Introduction to Corporate Finance

17: International Investment Decisions

sell their home currencies and buy dollars. Buying pressure from investors causes the dollar to appreciate

against foreign currencies. In general, the pressures exerted on currencies by investors are much

larger than those exerted by exporters and importers, because investors account for a larger fraction

of currency trading volume. For example, the total value of goods and services traded internationally

each year is about $16 trillion, which is equivalent to about four days’ worth of global currency trading.

Figure 17.3 shows daily averages for foreign exchange market turnover, by counterparty. It suggests

that the market share of turnover attributable to non-financial institutions is less than 10%.

In January 2011, the central bank of Peru announced
that it would raise a benchmark interest rate by
0.25%. Other things being equal, higher interest
rates tend to put upward pressure on a country’s

exchange rates because of capital inflows from

foreign investors. On the same day that Peru

announced the rate hike, Peru’s currency, the sol,

reached a 33-month high.

example

FIGURE 17.3 GLOBAL FOREIGN EXCHANGE MARKET TURNOVER BY COUNTERPARTY^1

Net—net basis, daily averages in April

2001–2013

USD bn

2013 Breakdown of other financial

institutions

0

1000

2000

3000

4000

5000

01

Reporting dealers

Non-financial customers

Other financial institutions

39% 53%

9%

Reporting dealers

Non-financial customers

Other financial institutions

24%

11%

11%

6%

1%

Non-reporting banks

Institutional investors

Hedge funds and PTFs^2

Official

sector

Other

04 07 10 13

1 Adjusted for local and cross-border inter-dealer double-counting; i.e. ‘net bank’ basis.

2 Proprietary trading firms

Source: Bank for International Settlements 2013. All rights reserved. April 2013: Preliminary Global Results, Monetary and Economic Department, Bank for International Settlements, September 2013, Graph 2, page 6.

Sometimes traders in the foreign exchange market buy and sell currency to offset other risks to which they

are exposed during the normal course of business. Hedging refers to the practice of trading an asset for the sole

purpose of reducing or eliminating the risk associated with some other asset. For example, suppose that an

Australian company expects to receive a £1,000,000 payment from a customer in the United Kingdom. The

payment is due in 90 days. This receivable is risky from the Australian company’s perspective, because the

exchange rate between dollars and pounds may fluctuate over the next 90 days. To hedge the risk of its pound-

denominated receivable, the Australian company might enter a forward contract to sell pounds for dollars in

90 days. By doing so, the company essentially locks in a dollar value for the £1,000,000 payment.

Hedgers influence currency values when they take positions to offset the risks of their existing exposures

to certain currencies. In contrast, speculators take positions to make a profit. Speculators sell a currency if

hedging

Trading an asset for the

sole purpose of reducing or

eliminating the risk associated

with some other asset