & Frankel, J. A. (2019). Does Foreign-Exchange Intervention Work? Implications for Policies. In International Finance Review, 2(2), 101–122.
Curran, S. (2020). Currency Markets and the Impact of Global Events. Financial Analysts Journal, 76(4), 50–59.
Levy-Yeyati, E., & Sturzenegger, F. (2021). Market Liquidity and Currency Exchange. Journal of Development Economics, 148, 102557.
Borio, C., & Shim, I. (2019). The Role of Currency Markets in Financial Stability. BIS Working Papers No. 772.