AOF Business in a Global Economy
Lesson 7 Foreign Exchange and International Financial Markets
AOF Business in a Global Economy
Lesson 7
Foreign Exchange and International Financial Markets
Student Resources
Resource / DescriptionStudent Resource 7.1 / Worksheet: Currency Rates and Conversions
Student Resource 7.2 / Anticipation Guide: The Foreign Exchange Market
Student Resource 7.3 / Reading: The Foreign Exchange Market
Student Resource 7.4 / Note-Taking Organizer: Why Exchange Rates Fluctuate
Student Resource 7.5 / Reading: Currency Exchange Fluctuations
Student Resource 7.6 / Worksheet: Predicting Currency Exchange Fluctuations
Student Resource 7.7 / Worksheet: Minimizing Foreign Exchange Risk
Student Resource 7.1
Worksheet: Currency Rates and Conversions
Student Names:______Date:______
Directions: Before you begin, record the name of the currency exchange rate source you are using and today’s exchange rates. (Abbreviations for each currency are provided in parentheses.) Then work with a partner to calculate the exchange rates for these problems before answering the questions. Be ready to share your answers with the class.
Currency Exchange Rate Source:______Today’s Date:______
Cur
Currency / Japanese Yen(JPY) / British Pound
(GBP) / Indian Rupee
(SR) / Brazilian Real
(BRL) / S. African Rand
(ZAR)
Exchange Rate (1 USD = ?)
1. Sample Problem: I am going to visit my cousin in England this year. He said I should take at least 400 British Pounds worth of spending money. How many US dollars is that?
2. Our shipping company is buying an apartment in Brazil for visiting executives to stay in. It is unfurnished. The accountant is trying to figure out if it would be cheaper to buy the furnishings in the US and ship them to Brazil, or if it would be cheaper to buy them there. Shipping will total 10% of the cost of the items, if they are bought in the US. Using today’s exchange rate, calculate the costs of these items from US dollars (USD) to Brazilian real (BRL). Then, add the shipping costs and figure out which option will be more cost effective. The items you must buy and their costs in each country are:
- Couch USD Price 1,000 BRL Price 4,200
- Bed USD Price 2,200 BRL Price 4,000
- Refrigerator USD Price 1,250 BRL Price 3,050
- Bedding USD Price 100 BRL Price 25
- Washer and dryer USD Price 950 BRL Price 2,200
Do your calculations on a separate sheet of paper and write your recommendation here:
3. You have been assigned to visit some clients in a few different countries for 10 days. Your boss would like an expense report in US dollars when you return. Calculate the cost of your meals and hotels for the expense report for your boss and the total cost of the trip.
Cape Town, S. Africa: days 1–3 / Bangalore, India: days 4–7 / Leeds, England: days 8–10Hotel Costs: 942 Rand (ZAR) / Hotel Costs: 750 Rupees (SR) / Hotel Costs: 984 Pounds (GBP)
Meal Costs: 431 Rand / Meal Costs: 194 Rupees / Meal Costs: 329 Pounds
Total Spent: / Total Spent: / Total Spent:
US Dollar Conversion: / US Dollar Conversion: / US Dollar Conversion:
Total spent on the trip in US dollars:
4. Your firm has asked you to research a new supplier for its raw materials of rubber, copper, and wood. Calculate the cost of the materials and recommend the country it would be most cost-effective to get each from.
rubber / India: 3 SR/kilo / S. Africa: 12 ZAR/kilo / Brazil: 12 BRL/kilocost in USD
copper / Japan: 42 JPY/troy ounce / India: 22 SR/troy ounce / Brazil: 14 BRL/troy ounce
cost in USD
wood / England: 655 GBP/cord / Brazil: 389 BRL/cord / S. Africa: 545 ZAR/cord
cost in USD
From which country should your firm get each raw material, based on the cost of buying it in the country it comes from?
Can you think of any other costs that should also be taken into account, and that might influence which country you advise your firm to choose?
Student Resource 7.2
Anticipation Guide: The Foreign Exchange Market
Student Name:______Date:______
Directions: For each of the statements below, underline “I agree” if you think the statement is accurate or “I disagree” if you disagree with it. Write one reason to explain your guess. After you read Student Resource 7.3, Reading: The Foreign Exchange Market, check your answers, correct them if necessary, and fill in the “I learned” section for each statement.
The foreign exchange market never closes.My guess: / I agree I disagree
My reason:
I learned:
Travelers who need foreign money make up the majority of currency exchanges.
My guess: / I agree I disagree
My reason:
I learned:
Banks lose money because of currency exchanges.
My guess: / I agree I disagree
My reason:
I learned:
The emotions of FX traders actually impact exchange rates.
My guess: / I agree I disagree
My reason:
I learned:
Student Resource 7.3
Reading: The Foreign Exchange Market
What is the Foreign Exchange Market?
When businesses, individuals, or governments need money (currency) to buy foreign goods or services or invest in another country, they must usually exchange their home currency for the foreign one to make the transaction. These transactions occur on the foreign exchange market, which is also called the Forex, or FX, market. It is the largest market in the world. Over 1.2 trillion dollars are traded daily on FX, and it is the only market that is open 24 hours per day. FX is a worldwide network of traders who connect with each other and trade over the phone and the Internet. Because FX trading does not have a central location, trades occur all over the globe; the difference in time zones allows trading to occur all day and night, though most trading occurs in New York, London, England, and Tokyo, Japan.
Who Trades on the FX Market?
There are four main types of traders in the FX market.
· Banks are responsible for about 2/3 of the market trading volume. They buy and sell currency to and from each other to make profits. Banks trade currency with each other at special, unpublished rates.
· Brokers are dealers who represent the banks on the FX market for some of their FX trading, finding the best exchange rates on behalf of the banks. Brokers allow banks to remain anonymous in their currency trading. They earn money by charging commissions on their transactions.
· Customers of FX mostly consist of large companies who need foreign currency to make purchases or investments. Other customers are individuals or smaller firms who require foreign currency for travel or purchases.
· Central banks (for example, the US Federal Reserve, the European Central Bank, and the Bank of England) sometimes participate in the FX market to influence the value of the currency they are responsible for. Central banks in some countries (notably China) buy or sell currency, or issue new currency to keep their currency’s exchange rate near a target rate they have set.
Why do they trade?
There are three main reasons traders exchange currency on the FX market. The first is to earn short-term profits from fluctuations in exchange rates. Investors, both big and small, can make profits because of exchange rate fluctuations, and banks and large international corporations hire currency managers to buy and sell currencies every day. The second reason is that firms must have the correct currency to buy the goods and services needed for their operations all over the world. The third reason for FX trading is for protection from losses due to currency fluctuations. Firms dealing with large amounts of money can gain, but also lose, from even the smallest fluctuations in currency exchange rates.
Why do exchange rates fluctuate?
Exchange rates fluctuate for three main reasons. The first is economic factors, including a country’s interest rates, its inflation rate, and the supply of and demand for its currency. The second reason exchange rates fluctuate is because of political conditions; generally, the more stable a country’s politics, the less widely its currency fluctuates. Finally, market psychology causes exchange rate fluctuations. Market psychology is the general “feeling” of the market. If there is fear or excitement about a currency, its price will be affected. Anyone making currency trades must be aware of these three factors to minimize their trading risk.
Student Resource 7.4
Note-Taking Organizer: Why Exchange Rates Fluctuate
Student Name:______Date:______
Directions: Fill in this table with the information you learn from the presentation.
The Foreign Exchange Market (FX) is where:The value of a currency is determined by the law of:
/ A fixed rate is: / One benefit of a fixed rate is:
A floating rate is: / One benefit of a floating rate is:
Three factors affect the value of a currency.
1.
2.
3. / P______Influences / include:
E______Policy and
Conditions / include:
Market ______ / is a phenomenon when ______
rates / are influenced by:
Governments manage currency in different ways. One is: / A strong currency is: / and is exhibited by:
A weak currency is: / and is exhibited by:
Student Resource 7.5
Reading: Currency Exchange Fluctuations
The foreign exchange (FX) market is where traders, banks, corporations, and governments exchange currency, that is buy or sell one country’s currency for another. This international trade in currency goes on around the world, 24 hours a day, with the three main centers for FX trading located in the United States, Japan, and the United Kingdom.
But how do those who trade in the FX market know how many dollars there are in a euro? Or yen in a rupee? Let’s look at the factors that determine currency exchange rates and cause them to fluctuate.
Currency, just like any other product for sale, follows the laws of supply and demand. Its price is its exchange rate. If many people want a certain currency and there’s not much available, that excess of demand over supply will cause that currency’s price to rise. On the other hand, if there’s too much of a particular currency available, compared to the demand for it, that currency’s price will fall.
The exchange rate of a country’s currency can either be floating or fixed. The value of a currency with a floating rate is determined by the market. On the other hand, if a currency is fixed, its value is “pegged” to another currency, group of currencies, or other measure of value, like gold. The central banks of countries with fixed exchange rates must buy and sell their own currency to maintain the fixed exchange rate.
Some governments choose fixed exchange rates to help control inflation or stabilize their currencies. But fixed exchange rates may fail to reflect the true value of a currency, since they do not adjust according to market forces. If a fixed exchange rate is too different from what is consistent with market supply and demand for the currency, the result can be a financial crisis that forces a change in the fixed exchange rate. Therefore, most countries choose to let the exchange rate of their currency vary according to supply and demand in the market; that is, they have a floating exchange rate.
There are a few currencies that traders in the currency market tend to prefer over others. But why? What exactly are they looking for? Let’s compare two countries. One has a stable government and political environment. Its economy is steadily growing, and it exports a variety of products to other foreign markets. The second country is in turmoil, perhaps undergoing a civil war, with an economy that has little to offer in the way of trade. In these cases, the first country’s currency would generally be more highly valued. People, companies, and other countries will want to do business with that country and therefore will desire its currency.
Political events can greatly affect a currency’s exchange rate. For instance, when a new government comes into power, it brings up a variety of questions. Will the new government maintain the current economic policies? Will its economic policies be better or worse? Will there be internal or regional political upheaval and fighting, or is the political landscape calm and stable? Traders consider how national and international politics affect what a currency is worth.
The economic policies of a country (which are decided by governments), and the condition of its economy, affect the value of its currency in the foreign exchange market. Central banks such as the US Federal Reserve have substantial control over interest rates, which determine the cost of borrowing money.
Whether a country’s gross domestic product is increasing or decreasing also impacts the value of its currency. Countries with growing industries see a rise in employment rates and prosperity for the nation. When a country’s prosperity rises, its currency tends to appreciate in value.
Economic conditions also influence exchange rates in other ways. One major factor influencing the value of a currency is inflation. When a country has high inflation, people from other countries may desire its currency less. When there’s inflation, what you can buy with a unit of a currency—its purchasing power—goes down. For example, a pack of gum that may have once cost $1 now costs $2 because of inflation. Thus, inflation in a country will cause the value of its currency to depreciate in relation to other countries’ money.
Like any other human endeavor, the foreign exchange market is influenced by the perceptions and emotions of the people involved. This is called market psychology. Investing in currency is in one way just like making other investments in that it involves risk. Currencies in developing countries with expanding economies are risky investments. They offer FX traders new opportunities, but these currencies often come from less economically and politically stable countries.