Fixed exchange rate vs flexible exchange rates Wholesale (Interbank ...
Fixed exchange rate vs flexible exchange rates 1. A nation’s choice as to which currency regime to follow reflects national priorities about all facets of the economy, including inflation, unemployment, interest rate levels, trade balances and economic growth. 2. Fixed exchange rates regime provides a. Stable price for international trade, lessen risks for all businesses and aid in the growth of international trade. b. Anti-inflation, restrict monetary and fiscal policies. c. Requires the nation to hold large amount of international reserve as a defence. It can be a burden. d. Less flexible than floated exchange rate, thus may not represent the economic fundamental. 3. Absolutely clean float is unrealistic. 4. A floating exchange rate does not mean that the exchange rate is largely determined by the market. It just means, the reserve bank will intervene periodically to make sure the exchange rate is at a reasonable level. 5. Government intervention in the FX market context refer to government mobilise its Foreign reserve in the FX market to buy/sell to change money supply and money demand. Under free floating, this sort of government intervention is minimal, the government’s aim is the exchange rate to fluctuate mainly with market responses to government policy, generally monetary policies and fiscal policies.
Australian’s floating rate system 1. Market force to determine the value of the currency. 2. The adoption of a floating exchange rate regime, however, did not mean that the RBA had become indifferent to either the level of, or movement in , the exchange rate, since thee can have a powerful influence on important aspects of the economy, particular economic growth and inflation. As such, the RBA has from time to time intervened in the foreign exchange market. 3. The way RBA intervene is through affecting the AUS$’s demand and supply by buying and selling Australian dollars against another currency, almost always the US dollar. 4. Questions: 1. Why will the exchange rate be connected to the economy fundamental? Of course, think of the demand and supply of a foreign currency. Say, if a company’s economy now largely increases the amount of exports, thus there will be more supply of domestic currency (i.e. the demand of the foreign currency)), the exchange rate will then change. 2. Why it will restrict the nation’s monetary and fiscal policy?
Wholesale (Interbank) foreign exchange market 1. Banks constantly quote a bid and ask price based on anticipated currency movements taking place and thereby make the market.
2. The interbank market is unregulated and decentralized. There is no specific location or exchange where these currency transactions take place. 3. Central Bank also play a role in setting currency exchange rates by altering interest rates. By increasing interest rates they stimulate traders to buy their currency as it provides a high return on investment and this drives the value of the corresponding central bank's currency higher with comparison to other currencies.
Wholesale market vs the retail market 1. Different from the retail market, the price is not determined by the counterparty (i.e., the other party against the banks). The counterparty does not reveal whether they wish or buy or sell until they have been given a two-way quote.). Thus, it is always the banks who quote the bid and ask price. a. The bid price is the bank’s purchasing price, which is the customer’s selling price. b. The ask price is the bank’s selling price, which is the customer’s purchasing price. 2. In both wholesale market and retail markets, the bank’s profit is determined by the bid-ask spread. 3. Retail market: individual speculates on the exchange rate between different currencies. 4. Wholesales market does not involve end-client. 5. Retail market has a. lower turnover of currency, b. Hold currency as inventory for trading purposes. c. The lower is the turnover, the greater is the risk that the dealer can exchange its “inventory” at a lower price back to its currency. 6. In the case of inconvertible currency a. Think of inconvertible currency as a commodity, it is usually just one-way transaction. (i.e. you can buy it from the market, but it is hard to sell it back.), so this inconvertible currencies then become the scarce resources. b. Retail market possess of this scarce resource, so it charges a higher rate. 7.
Monetary policy and exchange rate policy 1. Monetary policy decisions involve setting the interest rate on overnight loans in the money market, to eventually change other interest rates in the economy. 2. The RBA control the interest rate by controlling the supply of currency, using the exchange settlement fund. a. If the RBA supply less than the commercial banks needed, the commercial banks will borrow from the cash market, thus bid up the cash rate. b. Vice versa, if the RBA supply more than the commercial banks needed, 3. In a global financial crisis, there is a increased demand for risk-free liquid assets (国债) by private institutions. 4. The only effective way that a fixed exchange rate can operate is if all member countries adopt the same monetary policies. a. Monetary growth, and thereby inflation will be equalised in all member countries.
b. But notes, a difference in fiscal policies and labour market policies can cause inflation differences, and this may not be adjusted for by having a similar monetary policy. i. Expansionary budgetary policy can cause inflation ii. Differences in labour market policies, if wages are allowed to be rise without offsetting productivity improvements, this can cause inflation. 5. Market response to a country’s exchange rate is largely the response to the country’s monetary policy and fiscal policy.
Spot market Quotes 1. Direct quote vs indirect quote a. Direct quote is because it directly quotes how much it costs to buy 1 unit of foreign currency. b. Vice versa, indirect quote is how much it costs to buy one unit of local currency. c. Thus, whether a quote is a direct quote or indirect quote depends on where you see the quote. c 2. The standard practice is to describe exchange rates using direct quotes. a. Except Australia, new Zealand, south Africa and U.K 3. International convention a. “/” is read as “per” (e.g. USD/ASU = 0.08 is interpret as “0.08 USD per Australian dollar) 4. Australian convention a. It is the inversion of the international convention. “/” is read as “per”, but the other way round (e.g. USD/AUD = 0.08 is interpret as “0.08 AUD per US dollar) 5. Because Australia quotes indirect quote, when interpreting the bank’s quote, always set Australian dollar as $1 (e.g. bid: USD = 0.8245 means the bank will buy 0.8245 USD by 1 AUD 6. The ask price is always higher than the bid price, it is always the case that the higher number quoted is the ask price, a. In the country which quotes indirect price, bid refers to purchase of domestic currency, not foreign currency. b. In the country which quotes direct price，bid refers to the purchase of foreign currency c. In a country that quotes direct price.
Observations: 1. Spreads in the retail market (i.e. those exchange booth on the street) is much larger than the spreads in the wholesale market. 2. From the customers’ viewpoint, notes trade at a significant discount to telegraphic transfers.
Definitions: 1. An open market operation is an activity by a central bank to buy or sell government bonds on the open market. a. Through directly debiting or crediting the amount of base money that a bank has in its reserve account at the centre bank, and by buying or selling government bonds to the banks.
Foreign reserve: 1. It can be held by central banks, corporation and individuals. (p.s. not only central banks hold the foreign reserve.)
Purposes： 1. Short term buffer against trade payment imbalances? a. Trade payment imbalances means import bills > export receipts, and import bill require immediate payments. Reserve can be used to ensure such transactions to go ahead. 2. Allow the central bank to intervene in currency markets. a. Buying or selling foreign currencies
USD: 1. USD is the largest foreign reserve held by countries all over the world because: a. Most currencies are quoted against the USD. b. A great proportion of international trade payments are made in USD. c. It is inefficient to hold currencies of many countries.
General： 1. MNC will not always have lower risk, just like portfolio theory states, the risk reduced are relate to the correlation of two nations. If two nation are perfectly correlated to each other, international diversification may not be effective.
Australian’s floating rate system 1. Market force to determine the value of the currency. 2. The adoption of a floating exchange rate regime, however, did not mean that the RBA had become indifferent to either the level of, or movement in , the exchange rate, since thee can have a powerful influence on important aspects of the economy, particular economic growth and inflation. As such, the RBA has from time to time intervened in the foreign exchange market. 3. The way RBA intervene is through affecting the AUS$’s demand and supply by buying and selling Australian dollars against another currency, almost always the US dollar. 4. Questions: 1. Why will the exchange rate be connected to the economy fundamental? Of course, think of the demand and supply of a foreign currency. Say, if a company’s economy now largely increases the amount of exports, thus there will be more supply of domestic currency (i.e. the demand of the foreign currency)), the exchange rate will then change. 2. Why it will restrict the nation’s monetary and fiscal policy?
Wholesale (Interbank) foreign exchange market 1. Banks constantly quote a bid and ask price based on anticipated currency movements taking place and thereby make the market.
2. The interbank market is unregulated and decentralized. There is no specific location or exchange where these currency transactions take place. 3. Central Bank also play a role in setting currency exchange rates by altering interest rates. By increasing interest rates they stimulate traders to buy their currency as it provides a high return on investment and this drives the value of the corresponding central bank's currency higher with comparison to other currencies.
Wholesale market vs the retail market 1. Different from the retail market, the price is not determined by the counterparty (i.e., the other party against the banks). The counterparty does not reveal whether they wish or buy or sell until they have been given a two-way quote.). Thus, it is always the banks who quote the bid and ask price. a. The bid price is the bank’s purchasing price, which is the customer’s selling price. b. The ask price is the bank’s selling price, which is the customer’s purchasing price. 2. In both wholesale market and retail markets, the bank’s profit is determined by the bid-ask spread. 3. Retail market: individual speculates on the exchange rate between different currencies. 4. Wholesales market does not involve end-client. 5. Retail market has a. lower turnover of currency, b. Hold currency as inventory for trading purposes. c. The lower is the turnover, the greater is the risk that the dealer can exchange its “inventory” at a lower price back to its currency. 6. In the case of inconvertible currency a. Think of inconvertible currency as a commodity, it is usually just one-way transaction. (i.e. you can buy it from the market, but it is hard to sell it back.), so this inconvertible currencies then become the scarce resources. b. Retail market possess of this scarce resource, so it charges a higher rate. 7.
Monetary policy and exchange rate policy 1. Monetary policy decisions involve setting the interest rate on overnight loans in the money market, to eventually change other interest rates in the economy. 2. The RBA control the interest rate by controlling the supply of currency, using the exchange settlement fund. a. If the RBA supply less than the commercial banks needed, the commercial banks will borrow from the cash market, thus bid up the cash rate. b. Vice versa, if the RBA supply more than the commercial banks needed, 3. In a global financial crisis, there is a increased demand for risk-free liquid assets (国债) by private institutions. 4. The only effective way that a fixed exchange rate can operate is if all member countries adopt the same monetary policies. a. Monetary growth, and thereby inflation will be equalised in all member countries.
b. But notes, a difference in fiscal policies and labour market policies can cause inflation differences, and this may not be adjusted for by having a similar monetary policy. i. Expansionary budgetary policy can cause inflation ii. Differences in labour market policies, if wages are allowed to be rise without offsetting productivity improvements, this can cause inflation. 5. Market response to a country’s exchange rate is largely the response to the country’s monetary policy and fiscal policy.
Spot market Quotes 1. Direct quote vs indirect quote a. Direct quote is because it directly quotes how much it costs to buy 1 unit of foreign currency. b. Vice versa, indirect quote is how much it costs to buy one unit of local currency. c. Thus, whether a quote is a direct quote or indirect quote depends on where you see the quote. c 2. The standard practice is to describe exchange rates using direct quotes. a. Except Australia, new Zealand, south Africa and U.K 3. International convention a. “/” is read as “per” (e.g. USD/ASU = 0.08 is interpret as “0.08 USD per Australian dollar) 4. Australian convention a. It is the inversion of the international convention. “/” is read as “per”, but the other way round (e.g. USD/AUD = 0.08 is interpret as “0.08 AUD per US dollar) 5. Because Australia quotes indirect quote, when interpreting the bank’s quote, always set Australian dollar as $1 (e.g. bid: USD = 0.8245 means the bank will buy 0.8245 USD by 1 AUD 6. The ask price is always higher than the bid price, it is always the case that the higher number quoted is the ask price, a. In the country which quotes indirect price, bid refers to purchase of domestic currency, not foreign currency. b. In the country which quotes direct price，bid refers to the purchase of foreign currency c. In a country that quotes direct price.
Observations: 1. Spreads in the retail market (i.e. those exchange booth on the street) is much larger than the spreads in the wholesale market. 2. From the customers’ viewpoint, notes trade at a significant discount to telegraphic transfers.
Definitions: 1. An open market operation is an activity by a central bank to buy or sell government bonds on the open market. a. Through directly debiting or crediting the amount of base money that a bank has in its reserve account at the centre bank, and by buying or selling government bonds to the banks.
Foreign reserve: 1. It can be held by central banks, corporation and individuals. (p.s. not only central banks hold the foreign reserve.)
Purposes： 1. Short term buffer against trade payment imbalances? a. Trade payment imbalances means import bills > export receipts, and import bill require immediate payments. Reserve can be used to ensure such transactions to go ahead. 2. Allow the central bank to intervene in currency markets. a. Buying or selling foreign currencies
USD: 1. USD is the largest foreign reserve held by countries all over the world because: a. Most currencies are quoted against the USD. b. A great proportion of international trade payments are made in USD. c. It is inefficient to hold currencies of many countries.
General： 1. MNC will not always have lower risk, just like portfolio theory states, the risk reduced are relate to the correlation of two nations. If two nation are perfectly correlated to each other, international diversification may not be effective.
