CHAPTER 1 INTERNATIONAL FINANCIAL MARKETS (1)

1CHAPTER

INTERNATIONAL FINANCIAL MARKETS

Chapter Objectives
After studying this chapter, students should be able to:

1.1 Explain foreign market in international finance
1.2 Determine the concept of foreign exchange in financial

markets
1.3 Describe the concept of supply and demand of foreign

exchange
1.4 Explain types of foreign exchange transaction
1.5 Discuss foreign exchange quotations
1.6 Explain transaction costs in foreign exchange

LECTURE OUTLINE

Open your newspaper and look at the business section. What do these places have in Com-
mon the Bursa Malaysia, the NASDAQ Stock Exchange and the KRX Korea Stock Exchange?

INTRODUCTION
In daily life, we find ourselves in constant contact with internationally traded goods. If you enjoy
music, you may play a British manufactured CD of music by a Polish composer through a USA
amplifier and Spain speakers. You may be wearing clothing made in China or drinking milk from
New Zealand. As you drive to work, you will see cars manufactured in half a dozen different coun-
tries on the streets.

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Fewer noticeable in daily life are the international trade in financial assets, but its dollar volume is
much greater. This trade takes place in the international financial markets. When international
trade in financial assets is easy and reliable due to small transactions costs in liquid markets we
say international financial markets are characterized by high capital mobility.

DEFINITION OF INTERNATIONAL FINANCIAL MARKETS
A financial market is a place where people buy and sell securities in other words it’s provide for
exchanging and creating value of financial assets. The functions are as follows:
 A place for issuers to obtain financing, so that their operations can be expanded. For exam-

ple, a company may want to increase its production while the government may want to build
new roads and highways.
 A place for investor to invest their money, so that they can earn returns and increase their
welfare.

A security is a financial instrument that represents an ownership position in a publicly-traded cor-
poration (stock), a creditor relationship with governmental body or a corporation (bond), or rights to
ownership as represented by an option. A security is fungible, negotiable financial instrument that
represents some type of financial value. The company or entity that issues the security is known
as the issuer.

HISTORY FOR FOREIGN EXCHANGE

The foreign exchange market (fx or forex) as we know it today originated in 1973. However, money
has been around in one form or another since the time of Pharaohs. The Babylonians are credited
with the first use of paper bills and receipts, but Middle Eastern moneychangers were the first cur-
rency traders who exchanged coins from one culture to another.

History of Foreign Exchange

The system used for exchanging foreign currencies has evolved from the gold standard, to an
agreement on fixed exchange rates, to a floating rate system.

Gold Standard. From 1876 to 1913, exchange rates were dictated by the gold standard. Each cur-
rency was convertible into gold at a specified rate. Thus, the exchange rate between two curren-

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cies was determined by their relative convertibility rates per ounce of gold. Each country used gold
to back its currency. When World War I began in 1914, the gold standard was suspended. Some
countries reverted to the gold standard in the 1920s but abandoned it as a result of a banking pan-
ic in the United States and Europe during the Great Depression. In the 1930s, some countries at-
tempted to peg their currency to the dollar or the British pound, but there were frequent revisions.
As a result of the instability in the foreign exchange market and the severe restrictions on interna-
tional transactions during this period, the volume of international trade declined.

Agreements on Fixed Exchange Rates. In 1944, an international agreement (known as the Bretton
Woods Agreement) called for fixed exchange rates between currencies. This agreement lasted
until 1971. During this period, governments would intervene to prevent exchange rates from mov-
ing more than 1 percent above or below their initially established levels. By 1971, the U.S. dollar
appeared to be overvalued; the foreign demand for U.S. dollars was substantially less than the
supply of dollars for sale (to be exchanged for other currencies). Representatives from the major
nations met to discuss this dilemma. As a result of this conference, which became known as the
Smithsonian Agreement, the U.S. dollar was devalued relative to the other major currencies. The
degree to which the dollar was devalued varied with each foreign currency. Not only was the dol-
lar’s value reset, but exchange rates were also allowed to fluctuate by 2 percent in either direction
from the newly set rates. This was the first step in letting market forces (supply and demand) de-
termine the appropriate price of a currency. Although boundaries still existed for exchange rates,
they were widened, allowing the currency values to move more freely toward their appropriate lev-
els.

The Beginning of the free-floating system

After the Bretton Woods Accord came the Smithsonian Agreement in December of 1971. This
agreement was related to the Bretton Woods Accord, but acceptable for a greater fluctuation band
for the currencies. In 1972, the European community tried to move away from its dependency on
the dollar. The European Joint Float was established by West Germany, France, Italy, the Nether-
lands, Belgium and Luxemburg.

The agreement was similar to the Bretton Woods Accord, but allowed a greater range of fluctua-
tion in the currency values. Both agreements made mistakes similar to the Bretton Woods Accord
and in 1973 collapsed. The collapse of the Smithsonian agreement and the European Joint Float

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in 1973 signified the official switch to the free-floating system. This occurred by default as there
were no new agreements to take their place.

Governments were now free to peg their currencies, semi-peg or allow them to freely float. In
1978, the free-floating system was officially mandated. In a final effort to gain independence from
the dollar, Europe created the European Monetary System in July of 1978. Like all of the previous
agreements, it failed in 1993.

The major currencies today move independently from other currencies. The currencies are traded
by anyone who wishes. This has caused a recent entry of speculation by banks, hedge funds, bro-
kerage houses and individuals. Central banks intervene on occasion to move or attempt to move
currencies to their desired levels. The underlying factor that drives today's forex markets, however,
is supply and demand. The free-floating system is ideal for today's forex markets. It will be interest-
ing to see if in the future our planet endures another war similar to those of the early 20th century.

TIMELINE OF FOREIGN EXCHANGE

1944 - Bretton Woods Accord is established to help stabilize the global economy after World
War II.

1971 - Smithsonian Agreement established to allow for greater fluctuation band for currencies.
1972 - European Joint Float established as the European community tried to move away from its

dependency on the U.S. dollar.
1973 - Smithsonian Agreement and European Joint Float failed and signified the official switch

to a free-floating system.
1978 - The European Monetary System was introduced so other countries could try to gain in

dependence from the U.S. dollar.
1978 - Free-floating system officially mandated by the IMF.
1993 - European Monetary System fails making way for a world-wide free-floating system.

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CONCEPT OF FOREIGN EXCHANGE IN FINANCIAL MARKETS

The forex market is the market in which participants are able to buy, sell, exchange and speculate
on currencies. The forex markets is made up of banks, commercial companies, central banks, in-
vestment management firms, hedge funds, and retail forex brokers and investors.

The foreign exchange (FX or FOREX) market is the market where exchange rates are determined.
Exchange rates are the mechanisms by which world currencies are tied together in the
global marketplace, providing the price of one currency in terms of another. An exchange rate is a
price, specifically the relative price of two currencies.

The Price of Milk and the Price of Foreign Currency. An exchange rate is another price in the
economy. Let’s compare an exchange rate to the price of milk. Suppose that the price of a gallon
of milk is USD 2.50, or 2.50 USD/milk, using the above exchange rate market notation. When
we price milk, the denominator refers to one unit of the good that it is being bought –a
gallon of milk. When we price exchange rates, the denominator refers specifically to one unit of
a currency. Therefore, think of the currency in the denominator as the currency you are buying.

PARTICIPANTS

Commercial banks: Biggest participant in international transaction.
Corporations: Especially corporation with operation in various countries and engage in interna-
tional trade (include buying of material and selling of goods).
Non-bank financial institutions: Its number of institutions is expanding due to deregulation. Ex-
ample is hedge funds.
Central banks: Could intervene in foreign exchange market to achieve various policies objectives
or its macroeconomic policies could affect exchange rates.
Individual: Most common example is tourists.

CONCEPT OF SUPPLY AND DEMAND OF FOREIGN EXCHANGE

Various factors affect supply and demand of particular currency, hence determining its exchange
rates (price) in a free float system. As foreign currencies are traded in various foreign exchanges,

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there could be “mispricing”. However, efficient market system enables arbitrage activities to
achieve one exchange rate for all foreign exchange markets.

Supply & demand also create fluctuation (volatility) risk, which could be minimized through hedging
by using various financial instruments (included swap, futures and options). Changes in exchange
rates could affect the real economy (e.g. trade competitiveness and value of international debts).

There are various foreign exchange systems, ranging from the two extreme of floating exchange
rate system to fixed exchange rate system. Each of those systems could pose fundamental risk
(weaknesses of the system).

TYPES OF FOREIGN EXCHANGE TRANSACTION

The major foreign exchange markets that exist are:
 Spot markets
 Forward markets
 Futures markets
 Options markets
 Swaps markets

Spot market refers to the transactions involving sale and purchase of currencies for imme-
diate delivery. In practice, it may take one or two days to settle transactions.

Options are derivative instruments that give a choice to a foreign exchange market opera-
tor to buy or sell a foreign currency on or up to a date (maturity date) at a specified rate (strike
price).

Forward market transactions are meant to be settled on a future date as specified in the contract.
Though forward rates are quoted just like spot rates, but actual delivery of currencies takes
place much later, on a date in future.

Futures market is a localized exchange where derivative instruments called 'futures' are traded.
Currency futures are somewhat similar to forward, yet distinctly different. This aspect will be ex-
plained in detail in a subsequent chapter.

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Swaps, as the term suggests, are simply the instruments that permit exchange of two streams of
cash flows in two different currencies.

The most active foreign exchange market is that of UK (London), followed by that of USA, Japan,
Singapore, Switzerland, Hong Kong, Germany, France and Australia. All other markets, combined
together, represent only about 15 per cent of the total volume, traded globally.

The similarities and differences between the forward and futures markets.

Similarities Differences

Delivery at a future date. In the forward market, a gain or loss is
realized on the maturity date, while in
Gains and losses as a result of currency fluctua- the futures markets on a daily basis as
tions. positions are marked to market.

Total gain or loss depends on the difference be- In the futures market few currencies are
tween the future price (and forward price) and spot traded and trading occurs through or-
exchange rate on the maturity of the contract. ganized exchanges or clearing houses,
such as IMM.
Hedging facility and speculative
opportunity. Forward contracts are written for any
amount, futures for fixed amount.

FOREIGN EXCHANGE QUOTATIONS
A foreign exchange quotation or quote is a statement of willingness to buy or sell at an announced
rate.
Codes for selected Currencies required for quotes

USD – US Dollar EUR – Euro 7
GBP – British Pound IEP – Irish Pound
JPY – Japanese Yen CHF – Swiss Franc
CAD – Canadian Dollar AUD – Australian Dollar
SEK – Swedish Kroner MEP – Mexican Peso
DKK – Danish Kroner NZD – New Zealand $
INR – Indian Rupee SAR – Saudi Riyal

How to Read a Forex Quote

Currencies are always quoted in pairs, such as GBPUSD or USD/JPY. The reason they are quot-
ed in pairs is because in every foreign exchange transaction, simultaneously buying one currency
and selling another. Here is an example of a foreign exchange rate for the British pound versus the
U.S. dollar:

RM/USD = 0.23

BASE CURRENCY QUOTE CURRENCY

The first listed currency to the left of the slash ("/") is known as the base currency (in this example,
the Ringgit Malaysia), while the second one on the right is called the counter or quote currency (in
this example, the U.S. dollar). When buying, the exchange rate tells you how much you have to
pay in units of the quote currency to buy one unit of the base currency.

Example 1: You have to pay 0.23 U.S. dollars to buy 1 Ringgit Malaysia. When selling, the ex-
change rate tells you how many units of the quote currency you get for selling one unit of the base
currency. In the example above, you will receive 0.23 U.S. dollars when you sell 1 Ringgit Malay-
sia.

The base currency is the "basis" for the buy or the sell. If you buy EUR/USD this simply means
that you are buying the base currency and simultaneously selling the quote currency. In caveman
talk, "buy EUR, sell USD." You would buy the pair if you believe the base currency will appreciate
(gain value) relative to the quote currency. You would sell the pair if you think the base currency
will depreciate (lose value) relative to the quote currency.

DIRECT VERSUS INDIRECT QUOTATIONS

DIRECT QUOTATIONS

Every quote could potentially be a direct one or an indirect one at the same time. This generally
depends on your geographical location and your domestic currency. To simplify, a direct quote is a

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foreign exchange price quotation that can be easily understood, even by a person who doesn't
know the exchange rate of his domestic currency to the foreign one.

Let's look at this with an example. Assuming your are from the United States, your domestic cur-
rency is the US dollar. In this case, a USD/GBP quote of 0.66 will be a direct quote for you and it
will mean that one US dollar can buy 0.66 GB pounds. Conversely, if you were not from the US,
but from the UK, you would see USD/GBP quote of 0.66 as an indirect one, where one US dollar
could be bought for 0.66 GBP, yet you would not be provided with the knowledge of how many US
dollars can be bought with one unit of your domestic currency without calculating it.

In other words, a Forex direct quote shows how many foreign currency units could be bought for a
single unit of your domestic currency. This is rather simple and useful for people that want to easily
transfer foreign prices into the currency that is more common for them.

Now let's use the example of a European citizen who is visiting the USA. As you know that the
EUR/USD rate is 1.23456, you can simply divide all of the prices you see by 1.23456 to determine
the EUR value of what you have bought.

INDIRECT QUOTE

Indirect quotes show the exact opposite of direct quotes. Instead of displaying the value of a for-
eign currency in the domestic one, it shows the value of the domestic currency in a foreign one.
Here's an example of an indirect Forex quote. Assume you are from a European country, where
the local currency is EUR and you are seeing a quote as USD/EUR 0.8765. This means that one
US dollar is sold for 0.8765 euros. However, you have to note that if you were an American, this
quote would be a direct one for you.

As you can see, an indirect quote is a little bit harder to understand, as you are seeing the amount
of foreign currency you can get for one unit of your base currency. Still, this can be quite easy to
use. Whenever you are travelling to a foreign country and you see an indirect quote, you can simp-
ly multiply the amount of your purchase by the indirect quote to calculate the value in your domes-
tic currency.

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For example, if you are a European travelling to the US and you want purchase a laptop for 1,500
USD, knowing the USD/EUR Forex indirect quote of 0.8500, you can perform the following calcula-
tion: 1,500 USD x 0.8500 and you will see that your purchase will amount to 1,275 EUR.
Remember that with a direct quote you had to divide. Well, as the indirect quote is opposite to a
direct one, the division is substituted with a multiplication. In the case of a direct quote of
EUR/USD 1.17647, you would need to divide 1,500 USD (the price of the laptop) by the direct
quote of 1.17647 and you will get exactly the same price in Euros - 1,275 EUR.

CROSS EXCHANGE RATE
A cross rate is the currency exchange rate between two currencies when neither are official cur-
rencies of the country in which the exchange rate quote is given. Foreign exchange traders use the
term to refer to currency quotes that do not involve the U.S. dollar, regardless of what country the
quote is provided in.
CURRENCY CONVERSION
Example 1
In this case we select the row by the currency we are converting from, and the column by the cur-
rency we are converting to.

For example, to convert 2000 Chinese Yuan to Japanese yen, we choose the row for CNY and the
column for JPY.

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So, 2000 CNY = 13.290 x 2000 JPY
= 26580 JPY

Example 2

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TRANSACTION COSTS IN FOREIGN EXCHANGE
BID/ASK SPREAD OF BANKS
Bid/Ask Spread of Banks. Commercial banks charge fees for conducting foreign exchange trans-
actions. At any given point in time, a bank’s bid (buy) quote for a foreign currency will be less than
its ask (sell) quote. The bid/ask spread represents the differential between the bid and ask quotes,
and is intended to cover the costs involved in accommodating requests to exchange currencies.
The bid/ask spread is normally expressed as a percentage of the ask quote

Example 1(e):
To understand how a bid/ask spread could affect you, assume you have $1,000 and plan to travel
from the United States to the United Kingdom. Assume further that the bank’s bid rate for the Brit-
ish pound is $1.52 and it’s asked rate is $1.60. Before leaving on your trip, you go to this bank to
exchange dollars for pounds. Your $1,000 will be converted to 625 pounds (£), as follows:

Amount is U.S.dollars to be converted $1.00
Price charged by bank per pound = $1.60 =£625

Now suppose that because of an emergency you cannot take the trip, and you reconvert the £625
back to U.S. dollars, just after purchasing the pounds. If the exchange rate has not changed, you
will receive
£625 × (Bank’s bid rate of $1.52 per pound) = $950.
Due to the bid/ask spread, you have $50 (5 percent) less than what you started with. Obviously,
the dollar amount of the loss would be larger if you originally converted more than $1,000 into
pounds.
Bid-Ask Spread are used to calculate the fee that are charged by the bank
Bid = the price at which the bank is willing to buy
Ask = the price it will sell the currency

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COMPARISON OF BID/ASK SPREAD AMONG CURRENCIES

The differential between a bid quote and an ask quote will look much smaller for currencies that
have a smaller value. This differential can be standardized by measuring it as a percentage of the
currency’s spot rate.

BOND AND STOCK MARKET IN INTERNATIONAL FINANCIAL MARKETS

BOND

A bond is a formal debt instrument that obligates the borrower to repay a stated amount, referred
to as the principal or face amount, at a specified maturity date. In return for the use of the money
borrowed, the borrower also agrees to pay interest over the life of the bond.

Bonds usually are issued to many lenders, while notes most often are issued to a single lender
such as a bank. Traditionally, interest on bonds is paid twice a year (semiannually) on designated
interest dates, beginning six months after the original bond issue date.

For most large corporations, bonds are sold, or underwritten, by investment houses. The three
largest bond underwriters are JPMorgan Chase, Citigroup, and Bank of America. The issuing
company—the borrower—pays a fee for these underwriting services. Other costs include legal,
accounting, registration, and printing fees. To keep costs down, the issuing company may choose
to sell the debt securities directly to a single investor, such as a large investment fund or an insur-
ance company. This is referred to as a private placement.

Thus a bond is like a loan: the issuer is the borrower (debtor), the holder is the lender (creditor),
and the coupon is the interest. Bonds provide the borrower with external funds to finance long-term
investments, or, in the case of government bonds, to finance current expenditure.

Bonds and stocks are both, securities but the major difference between the two is that (capital)
stockholders have an equity stake in the company (i.e., they are owners), whereas bondholders
have a creditor stake in the company (i.e., they are lenders). Another difference is that bonds usu-
ally have a defined term, or maturity, after which the bond is redeemed, whereas stocks may be
outstanding indefinitely. An exception is a console bond, which is perpetuity (i.e., bond with no ma-
turity).

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FEATURES OF BONDS

The most important features of a bond are:
 Nominal, Principal or Face Amount—The amount over which the issuer pays interest, and
which has to be repaid at the end.
 Issue price—The price at which investors buy the bonds when they are first issued. The net
proceeds that the issuer receives are calculated as the issue price, less issuance fees,
times the nominal amount.
 Maturity date—The date on which the issuer has to repay the nominal amount. As long as
all payments have been made, the issuer has no more obligations to the bond holders after
the maturity date. The length of time until the maturity date is often referred to as the term
or maturity of a bond.
 Coupon—The interest rate that the issuer pays to the bond holders. Usually this rate is
fixed throughout the life of the bond. The name coupon originates from the fact that in the
past, physical bonds were issued which had coupons attached to them. On coupon dates
the bond holder would give the coupon to a bank in exchange for the interest payment.
 Coupon dates—The dates on which the issuer pays the coupon to the bond holders. It can
be paid quarterly, semi-annually or annually.

TYPES OF BOND

1. Zero-Coupon Bonds:

 This is a type of bond that makes no coupon payments but instead is issued at a con-
siderable discount to par value. For example, let's say a zero-coupon bond with a
$1,000 par value and 10 years to maturity is trading at $600; you'd be paying $600
today for a bond that will be worth $1,000 in 10 years. The issue price of Zero Cou-
pon Bonds is inversely related to their maturity period, i.e. longer the maturity period
lesser would be the issue price and vice-versa.

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2. High-Yield Bonds:

 High yield (non-investment grade) bonds are from issuers that are considered to be at
greater risk of not paying interest and/or returning principal at maturity. As a result, the is-
suer will offer a higher yield than a similar bond of a higher credit rating and, typically, a
higher coupon rate to entice investors to take on the added risk.

3. Corporate Bonds:

 These are issued by large corporations and have higher yields because there is a higher
risk of a company defaulting as compared to government bonds.

4. Government Bonds:

 These are the bonds issued by government in its own currency. They are usually referred
to as risk-free bonds. Bonds issued by national governments in foreign currencies are re-
ferred to as sovereign bonds.

5. Convertible Bonds:

 The holder of a convertible bond has the option to convert the bond into equity (in the same
value as of the bond) of the issuing firm (borrowing firm) on pre-specified terms.

 Convertible bonds may be fully or partly convertible. For the part of the convertible bond
which is redeemed, the investor receives equity shares and the non-converted part remains
as a bond.

6. Inflation-indexed (or inflation-linked) Bond:

 It provides protection against inflation, and is designed to cut out the inflation risk of an in-
vestment.

7. Extendible and Retractable Bonds:

 Extendible and Retractable bonds have no fixed maturity date.
 While the maturity period of extendible bonds can be extended on the demand of the buyer

of these bonds, the maturity period of retractable bond can be reduced and the principal
amount returned to the buyer if he feels so.

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8. Floating Rate Bonds:

 Floating Rate Notes are bonds in which interest rate depends on the interest rate pre-
vailing in the market. The interest rate paid to the bondholder at regular intervals com-
prises of the interest rate prevailing in the market and ‘spread’, which is a rate that is
fixed when the prices of the bond are being fixed and it remains constant till the maturi-
ty period of the bond.

9.Perpetual Bonds:

 Perpetual Bonds, which are also known as the name of Consol, are the bonds which
have no maturity period and keep on paying interest to the investors regularly. The is-
suer of Perpetual Bonds is not required to redeem these bonds. They are generally
treated as equity and not as loan / debt.

Some other Types of bonds:

Asset Backed Securities, subordinated bonds, Bearer Bonds, Municipal Bonds, Lottery Bonds,
War Bonds.

RISKS OF INVESTING IN BONDS

 Interest rate risk when interest rates rise, bond prices fall; conversely, when rates de-
cline, bond prices rise. The longer the time to a bond’s maturity, the greater its interest
rate risk.

 Reinvestment risk when interest rates are declining, investors have to reinvest their in-
terest income and any return of principal, whether scheduled or unscheduled, at lower
prevailing rates.

 Inflation risk Inflation causes tomorrow’s Ringgit Malaysia (RM) to be worth less than
today’s; in other words, it reduces the purchasing power of a bond investor’s future in-
terest payments and principal, collectively known as “cash flows.” Inflation also leads to
higher interest rates, which in turn leads to lower bond prices.

 Market risk The risk that the bond market as a whole would decline, bringing the value
of individual securities down with it regardless of their fundamental characteristics.

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Default risks The possibility that a bond issuer will be unable to make interest or principal pay-
ments when they are due. If these payments are not made according to the agreements in the
bond documentation, the issuer can default

Call risk Some corporate, municipal and agency bonds have a “call provision” entitling their issu-
ers to redeem them at a specified price on a date prior to maturity. Declining interest rates may
accelerate the redemption of a callable bond, causing an investor’s principal to be returned sooner
than expected. In that scenario, investors have to reinvest the principal at the lower interest rates.

If the bond is called at or close to par value, as is usually the case, investors who paid a premium
for their bond also risk a loss of principal. In reality, prices of callable bonds are unlikely to move
much above the call price if lower interest rates make the bond likely to be called.

Liquidity risk The risk that investors may have difficulty finding a buyer when they want to sell and
may be forced to sell at a significant discount to market value.

they are due and therefore default.

Event risk The risk that a bond’s issuer undertakes a leveraged buyout, debt restructuring, merger
or recapitalization that increases its debt load, causing its bonds’ values to fall, or interferes with its
ability to make timely payments of interest and principal. Event risk can also occur due to natural
or industrial accidents or regulatory change. (This risk applies more to corporate bonds than mu-
nicipal bonds.)

WHAT IS SHARE

Shares represent a fraction of ownership in a business. The common feature of all these is equity
participation. Different classes of shares have different voting rights.

Ownership of shares is documented by a legal document that specifies the amount of shares
owned by the shareholder, and other specifics of the shares, such as the par value or the class of
the shares (if any).

These days these stock certificates have been dematerialized.(No physical document!)

STOCK

The amount is invested or contributed by the investors and then they are collectively sold and pur-
chased by new or existing investors through various means such as brokers of stock market /

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companies etc. , thus directly or indirectly giving birth or using the STOCK MARKET (Share Mar-
ket).
WHAT IS STOCK MARKET?

• A stock market or equity market is a public entity for the trading of company stock (shares)
and derivatives at an agreed price; these are securities listed on a stock exchange as well
as those only traded privately.

• For example, if a company has 1000 shares of stock outstanding and a person owns 50 of
them, then he/she owns 5% of the company.

Stock divide by two, which is:
 Common stock is ownership in a company…stocks traded on the open market.
Those who own these stocks earn a dividend from their share of the company profits.
Some companies such as Microsoft don't pay dividends, and never have any intentions of
doing so.
The obvious risk with common stock is that the price may fall and you risk losing what you
have invested. A good thing about common stock is that you can not lose more than your
initial investment.
 Preferred Stock sold by companies and is then traded among investors on the secondary
market. Preferred stock is less risky than common stock, therefore investors can expect
less reward.
Like Bonds (which give interest payments to the owner), preferred stocks give regular divi-
dends for a period of time. There is no hope for making big money (large capital gains) but
these are also less risky than common

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IQ TEST CHAPTER 1

PART A: Fill in the blank

a. The market in which currencies are exchanged is generally known as the _____________ .
b. The market in which the immediate exchange of currencies takes place is known as the _____

market.
c. The market in which the future exchange of currencies takes place is known as the _________

market.
d. An arrangement between countries known as the _______________ Agreement called for

fixed exchange rates between currencies in 1944.
e. A bank will buy a foreign currency at the ________________ quote and will sell a foreign cur-

rency at the ____________ quote.
f. A currency ___________ option provides the right, but not the obligation, to buy a specific cur-

rency at a specific price within a specific period of time.
g. A currency put option provides the right, but not the obligation, to _____________ a specific

currency at a specific price within a specific period of time.
h. A _______________________ expresses the amount of one foreign currency per unit of an-

other foreign currency.
i. A _____________ is the sale (purchase) of a foreign currency with a simultaneous agreement to

repurchase (resell) it at some date in the future.
j. The ______________________ represents the differential between the bid and ask quotes,

and is intended to cover the costs involved in accommodating requests to exchange curren-
cies.

PART B: Problem scenario

(a) (i) State the terms and quote below.
(a) GBP0.6766: based____________________: quoted in _______________terms.
(b) CAD1.3456: based____________________: quoted in _______________terms.
(c) AUD0.3212: based____________________: quoted in _______________terms.
(d) EUR1.5986: based____________________: quoted in _______________terms.
(e) CZK0.6726:based_____________________: quoted in _______________terms.

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(ii) Fill in the blank codes for selected currencies. Codes
No. Currency

1. Argentina Peso

2. CZK

3. Omani Rial

4. KRW

5. Euro

6. VND

7. BND

8. Saudi Arabian Riyal

9. HKD

10. CNY

b)
(i)

(ii) A bank exchanges 1 British pound (GBP) for 1:9 Australian dollars (AUD). Convert:

a. 40 GBP to AUD
b. 500 AUD to GBP.

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(iii) Maybank offers the following exchange rate between Ringgit Malaysia (MYR) and Rupiah
(IDR). The bank sells 1MYR for 0.82 IDR and buys 1MYR for 0.78 IDR. A customer wishes to
exchange 800 MYR for IDR.
a. Find how many IDR the customer will receive.
b. The customer has to cancel his trip and change his money back later, when the rate
are “sell 1 MYR = 0.815 IDR, buys 1 MYR=0.779 IDR”, used the “sell” information to
find how many MYR he receives.

(iv) A currency exchange service exchanges 1 euro for Japanese yen with the buy rate 135:69,
and sell rate 132:08. Azman wishes to exchange 800 euros for yen.

a. How many yen will he receive?
b. b If the yen in a were exchanged immediately back to euros, how many euros would

they be worth?

(v) For questions 1 to 4, suppose you are a citizen of the USA and use the currency table below.

1. On holiday you set aside 300 USD to spend in each country you visit. How much local
curency can you buy in:
(a) Europe (euros)
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(b) the United Kingdom c Singapore d Australia?
2. Find the cost in USD of:

(a) 400 Canadian dollars
(b) 730 Swiss francs
(c) U12430
(d) 4710 DKK.
3. Find the price in American dollars of:
(a) a computer worth 7000 Hong Kong dollars
(b) a rugby ball worth 35 NZD
(c) a watch worth 949 SAR.
4. Find how many US dollars you could buy for:
(a) €2500
(b) 57000 rand
(c) $165
(d) 86370 baht.

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