· Cable and Mail Transfers
Several financial instruments are used to facilitate foreign exchange trading. One of the most important is the cable transfer, an execute order sent by cable to a foreign bank holding a currency seller's account. The cable directs the bank to debit the seller's account and credit the account of a buyer or someone the buyer designates.
The essential advantage of the cable transfer is speed because the transaction can be carried out the same day or within one or two business days. Business firms selling their goods in international markets can avoid tying up substantial sums of money in foreign exchange by using cable transfers.
When speed is not a critical factor, a mail transfer of foreign exchange may be used. Such transfers are written orders from the holder of a foreign exchange deposit to a bank to pay a designated individual or institution on presentation of a draft. A mail transfer may require days to execute, depending on the speed of mail deliveries.
· Bills of Exchange
One of the most important of all international financial instruments is the Bill of Exchange. Frequently today the word draft is used instead of bill. Either way, a draft or bill of exchange is a written order requiring a person, business firm, or bank to pay a specified sum of money to the bearer of the bill.
We may distinguish sight bills, which are payable on demand, from time bills, which mature at a future date and are payable only at that time. There are also documentary hills, which typically accompany the international shipment of goods. A documentary bill must be accompanied by shipping papers allowing importers to pick up their merchandise. In contrast, a clean hill has no accompanying documents and is simply an order to a bank to pay a certain sum of money. The most common example arises when an importer requests its bank to send a letter of credit to an exporter in another country. The letter authorizes the exporter to draw bills for payment, either against the importer's bank or against one of its correspondent banks.
· Foreign Currency and Coin
Foreign currency and coin itself (as opposed to bank deposits) is an important instrument for payment in the foreign exchange markets. This is especially true for tourists who require pocket money to pay for lodging, meals, and transportation. Usually this money winds up in the hands of merchants accepting it in payment for purchases and is deposited in domestic banks. For example, U.S. banks operating along the Canadian and Mexican borders receive a substantial volume of Canadian dollars and Mexican pesos each day. These funds normally are routed through the banking system back to banks in the country of issue, and the U.S. banks receive credit in the form of a deposit denominated in a foreign currency. This deposit may then be loaned to a customer or to another bank.
· Other Foreign Exchange Instruments
A wide variety of other financial instruments are denominated in foreign currencies, most of this small in amount. For example, traveler's checks denominated in dollars and other convertible currencies may be spent directly or converted into the currency of the country where purchases are being made. International investors frequently receive interest coupons or dividend warrants denominated in foreign currencies. These documents normally are sold to a domestic bank at the current exchange rate.
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III. Foreign exchange rates
Determining foreign exchange rates
As I’ve already mentioned the prices of foreign currencies expressed in terms of other currencies are called foreign exchange rates. There are today three markets for foreign exchange: the spot market, which deals in currency for immediate delivery; the forward market, which involves the future delivery of foreign currency; and the currency futures and options market, which deals in contracts to hedge against future changes in foreign exchange rates. Immediate delivery is defined as one or two business days for most transactions. Future delivery typically means one, three, or six months from today.
Dealers and brokers in foreign exchange actually set not one, but two, exchange rates for each pair of currencies. That is, each trader sets a bid (buy) price and an asked (sell) price. The dealer makes a profit on the spread between the bid and asked price, although that spread is normally very small.