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Dr Katarzyna Sum Chair of International Finance Warsaw School of Economics

Dr Katarzyna Sum Chair of International Finance Warsaw School of Economics. INTERNATIONAL FINANCE. Getting started. Slides available for download: http://akson.sgh.waw.pl/~ksum/ Contact: ksum@sgh.waw.pl Office hours: Tuesday 01.30-02.30 PM, room 20M.

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Dr Katarzyna Sum Chair of International Finance Warsaw School of Economics

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  1. Dr Katarzyna SumChair of International FinanceWarsaw School of Economics INTERNATIONAL FINANCE International Finance 130440-1165

  2. Getting started Slides available for download: http://akson.sgh.waw.pl/~ksum/ Contact: ksum@sgh.waw.pl Office hours: Tuesday 01.30-02.30 PM, room 20M International Finance 130440-1165 International Finance 130440-1165

  3. Final note • A multiple choice test • The scope of test - according to the syllabus available on http://akson.sgh.waw.pl/~ksum/ International Finance 130440-1165 International Finance 130440-1165

  4. Broad lecture outline • The foreign exchange market • The balance of payments • International monetary system International Finance 130440-1165 International Finance 130440-1165

  5. Basic literature • P. Krugman, M.Obstfeld, International economics: theory and policy.Part II, Pearson, Addison Wesley, Boston2009. • F. Mishkin, The economics of money banking and financial markets, 8e., Prentice Hall, 2007 International Finance 130440-1165 International Finance 130440-1165

  6. Financial markets-classification and functions • The notion of financial markets • Classification,instruments, participants • Current developments • The FX market and the derivatives market International Finance 130440-1165 International Finance 130440-1165

  7. The notion of financial markets • Financial markets enable the flow of savings from households to companies • Allocation of savings • Offering instruments enabling financial management International Finance 130440-1165 International Finance 130440-1165

  8. Classification • Money market • Capital market • Foreign exchange market • Derivatives market International Finance 130440-1165 International Finance 130440-1165

  9. Spot and forward market • Spot- transaction within 2 working days- primary intruments • Forward: transaction within 30,90 or 180 days- derivatives International Finance 130440-1165 International Finance 130440-1165

  10. International Finance 130440-1165 International Finance 130440-1165

  11. Money market • Enables liquidity management of several institutions • Short term borrowing and lending (up to 1 year) • Participants- banks International Finance 130440-1165 International Finance 130440-1165

  12. Money market • Short term (few days-3 months) • repo – conducting two contrary transactions on the spot and the forward market • Long term (3 months-1 year) • treasury bills- issued by governements • certificates of deposits- issued by banks • commercial papers- issued by companies International Finance 130440-1165 International Finance 130440-1165

  13. Capital market • Enables participants to allocate or gain capital • Long term fundraising • Stock and bond market • Participants: • stock market- issuers (companies) and shareholders (institutional and private investors) • bond market- issuers (governements or companies), banks International Finance 130440-1165 International Finance 130440-1165

  14. Foreign exchange market • Enables currency exchange in order to conduct international trade, enables also currency investment trade • Participants: • commercial banks, central banks, companies, hedge funds, investment funds acting as • hedgers, arbitrageurs, speculators International Finance 130440-1165 International Finance 130440-1165

  15. Foreign exchange market • Spot transactions • Currency futures • Currency/ FX swaps • Currency options International Finance 130440-1165 International Finance 130440-1165

  16. Derivatives market • Enables institutions to hedge the risk of changes in security prices and exchange rates • The price derives from the value of the underlying instrument • Participants: • commercial banks, central banks, companies, hedge funds, investment funds acting as • hedgers, arbitrageurs, speculators International Finance 130440-1165 International Finance 130440-1165

  17. Derivatives market • Forward transactions • Swaps • Options International Finance 130440-1165 International Finance 130440-1165

  18. Financial market intermediaries • Commercial banks • Investment banks • Investment funds and insurance companies • Hedge funds International Finance 130440-1165 International Finance 130440-1165

  19. Raising capital- banks vs FM • Financial markets are able to take higher risks than banks • Lower risk premium + no colleteral needed  lower cost of fundraising at the financial markets • Financial markets are more future oriented than banks • Monitoring the efficiency of the borrower International Finance 130440-1165 International Finance 130440-1165

  20. Current issues • Growing liquidity • Growing importance of the derivatives market • Growing importance of capital markets International Finance 130440-1165 International Finance 130440-1165

  21. Growing liquidity • Capital flow liberalisation • IT progress • New instruments and products • New methods of risk management International Finance 130440-1165 International Finance 130440-1165

  22. Growing importance of derivatives market • The need of new risk hedging techniques • Basic and structurized instruments • Growing role of speculation International Finance 130440-1165 International Finance 130440-1165

  23. Growing importance of capital markets • Shrinking role of banks as financial intermediary • Growing role of bond issuance • Growing role of stock market transactions International Finance 130440-1165 International Finance 130440-1165

  24. FX market- daily turnover Source: BIS International Finance 130440-1165 International Finance 130440-1165

  25. FX market- numbers 10% of the transactions related to trade, 90% speculation Financial centres: • London 36% of global transactions • Nowy Jork 18% of global transactions • Tokio 6% of global transactions International Finance 130440-1165 International Finance 130440-1165

  26. FX market- numbers • Spotturnover • 37% of the whole turnover • 48% growth during 2007-2010 • Forward turnover • 63% of the whole turnover • 7% growthduring2007-2010 International Finance 130440-1165 International Finance 130440-1165

  27. Market participants • Hedgers • Arbitrageurs • Speculators International Finance 130440-1165 International Finance 130440-1165

  28. Market participants • Hedging- taking a bet on price changes or buying „insurance” against price changes • Speculation and arbitrage- looking for extraordinary gains International Finance 130440-1165 International Finance 130440-1165

  29. Turnover by instrument Source: BIS International Finance 130440-1165 International Finance 130440-1165

  30. FX swaps • an instrument being a contract for exchanging one currency against another at the spot ER parallely aggreeing on a reversed transaction at the forward ER in the future • betting on ER changes • Example: • a company wants to invest an amount of USD in bonds denominated in EUR knowing to be needing USD back in 3 months International Finance 130440-1165 International Finance 130440-1165

  31. Currency futures • An instrument being a contract for exchanging one currency for another at a specified date in the future at a specified ER • Betting on ER changes • Example: • arbitrageurs expecting high volatility of the spot ER International Finance 130440-1165 International Finance 130440-1165

  32. Currency options • An instrument which gives the owner the right but no obligation to buy or sell an amount of foreign currency at a specified ER • „Insurance” against potential losses • Put and call options • The option issuer is obliged to buy or sell the foreign currency if the owner wishes to execute his right International Finance 130440-1165 International Finance 130440-1165

  33. Currency options Example: • Receiving payments in foreign currency at an unspecified date- put option • Settling payments in a foreign currency at an unspecified date- call option • Popular for commercial banks and institutions managing large investments abroad due to high market risk exposure International Finance 130440-1165 International Finance 130440-1165

  34. Derivatives- daily turnover Source: BIS International Finance 130440-1165 International Finance 130440-1165

  35. Participants • Hedgers • Arbitrageurs • Speculators International Finance 130440-1165 International Finance 130440-1165

  36. Instruments • Forward transactions • Swaps • Options International Finance 130440-1165 International Finance 130440-1165

  37. Interest rate derivatives market • Forward rate agreement • Interest rate swap • Interest rate options International Finance 130440-1165 International Finance 130440-1165

  38. Daily derivatives market turnover by instrument Source: BIS International Finance 130440-1165 International Finance 130440-1165

  39. FRA • Forward rate agreement- an instrument being a contract for settling the difference between the forward rate at the day of signing the contract and the interest rate on the day of the settlement of the contract • Example: • having 3 months bonds and hedging the risk of their value decrease by signing a FRA contract International Finance 130440-1165 International Finance 130440-1165

  40. IRS • Interest rate swap- an instrument being a contract for settling periodically interest rate differences between the long term interest rate at the day of signing the contract and the short term interest rate in the next periods • Example: • the purchase of 5 year bonds financed through a 3 months loan- hegding the risk of their price decrease International Finance 130440-1165 International Finance 130440-1165

  41. Interest rate options • Higher cost than other derivatives • We actually have to buy the „insurance” against price changes • In practice- investors buying and issuing options at the same time International Finance 130440-1165 International Finance 130440-1165

  42. Arbitrage • F-S/S>i*t/360 or • F-S/S<i*t/360  Arbitrage • F-S/S=i*t/360  The price difference reflects the interest rate The prices on the spot and forward market change paralelly! International Finance 130440-1165 International Finance 130440-1165

  43. Spot and forward on the FX market Premium FR> SR Discount FR<SR Slower fluctuations of FR than SR International Finance 130440-1165 International Finance 130440-1165

  44. Speculation • The possibility to apply leverages • Low collateral needed • Daily settling of transactions • Larger risks and potential gains and losses International Finance 130440-1165 International Finance 130440-1165

  45. Derivatives-problems • Misusage of derivatives • Wrong risk ditribution on FM • Wrong assesment of risks • Eg. Currency options during the crisis International Finance 130440-1165 International Finance 130440-1165

  46. Summing up • Financial marktes enable the flow of savings from households to comapnies • Raising capital on financial markets may be avantagous vs banks International Finance 130440-1165 International Finance 130440-1165

  47. Summing up • Currently-growing liquidity of the financial markets • Currently- growing importance of the derivatives market • Currently-growing imoprtance of capital markets International Finance 130440-1165 International Finance 130440-1165

  48. Summing up • The largest turnover on derivatives market • A large amount currency market derivatives • Only 10% related to trade • Derivatives can be usufull intruments provided there is proper risk assesment International Finance 130440-1165 International Finance 130440-1165

  49. References • P. Krugman, M.Obstfeld, International economics: theory and policy.Part II, Pearson, Addison Wesley, Boston2009 • F. Mishkin, The economics of money banking and financial markets, 8e., Prentice Hall, 2007 • A. Sławiński, Rynki finansowe, PWE, Warszawa 2006. • Triennial Central Bank Survey, Foreign exchange and derivatives market activity in April 2010, Monetary and Economic Department, Bank of International Settlements, 2010 International Finance 130440-1165 International Finance 130440-1165

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