FOREIGN EXCHANGE MARKET ~customers of commercial and >Method of Quotation

central banks
INTRODUCTION -For Interbank dollar trades
-Forward Market
#The Currency Market: ~American terms
~Arbitrageurs
>where money dominated as one ~European terms
currency is bought and sold with ~Traders
-For Nonbank customers:
money denominated in another
~hedgers
currency. Direct Quote
~speculators
#International Trade and Capital -gives the home currency price of
Transactions #CLEARING SYSTEMS one unit of foreign currency.
>facilitated with the ability to transfer >Clearing House Interbank Payment >Transaction Costs
purchasing power between countries.
System(CHIPS) -Bid-Ask Spread
#Location
-Used in U.S. for Electronic fund ~used to calculate the fee charged by
1. OTC-Type: no specific location Transfers the bank
2. Most trade by phone, telex, SWIFT >FedWire BID: the price at which the bank is
willing to buy
(Society for Worldwide Interbank -operated by the fed
Financial Telecommunication) ASK: the price it will sell the currency
-used for domestic transfers
>Precent Spread Formula (PS):
#Electronic Trading
-ORGANIZATION OF THE FOREIGN
EXCHANGE MARKET- >Automated Trading Ask  Bid
PS  100
-genuine screen-based market Ask

#Participants in the Foreign Exchange > Results:

>Participants at 2 levels -Reduces cost of trading

>Cross Rates
- Wholesale Level (95%) -Threatens traders’ oligopoly of
information -The Exchange rate between 2
~Major Banks non-US$ Currencies.
-Provides Liquidity
- Retail Level >Currency Arbitrage
~Business Customers -If cross rates differ from one financial
# Size of The Market
center to another, and profit
(Refer to PPT slide 15) opportunities exist.
>Two types of Currency markets
-Buy cheap in one int’l market, sell at a
-Spot Market higher price in another
-THE SPOT MARKET-
~immediate transaction -Role of Available Information

~recorded by 2nd business day >Settlement Date Value Date

#Spot Quotations
-Forward Market -Date monies are due
>Sources
~transactions take place at a -2nd Working day after date of original
specified future date -All Major Newspapers transaction
-Major currencies have four different >Exchange Risk
quotes:
>Participants by Market -bankers= middlemen
~spot price
-Spot Market ~incurring risk of adverse
~30-Day exchange rate moves.
~Commercial Banks
~90-Day ~increased uncertainty about
~Brokers
future exchange rate requires
~180-Day
#SPOT MARKET
1. Demand for higher risk premium
2. Bankers widen bid-ask spread
>Mechanics of Spot Transaction
1. Currency transaction:
Verbal agreement, U.S.
importer specifies:
-Account to debit(his accnt)
-Account to credit(exporter)
2. Bank send importer contract note
including:
-amount of foreign currency
-agreed exchange rate
-confirmation of step 1
3. Settlement
-Correspondent bank in HK
transfers HK$ from nostro accnt
to exporter’s value date
-THE FORWARD MARKET-
#Forward Contract
>an agreement between a bank and a
customer to deliver a specified amount
of currency against another currency at
a specified future date and at a fixed
exchange rate.
>Purpose of a forward:
-Hedging: the act of reducing
exchange rate risk
#Forward Rate Quotations
>Two Methods
-Outright Rate: quoted to commercial
customers.
-Swap Rate: quoted in the Interbank
market as a discount or premium
>Calculating The Forward Premium or
Discount
F  S 12
  100
S n
-Investors are almost always
risk-averse.
F= Forward rate of exchange
>The Time Value of Money:
S= Spot rate of exchange
-Everyone agrees on the basic
n= Number of Months in th Forward
principle
Contract
>The Importance of Cash Flows:
#Forward Contract Maturities
-Most Investment research deals with
>Contract Terms
predicting future corporate earnings.
-30-Day
>The Tax Factor:
-90-Day
-The tax code is complicated and not
-180-Day all investments are taxed equally
-360-Day >Economy, Industry and Company (EIC)
analysis:
>Long-term Contracts
-The analysts first considers conditions
in the overall economy (market risk)
-INTEREST RATE PARITY THEORY- -Then determines which industries are
the most attractive in light of the
(Refer to PPT Slide36-41)
economic conditions (using Porter’s
competitive strategy analysis
framework, for example)
-Finally, identifies the most attractive
FUNDAMENTAL STOCK ANALYSIS companies within the attractive
#Fundamental Analysts industries.
-believe securities are priced
according to fundamental economic
data.
-study anything that can affect the
security’s value:
-macro to micro economic factors
-qualitative and quantitative
factors
#Technical Analysts
Threats of
-think investor behavior and supply New Entrants
and demand factors play the most
important role.
Suppliers’ Rivalry Buyers’
bargaining among bargaining
power existing Power
#Fundamental Analysis competitor
-a method of measuring a security’s
Threat of
intrinsic value by examining related
Substitute
economic and financial factors.
#Valuation Philosophies
>Investors’ understanding of risk
premiums: #VALUE vs. GROWTH Investing

>The Value Approach to Investing
-Value Investor
~believes that securities should be
purchased only when the underlying
fundamentals(macroeconomic
information, industry news, and a
firm’s financial statement) justify
purchase.
>The Growth Approach to Investing
>Growth investors
~seek steadily growing
companies.
There are two factions:
-Information trader
~ are in a hurry; they
believe information differentials in
the marketplace can be profitably
exploited.
-True growth investors
~are more willing to
wait, but they share the belief that
good investment managers can earn
above-average returns for their
clients.
#Intrinsic Value
>Financial analysts believe that the
stock price of does not reflect its true
value.
>Fundamental analysis assists in
estimating the intrinsic value of
stocks
#Qualitative factors
>Intra-Factors
-Intangibles of the Company
-Business Model
-Competitive Advantage
-Management of the Company
-Corporate Governance
-Financial and Information
-Transparency
-Structure of the Board of Directors
>Inter-Factors -Book values normally ignore
intangible assets’ fair value.
-Industry
-Book values represent historical
-Customers
values. The current fair value of the
-Market Share assets may be much different from
the balances in the balance sheet, as
-Growth of Industry explained above.
-Competition -Future growth potential in earnings is
also not considered in the book
-Regulations
values.
#Price-earnings ratio (P.E.)
Market Pr ice
>The ratio which compares this EPS to Market / BookRatio 
BPS
share price is called the price-earnings #Return On Equity
ratio (PER)
>The value which compares this EPS
>It is an indicator which shows how (earnings per share) and BPS (book
many times higher the share price is to value per share) is called the rate of
earnings per share and a typical return on equity (ROE).
indicator when considering undervalue
and overvalue. >This uses shareholders’ equity to show
how much a company has increased
Market Pr ice earnings, and a high ROE means that
PER 
EPS the company is being managed that
pmuch more efficiently.
#Earning per share
EPS
> is current income divided by the total ROE %  100
number of outstanding shares. BPS
#Dividend Yield
Income
EPS 
# OfCommonShares >The dividend yield or dividend-price
ratio of a share is the dividend per
#Book value per share share, divided by the price per share. It
is also a company's total annual
>net assets* divided by the total
dividend payments divided by its
number of outstanding shares.
market capitalization, assuming the
NetIncome number of shares is constant.
BPS 
# OfOuts tan dingShares CDY (%) 
Most Recent Full - Year Dividend
100
Current Share Price
#Price-to-book Value Ratio
>The value which compares this
number to share price is called the
price-to-book value ratio (PBR).
> A price-to-book value ratio under 1
means the share price is lower than
the dissolution value on the books.
>A P/B ratio of less than 1.0 can
indicate that a stock is undervalued,
while a ratio of greater than 1.0 may
indicate that a stock is overvalued.
>Below are the reasons that undercut
the reliability of book values for any
major analysis: