>> Our next market is the foreign exchange market. Most companies are in one way or another nowadays, exposed to changes in the exchange rate. Either because the company is exporting it's goods overseas and gets paid in foreign currencies. Or it is importing it's raw materials from overseas and needs to pay for those raw materials in foreign currencies. Or the company has got overseas operations, assets perhaps overseas, or it has overseas liability. It's borrowed from overseas money markets to fund its overseas assets. But even if none of these items apply to a corporation. It is still very likely that, that corporation’s financial position is influenced by changes in exchange rate. Foreign competition would nowadays affect most corporations. And even when not directly engaging with overseas markets, indirectly it will still affect the competitive position of pretty much every corporation. So where's the market for foreign exchange? As with depth market, this is an Over-The-Counter market. That's a wholesale market, no place there for retail investors. It's a dealer market where dealers are continuously quoting buy and sell prices. Only a small number of dealers are in fact accredited by the monetary authorities of the country in which these dealers operate. They provide real time currency prices at which the corporations can trade their exchange positions. Companies would contact their brokers to do so. The brokers would then provide the order to the dealers and the dealers would quote a buy sell price for the currencies that they're offered. The dealers then will transact at those quoted prices. So what the FX market, the foreign exchange market does? Is it organizes trading in currencies, that's distinct from two important functions that the equity in debt market fulfill. It does not provide financing opportunities. So whereas corporations, access, debt and equity markets, to find the funds to invest in net present value projects that are positive. This does not occur on the foreign exchange market. So a loan in foreign currency would have to be obtained from a money market overseas. Is there no primary market here for currencies? Well, yes there is. The monetary authorities of course, have the opportunity to print more currency. That will have a direct impact on the price of that currency relative to other currencies. Which leads me to the exchange rate, the price that is determined on foreign exchange market. Unlike share prices, unlike bond prices, money market prices, this is not what we would label as an absolute price. It is in fact, a relative price. Where we express the price of one asset, one currency, in terms of another currency. So the example here is the U.S. Dollar, in terms of Chinese Yuan's, equals 6.2. So the way we denote the currency, the exchange rate U.S. Dollars in terms of Chinese Yuan. The first named currency is also known as the domestic currency, or the trade currency, or the base currency, we've got various names for it. That's the US dollar in the example, against the foreign currency, the Chinese Yuan. Also known as the terms currency, in which we express the value of the domestic currency. So US dollar, Chinese Yuan, indicates that 6.2 Chinese Yuan buy 1 US dollar. Alternatively, we could swap the currencies around in the exchange rate and we get the Chinese Yuan in terms of US Dollar. That would be 0.1613 which if you want to compute it yourself, it's simply the inverse of 6.2. So 16.13 US dollar cents buys one Chinese Yuan. Another important feature of the exchange rate is how we express an increase in its value versus a decrease in it's value. For exchange rates, we call that an Appreciation. An improvement in the domestic trade or base currency. So in the U.S. dollar, Chinese Yuan example. That would be an increase in the value of the U.S. dollar. So let's say that that exchange rate, USD/CNY goes from 6.2 to 6.5. Then, after that change it would now take 6.5 Chinese Yuan to buy one US dollar. The US dollar has increased in value. The flip side is Depreciation. A decrease in the value of the trade currency, the base currency. In this case, the US dollar. If over time, the US dollar, Chinese Yuan goes from 6.2 to 6.0. Then that tells us that now it only takes 6.0 Chinese Yuans to buy one US dollar. The US dollar has decreased in value, depreciated in value. When we talk about exchange rate movements, it is worth figuring out what type of exchange rate applies. And with that I mean, a distinction between fixed exchange rates, managed exchanged rates, or floating exchange rates. So some countries have decided to fix the value of their currency. Also known as pegging, the value of their currency against another currency. The example I give here is one, where the Belize Dollar is fixed against the US dollar. Two Belize dollars buy one US dollar. In the graphic, you can see that represented by the red line. Over time, there is no variation whatsoever in the exchange rate. That can only be achieved with intervention, continuous intervention by the monetary authorities. Other countries, other monetary authorities have decided to manage or to control the value of their currency against other currencies. So that would be a managed currency. A good example there is the Chinese Yuan, also indicated in this graph. The Chinese monetary authorities have decided to control the variations. In the value of their currency against the U.S. dollar. It doesn't look anything like the Belize Dollar exchange rate in the graphic. But nonetheless, there is evidence there that the price variations are carefully controlled by the Chinese monetary authorities. And then there's the third group of currencies where the value determination, the exchange rate is entirely left to the devices of the market. Where demand meets supply for two currencies. What about the Euro? You would of heard about the Euro is the common currency of many European countries. Set a fixed exchange rate, well it is internally but it is not against the US dollar or for example the Chinese Yuan. So the Euro, in its own right is not a fixed currency but in fact, a floating currency. Foreign exchange is traded in the well-known financial centers. New York, Frankfurt, Tokyo, London, Sydney. Those are the traditional foreign exchange markets. If you look carefully, you will notice that these markets in fact straddle the Earth. What that means is that there is truly 24/7 price discovery in the most traded global currencies, including the US Dollar, Euro, Chinese Yuan, Japanese Yen and Great British Pound. But new centers are emerging. Just as for equity and debt markets. Where economic growth occurs, financial centers follow. So Beijing, Mumbai, Seoul, and São Paulo, are the new currency centers of the world. Foreign exchange trading occurs on an over-the-counter platform, it's a wholesale market. But, we also see online platforms emerging, making this market in fact accessible to some extent to retail investors as well.
