International Corporate Finance: Value Creation with Currency Derivatives in Global Capital Markets, + Website

CHAPTER 5

The Foreign Exchange Market

The price of an article is charged according to difference in location, time, or risk to which one is exposed in carrying it from one place to another or in causing it to be carried. Neither purchase nor sale according to this principle is unjust.

Saint Thomas Aquinas, ca. 1264

If there were a single world currency, there would be no need for a foreign exchange market. At its simplest, the raison d'être of the foreign exchange market is to enable the transfer of purchasing power from one currency into another, thereby facilitating the international exchange of goods, services, and financial securities. Trade carried over great distances is probably as old as humankind and has long been a source of economic power for the nations that embraced it. Indeed, international trade seems to have been at the vanguard of human progress and civilization: The Phoenicians, Greeks, and Romans were all great traders whose activities were facilitated by marketplaces and money changers, both of which set fixed places and fixed times for exchanging goods. From time immemorial traders have been faced with several problems: how to pay for and finance the physical transportation of merchandise from point A to point B, which could be several hundreds or thousands of miles away and weeks or months away; how to insure the cargo (from the risk of being lost at sea or to pirates or bandits); and last, how to protect against price fluctuations in the value of the cargo ...