Chapter 8 ● It provides a lot of services to individuals,

Foreign Exchange Market businesses, governments, and the country

The foreign exchange market is an over-the- as a whole.
counter (OTC) global marketplace that determines ● It is not only a place where foreign
the exchange rate for currencies around the world. It currencies are bought or sold but also
is also known to be the largest financial market in another venue for investment.
the world. Participants in these markets can buy,
sell, exchange, and speculate on the relative FUNCTIONS OF THE FOREIGN EXCHANGE MARKET
exchange rates of various currency pairs. 1. Transfer of purchasing power
2. A source of credit
FOREIGN EXCHANGE 3. Used for hedging
Foreign exchange, also known as Forex or EX, is
the conversion of one currency into another at a Advantages of the Foreign Exchange Market
specific rate known as the foreign exchange rate. 1. It brings in the liquidity of money and
enables huge volumes of trade to
ROLE OF FINANCIAL INSTITUTIONS IN FOREIGN happen which provides ample source pf
EXCHANGE TRANSACTIONS employment profits for various
● The main traders of Forex are central banks, businesses.
commercial banks, importers and exporters, 2. It is so huge that no single entity can
hedge funds, business travelers and impact and there is a seamless flow of
tourists, and individual speculators. information that makes the currency
● In the Philippines, BSP is the central bank. markets highly efficient.
Its principal role in the foreign exchange 3. It is necessary to make foreign
investments as it allows the currency to
market is to ensure orderly conditions in
be converted into local currency for
the market.
investment in the business of the
● Peso-dollar trading between the member-
country in question.
banks of the Bankers Association of the
4. It enables the different currencies to be
Philippines (BAP) and BSP is done through priced about other currencies and a
the Philippine Dealing System (PDS) usually stronger currency is
● Most of the BAP-member banks that characterized by strengthening the
engage in peso-dollar trading use an economy.
electronic platform called the Philippine 5. It enables multinational corporations that
Dealing & Exchange Corporation (PDEx) engage in cross- border transactions to
which is a SEC-registered fixed-income hedge the risk of their future receipts
securities market. and payments denominated in foreign
currencies.
CURRENCY CODES
● Every currency is given a three-letter code Disadvantages of the foreign exchange
assigned by the International Standards markets
Organization (ISO). The table below
presents some of the currencies known 1. They can be controlled by the respective
globally. governments.
2. They increase various risks, out of
WHAT IS FOREIGN EXCHANGE MARKET? which the most prominent is
● It is decentralized. counterparty risk as the currency market
is international and the failure of one
● It is most probably the most active market.
 counterparty can impact a whole lot of Foreign exchange market: Global
other counterparties. industry trends, share, size, growth,
3. Due to the sheer size of currency opportunity, and forecast 2021- 2026
markets, they are largely unregulated
despite any number of measures being The global foreign exchange market is
taken but the local government of each expected to grown at a CAGR of 75%
country. during 2021- 2026.
4. They conduct high- leverage trades. Big Transactions in the foreign Exchange
institutions and hedge funds bet heavily Market
in these markets which make them
prone to failure and closure in case their Swaps transactions.
bets go wrong. It is an agreement between two parties
to exchange specified periodic cash
Foreign exchange markets participants flows in the future.
• Bank and non- bank foreign exchange
Direct and Indirect Quotations
dealers.
A direct quote, which is also known as a
• Foreign exchange brokers.
“ price quotation”, is one that expresses
• Individuals and firms conducting
how much domestic currency is needed
personal, commercial and investment
to buy a unit of foreign currency.
transactions.
• Speculators and arbitragers.
Base and Variable Currencies
Central banks and treasuries
In quoting the exchange rate between
two currencies, it is a must to keep the
Analyzing trends in the Foreign
number of units of one currency fixed
exchange markets
while making changes in the other to
1. Fundamental Analysis.
reflect the change.
2. Technical Analysis.

CROSS RATE
Global Foreign exchange market Trends
The table below show a how much US
dollars to buy 1 Philippine peso (indirect
• The global foreign exchange market is
quote) or how much Philippine peso to
driven by urbanization, changing
buy one US dollar (direct quote). In the
lifestyles, rising incomes, and increased
same way, it shows how much US
global tourism.
dollars are ended to buy one British
• The forex market offers high liquidity,
pound (indirect quote) or how much
transactional transparency, 24/7 trading,
British pound is needed to buy one US
and vast trading volume, attracting
dollar.
international traders.
• Digitization and technological
BID and ASK Quotes
advancements are contributing to
The price a foreign exchange trader is
market growth, offering convenient
willing to sell a currency pair is called
internet- based platforms for secure and
the bid price. While the price the forex
efficient currency exchange.
exchange trader will buy a currency pair
• companies are investing in developing
at is called the asking price. Both the bid
the overall market.
and ask prices are provided in real-time
and are constantly changing depending
on the demand and supply of the
currency pair.
APPRECIATION AND DEPRECIATION
When the value of one currency
increases, it is said that it has
appreciated.

RATES OF RETURN
The formula that is introduced will
determine the rate at which the dealer
gains in trading. Using a USD-PHP
quote rate, let S0 be the exchange rate
for US dollars in terms of the Philippine
peso as quoted in Manila. The rate of
return for a Filipino trader who buys
dollars is using the quotation:

Rd=(S1-S0) / S0

PURCHASING POWER PARITY

-sometimes referred to as the law of one
price. It is a theory starting that the
exchange rates between two
o=countries are in equilibrium when their
purchasing power is the same.
The formula for purchasing power parity
is shown as
Ph=P1(spot rate)
Where: Ph= price of the goods or
service in the country
Pf= price of the good in the
foreign country

Interest Rate Parity

The interest rate parity implies that the

interest rate returns on fixed income
securities would be the same in all
countries after adjusting for risk. This
interest rte parity primarily describes the
relationships that link spot exchange
rates, interest rates and forward
exchange rates.

Formula:
Forward exchange rate=(1+rh)
Spot exchange rate (1+rf )