CHAPTER FOUR

ROLE OF FINANCIAL MARKET IN THE FINANCIAL

SYSTEM
4.1 The organization and structure of markets
4.1.1 The organization of markets
 A Market is an institutional mechanism where supply and demand meet to exchange goods and services; or
a place or event at which people gather in order to buy and sell things in order to trade. Exciting with many
different functions, the financial system fulfills its various roles mainly through markets where financial
claims and financial services are traded.
 These markets may be viewed as channels through which moves a vast flow of loan able funds that
continually being drawn upon by demanders of funds and continually being replenished by suppliers of
funds. Filled with a desire to lend or to borrow, the end users of most financial systems are faced with a
choice between three broad approaches:
 Firstly, they may decide to deal directly with another, which is costly, risky, inefficient, consequently;
and not very likely.
 More typically, they may decide to use one or more of many organized markets. In these markets,
lenders buy the liabilities issued by the borrowers. If the liability is newly issued, then the issuer
receives funds directly from the lender. More frequently, however, a lender will buy an existing liability
from another lender. In effect, this refinances the original loan though the borrower is completely
unaware of this secondary transaction.
 Alternatively, borrowers and lenders may decide to deal via intermediaries. In this case, lenders have an
asset – a bank deposit or contribution to a life insurance or pension fund – which cannot be traded but
can only be returned to the intermediary. Similarly, intermediaries create liabilities, typically in the form
of loans for borrowers. These remain in the intermediaries balance sheets until they are repaid.
Intermediaries themselves will also make use of markets, issuing security to finance some of their
activities and buying shares and bonds as part of their asset portfolio.
4.1.2 The role of markets in an economy
 The financial markets perform a vital function within the economic system. The financial markets channel
savings which come mainly from households to those individuals and institutions who need more money
(funds) for spending than are provided by current income.
 It is known that the basic function of any economy is to allocate scarce resources in order to produce the
goods and services needed by society.

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Figure 1: Circular flow of production and payment.

Land and other Flow of Goods and Services

Production
Natural resources Sold to the public
Labor and managerial Flow of
Payments
skills
Capital equipment
 The diagram shows that the system is just a circular flow between producing units (mainly business and
government) and consuming units (mainly households). In modern economies, households provide labor,
management skills, and natural resources to business firms and governments in return for income in the
form of wages, rents and dividends.
 Therefore, one can see that markets are used to carry out the task of allocating resources which are scarce
relative to the demand of the society. Here we are referring to the markets which are different from the
financial markets; the goods market and the factor markets.
4.2 The Structure of Markets
 It is known that the basic function of any economy is to allocate scarce resources in order to produce the
goods and services needed by society. In modern economies, households provide labor, management skills,
and natural resources to business firms and governments in return for income in the form of wages, rents
and dividends.
 Consequently, one can see that markets are used to carry out the task of allocating resources which are
scarce relative to the demand of the society. Here we are referring to the markets which are different from
the financial markets, the goods market and the factor markets.
 These are:- Factor markets, Product market and Financial markets.
a) Factor markets: - are markets where consuming units sell their labor, management skill, and other
resources to those producing units offering the highest prices. i.e. this market allocates factors of
production (Land, labor and capital) and distribute incomes in the form of wages, rental income and so
on to the owners of productive resources.
b) Product market: - are markets where consuming units use most of their income from the factor markets
to purchase goods and services i.e. this market includes the trading of all goods and services that the
economy produces at a particular point in time.
c) Financial markets: - There are markets in which flow of funds, flow of financial services, income and
financial claims is affected i.e. essentially; financial markets do have three main tasks. These are:
1. They determine the nature of credit available at a macroeconomic level;
2. They attract savers and borrowers; and
3. They set interest rate and security prices.

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 Allocating resources which are scarce relative to the demand of society, one can see that the market place
determines what goods and services will be produced and in what quantity. This is accomplished mainly
through changes in the prices of commodities and services offered in the market.
 In addition, it is easy to understand that markets also distribute income. In a pure market system, the income
of an individual or business firm is determined solely by the contributions each makes to production.
 Markets provide superior productivity, innovation and sensitivity to consumer needs with increased profits,
higher wages and other economic benefits.
4.3 Importance of Financial Markets in the Economy
 Financial markets perform the essential economic function of channeling funds from households, firms, and
governments that have saved surplus funds by spending less than their income to those that have a shortage
of funds because they wish to spend more than their income.
 The principal lender-savers are households, but business enterprises and the government (particularly state
and local government), as well as foreigners and their governments, also sometimes find themselves with
excess funds and so lend them out.
 The most important borrower-spenders are businesses and the government but households and foreigners
also borrow to finance their purchases of cars, furniture, and houses.
 The first way is the direct finance, in which borrowers borrow funds directly from lenders in financial
markets by selling them securities (also called financial instruments), which are claims on the borrower’s
future income or assets.
 The second route is called indirect finance, because it involves a financial intermediary that stands between
the lender-savers and the borrower-spenders and helps transfer funds from one to the other. A financial
intermediary does this by borrowing funds from the lender-savers and then using these funds to make loans
to borrower-spenders.
 For example, a bank might acquire funds by issuing a liability to the public (an asset for the public) in the
form of savings deposits. It might then use the funds to acquire an asset by making a loan to firms or by
buying a bond in the financial market. The ultimate result is that funds have been transferred from the public
(the lender-savers) to the borrower-spender with the help of the financial intermediary (the bank).
 The process of indirect finance using financial intermediaries called financial intermediation is the primary
path for moving funds from lenders to borrowers.
 Why is this channeling of funds from savers to spenders so important to the economy? The answer is
that the people who save are frequently not the same people who have profitable investment opportunities
available to them, the entrepreneurs. Without financial markets, it is hard to transfer funds from a person
who has no investment opportunities to one who has them; both of them would be stuck with the status quo,

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 and both would be worse off. Financial markets are hence essential to promoting economic efficiency. Thus
financial markets are critical for producing an efficient allocation of capital, which contributes to higher
production and efficiency for the overall economy.
 Well-functioning financial markets also directly improve the well-being of consumers by allowing them to
time their purchases better. They provide funds to young people to buy what they need and can eventually
afford without forcing them to wait until they have saved up the entire purchase price. Financial markets
that are operating efficiently improve the economic welfare of everyone in the society.
4.4 Formation of Financial Markets within the Financial System
 Depending on the characteristics of financial claims being traded and the needs of different investors, the
flow of funds through financial markets around the world may be divided into different segments.
 These include: The Money Market and Capital Market; Primary and Secondary Markets; Open and
Negotiated Markets as well as Spot; Futures, Forward, and Option Markets.
1. The Money Market versus the Capital Market
 Money is a medium of exchange which ensures the success of exchange by being the one item on offer that
is always acceptable. Money is necessary because human beings must exchange to live together in peace,
and to prosper.
 One of the most important divisions in the financial system is between money market and the capital
market. The money market is designed for the making of short-term loans. It is the institution through which
individuals and institutions with temporary surpluses of funds meet the needs of borrowers who have
temporary funds shortages (deficits). Thus, the money market enables economic units to manage their
liquidity positions.
 By conventions, a security or loan maturing within one year or less is considered to be a money market
instrument. One of the principal functions of the money market is to finance the working capital needs of
corporations and to provide governments with short-term funds in lieu of tax collections. The money market
also supplies funds for speculative buying of securities and commodities.
 In other words, the money market is the global financial market for short-term borrowing and lending. It
provides short-term liquid funding for the global financial system. The money market is a sector of the
capital market where short-term obligations such as Treasury bills, commercial paper and bankers'
acceptances are bought and sold.
 A money market consists of financial institutions and dealers in money or credit who wish to either borrow
or lend. Participants borrow and lend for short periods of time, typically up to twelve months.
 Money market trades in short term financial instrument commonly called "paper". This contrasts with the
capital market for longer-term funding, which is supplied by bonds and equity.

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 In contrast, the capital market is designed to finance long-term investments by businesses, governments and
households. Trading of funds in the capital market makes possible the construction of factories, highways,
schools, and homes. Financial instruments in the capital market have original maturities of more than one
year and range in size from small loans to multimillion Birr credits.
 The capital market includes the stock market, the bond market, and the primary market. Securities trading
on organized capital markets are monitored by the government; new issues are approved by authorities of
financial supervision and monitored by participating banks. This market brings together all the providers
and users of capital.
 Financial products such as stocks, bonds, mutual funds, and insurance make the transfer of capital possible.
Financial intermediaries, such as banks, brokerage firms, and insurance companies facilitate the transfer of
capital. Capital market is the broad term for the market where investment products such as stocks and bonds
are bought and sold. It includes all the people and organizations which support the process. Such markets
may not necessarily have a physical presence.
 The capital markets consist of the primary market, where new issues are distributed to investors, and the
secondary market, where existing securities are traded. So it is the market in which corporate equity and
longer-term debt securities (those maturing in more than one year) are issued and traded. It consists of a
market for medium to long-term financial instruments; financial instruments traded in the capital market
include shares, and bonds issued by the government, state governments, corporate borrowers and financial
institutions.
 The capital market is the market for long-term loans and equity capital. The capital market (securities
market) is the market for securities, where companies and the government can raise long-term funds. A
security is a fungible, negotiable instrument representing financial value. Securities are broadly categorized
into debt and equity securities such as bonds and common stocks, respectively. The company or other entity
issuing the security is called the issuer.
 Who are the principal suppliers and demanders of funds in the money market and the capital
market? In the money market, commercial banks are the most important institutional supplier of funds
(lender) to both business firms and governments. Non financial business corporations with temporary cash
surpluses also provide substantial short-term funds to the money market.
 On the demand-for-funds side, the largest borrower in the money market is the Treasury Department, which
borrows billions of Birr frequently. Other governments around the world are very often among the leading
borrowers in their own domestic money markets. The largest and best-known corporations and securities
dealers are also active borrowers in money markets around the world. Due to the large size and strong
financial standing of these well-known money market borrowers and lenders, money market instruments are
considered to be high-quality ,”near money” IOUs (promises to pay).
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 Quite the reverse, the principal suppliers and demanders of funds in the capital market are more varied than
in the money market. Families and individuals, for example, tap the capital market when they borrow to
finance a new home. Governments rely on the capital market for funds to build schools and highways and
provide essential services to the public.
 Ranged against these many borrowers in the capital market are financial institutions, such as insurance
companies, mutual funds, security dealers, and pension funds that supply the bulk of capital market funds.
 The money market and the capital market may be further subdivided into smaller markets, each important to
selected groups of demanders and suppliers of funds. Within the money market, for example, is the huge
Treasury bill market. Treasury bills-short-term IOUs issued by many governments around the world-are a
safe and popular investment medium for financial institutions, corporations of all sizes, and wealthy
individuals.
 Somewhat larger in volume is the market for certificates of deposit (CDs) issued by the best known banks
and other depository institutions to raise funds in order to carry on their lending activities.
 The capital market, too, is divided into several sectors, each having special characteristics. For example, one
of the largest segments of the capital market is devoted to residential and commercial mortgage loans to
support the building of homes and business structures, such as factories and shopping centers. Households
(individuals and families around the world) borrow in yet another segment, using consumer loans to make
purchases ranging from automobiles to home appliances. There is also an international capital market for
borrowing by large corporations represented by Eurobonds and Euronotes.
 Probably the best-known segment of the capital market is the market for corporate stock represented by the
major exchanges, such as the New York Stock Exchanges (NYSE) and the Tokyo Exchanges, and a vast
over the –counter (OTC) market including electronic stock trading over the internet.
 No matter where it is sold, each share of stock (equity) represents a certificate of ownership in a corporation,
entitling the holder to receive any dividends paid out of current earnings. Corporations also sell a huge
quantity of corporate notes and bonds in the capital market each year to raise long-term funds. These
securities, unlike shares of stock, are pure IOUs, evidencing a debt owed by the issuing company.
2. Open versus Negotiated Markets
 Another distinction between markets in the global financial system that is often useful focuses on open
markets versus negotiated markets.
 For example, some corporate bonds are sold in the open market to the highest bidder and are bought and
sold any number of times before they mature and are paid off. In contrast, in the negotiated market for
corporate bonds, securities generally are sold to one or a few buyers under private contract.

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 An individual who goes to his or her local banker to secure a loan for a new car enters the negotiated market
for auto loans. In the market for corporate stocks, there are the major stock exchanges, which represent the
open market operating at the same time, however, in the negotiated market for stock in which a corporation
may sell its entire stock issue to one or a handful of buyers.
3. Primary versus Secondary Markets
 The global financial markets may also be divided into primary markets and secondary markets. Primary
Market, also called the new issue market, is the market for issuing new securities. Many companies,
especially small and medium scale, enter the primary market to raise money from the public to expand their
businesses.
 They sell their securities to the public through an initial public offering. The securities can be directly
bought from the shareholders, which is not the case for the secondary market. The primary market is a
market for new capitals that will be traded over a longer period.
 In the primary market, securities are issued on an exchange basis. The underwriters, that is, the investment
banks, play an important role in this market: they set the initial price range for a particular share and then
supervise the selling of that share. Investors can obtain news of upcoming shares only on the primary
market. The issuing firm collects money, which is then used to finance its operations or expand business by
selling its shares.
 Before selling a security on the primary market, the firm must fulfill all the requirements regarding the
exchange. After trading in the primary market the security will then enter the secondary market, where
numerous trades happen every day.
 The primary market accelerates the process of capital formation in a country's economy. The primary
market excludes several other new long-term finance sources, such as loans from financial institutions.
Many companies have entered the primary market to earn profit by converting its capital, which is basically
a private capital, into a public one, releasing securities to the public. This phenomena is known as "public
issue" or "going public."
 There are three methods through which securities can be issued on the primary market. These are:
 Rights issue,
 Initial Public Offer (IPO), and
 Preferential issue.
 A company's new offering is placed on the primary market through an initial public offer.
 Firms raise new capital in a primary market transaction by issuing new securities (stocks or bonds) once and
these securities subsequently trade in the secondary market forever. 

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 Initial public offering (IPO) is stock issued for the very first time to the public when a company "goes
public."  The holders of these stocks can have the following rights:
 Preemptive rights - on issuance of additional share allows existing investors to maintain their
ownership position (as a percentage) when new stock is issued.  Without this right investors would
have their ownership interest diluted. 
 Rights of offering - allow existing stockholders to buy additional shares in the company at a
subscription price that is generally lower than the market price. Rational stock holders will either
exercise the right or sell it (those who let it expire will find out that the market value of their
remaining holding shrinks-the market price will almost certainly drop when the rights are exercised
since the subscription price is much lower than the market
 In contrast, the secondary market deals in securities previously issued. Its chief function is to provide
liquidity to security investors-that is, provide an avenue for converting financial instruments into ready cash.
If you sell shares of stock or bonds you have been holding for some time to a friend or call a broker to place
an order for shares currently being traded on the stock exchanges, you are participating in a secondary-
market transaction.
 In other words, Secondary Market is the market where, unlike the primary market, an investor can buy a
security directly from another investor in lieu of the issuer. It is also referred as "after market".
 The securities initially are issued in the primary market, and then they enter into the secondary market. All
the securities are first created in the primary market and then, they enter into the secondary market. In other
words, secondary market is a place where any type of used goods is available. In the secondary market
shares are maneuvered from one investor to other. That is, one investor buys an asset from another investor
instead of an issuing corporation. So, the secondary market should be liquid.
 Secondary Market has an important role to play behind the developments of an efficient capital market. It
connects investors' favoritism for liquidity with the capital users' wish of using their capital for a longer
period. For example, in a traditional partnership, a partner cannot access the other partner's investment but
only his or her investment in that partnership, even on an emergency basis. Then he or she may breaks the
ownership of equity into parts and sell his or her respective proportion to another investor. This kind of
trading is facilitated only by the secondary market.
 The volume of trading in the secondary market is far larger than trading in the primary market. However,
the secondary market does not support new investment. Nevertheless, the primary and secondary markets
are closely intertwined. For example, a rise in security prices in the secondary market usually leads to a
similar rise in prices on primary-market securities, and vice versa. This happens because some investors will
switch from one market to another in response to differences in price or yield.

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 Furthermore, it is a market in which stocks once issued are traded –that is bought and sold by investors. For
example it includes the New York stock Exchange (NYSE), National Association of Securities Dealers
Automated Quotation (NASDAQ) and American Stock Exchange (AMEX). 
 Secondary market for equity serves two purposes: marketability and Share price valuation:
1. Marketability - allows buyers in the primary market to subsequently sell shares.  It would be hard to
sell stock in primary market if there wasn't a secondary market.
2. Share price valuation - active trading in secondary markets establishes a true fair market value of
stock.
 Secondary Market further classified as: Dealer Market; Agency Market; Fully Automated
Trading system; and Stock Market Indexes.
i. Dealer Market – OTC (Over the Counter), dealer network, like NASDAQ, where dealers
("market makers") specialize in buying/selling certain stocks. You are buying (selling) the stock
from (to) the dealer, not from (to) another investor, who holds the stock in his/her account. 

 Bid (dealer buys)

 Ask (dealer sells)
 Spread is the dealer's commission, For e.g., $5(bid)-$5.05(ask), 1% spread.    
If the market is very competitive; thus the spreads could be very lower.  No limits on the
number of dealers/market makers for a certain stock, and no limit on the number of stocks a
dealer can trade.  
ii. Agency Market – Agencies like AMEX and NYSE are organized as "floor-broker / specialist-
market-maker" centralized trading systems, where face-to-face trading takes place at a physical
location/trading floor.
The broker takes a buy (sell) order from a client/investor/trader, and matches it with a sell (buy)
order from another client/trader. It is more of an auction market.
iii. Fully Automated Trading system - It serves in the countries where trading is completely
automated. Quotations and trading takes place directly by computer.  Orders are filled faster, and
very few people are needed to operate an exchange.
iv. Stock Market Indexes - A Stock Market Index is composite value of a group of stocks traded on
secondary markets. Movements in a stock market index provide investors with information on
movements of a broader range of secondary market securities.
4. Spot versus Futures, Forward, and Option Markets
 We may also distinguish between spot markets, futures or forward markets, and option markets.

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 A spot market is one in which assets or financial services are traded for immediate delivery (usually within
one or two business days). If you pick up the telephone and instruct your broker to purchase X-Corporation
shares at today’s price, this is a spot market transaction. You expect to acquire ownership of X-Corporation
shares within a matter of minutes.
 A future or forward market, on the other hand, is designed to trade contracts calling for the future
delivery of financial instruments. For example, you may call your broker and ask to purchase a contract
from another investor calling for delivery to you of Birr 1 million in government bonds six months from
today. The purpose of such a contract would be to reduce risk by agreeing on a price today rather than
waiting six months, when government bond prices might have risen.
 Finally, options markets also offer investors in the money and capital markets an opportunity to reduce
risk. These markets make possible the trading of options on selected stocks and bonds, which are
agreements (contracts) that give an investor the right to either buy from or sell designated securities to the
writer of the option at a guaranteed price at any time during the life of the contract.
5. Debt versus Equity Markets:
 The issue of Debt market and Equity market has become very important in the modern day financial context
as a lot of companies are in need of generating money that allows them to execute a wide variety of
financial activities like initiation, expansion and acquisition.
 The question of equity and debt financing has been an important one for the business establishments for a
considerable period of time now. Since it is necessary to have a continuous stream of finances coming in the
company for various purposes these financial options have become very important. Thus, it is obvious that
the business enterprises need to be aware of the various implications of these two sources of financing and
make a decision after carefully reviewing their own needs as well as strengths and weaknesses.
 Debt instruments are particular types of securities that require the issuer (the borrower) to pay the holder
(the lender) certain fixed dollar amounts at regularly scheduled intervals until specified time (the maturity
date) is reached, regardless of the success or failure of any investment projects for which the borrowed
funds are used. An example of a debt instrument is a 30-year mortgage.
 In contrast, equity is a security that confers on the holder an ownership interest in the issuer. There are two
general categories of equities: "preferred stock" and "common stock."
 Common stock shares issued by a corporation are claims to a share of the assets of a corporation as well as
to a share of the corporation's net income -- i.e., the corporation's income after subtraction of taxes and other
expenses, including the payment of any debt obligations. This implies that the return that holders of
common stock receive depends on the economic performance of the issuing corporation.

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 Holders of a corporation's common stock typically participate in any upside performance of the corporation
in two ways:
by receiving a share of net income in the form of dividends; and
by enjoying an appreciation in the price of their stock shares.
 However, the payment of dividends is not a contractual or legal requirement. Even if net earnings are
positive, a corporation is not obliged to distribute dividends to shareholders. For example, a corporation
might instead choose to keep its profits as retained earnings to be used for new capital investment (self-
financing of investment rather than debt or equity financing).
 On the other hand, corporations cannot charge losses to their common stock shareholders. Consequently,
these shareholders at most risk losing the purchase price of their shares, a situation which arises if the
market price of their shares declines to zero for any reason.
 Preferred stock shares are usually issued with a par value (e.g., $100) and pay a fixed dividend expressed as
a percentage of par value. Preferred stock is a claim against a corporation's cash flow that is prior to the
claims of its common stock holders but is generally subordinate to the claims of its debt holders.
 In addition, like debt holders but unlike common stock holders, preferred stock holders generally do not
participate in the management of issuers through voting or other means unless the issuer is in extreme
financial distress (e.g., insolvency).
To sum up; the following are the basic functions of the financial markets:
Borrowing and Lending: Financial markets permit the transfer of funds (purchasing power) from one
agent to another for either investment or consumption purposes.
Price Determination: Financial markets provide vehicles by which prices are set both for newly issued
financial assets and for the existing stock of financial assets.
Information Aggregation and Coordination: Financial markets act as collectors and aggregators of
information about financial asset values and the flow of funds from lenders to borrowers.
Risk Sharing: Financial markets allow a transfer of risk from those who undertake investments to those
who provide funds for those investments.
Liquidity: Financial markets provide the holders of financial assets with a chance to resell or liquidate
these assets.
Efficiency: Financial markets reduce transaction costs and information costs.
6. International, Domestic and Foreign Exchange Markets
I. International and Domestic Markets
 Because of the globalization of financial markets throughout the world, a corporation is not limited to
raising funds in the financial market where it is domiciled. Globalization means the integration of financial
market throughout the world into a global financial market.
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 From the perspective of a given country, financial markets can be classified into two markets: an internal
market and an external market. The internal market is also called the national market.
 It can be decomposed into two parts: the domestic market and the foreign market. The domestic market is
where issuers domiciled in the country issue securities and where those securities are subsequently traded.
 The foreign market of a country is where issuers not domiciled in the country issue securities and where the
securities are then traded. The rules governing the issuance of foreign securities are those imposed by
regulatory authorities where the security is issued. For example, securities issued by non-Ethiopian
corporations in the Ethiopia must comply with the regulations set forth in Ethiopia securities law and other
requirements imposed by the other concerned parties.
 To add some in other ways, a non-Japanese corporation that seeks to offer securities in Japan, for example,
must comply with Japanese securities law and regulations imposed by the Japanese Ministry of Finance.
 The external market, also called the international market, includes securities with the following
distinguishing features:
(1) They are underwritten by an international syndicate,
(2) They are offered at issuance simultaneously to investors in a number of countries, and
(3) They are issued outside the jurisdiction of any single country.
 The international market is commonly referred to as the offshore market or, more popularly, the
Euromarkets. We refer to the collection of all these markets—the domestic market, the foreign market, and
the Euromarkets—as the global financial market.
 The global financial market can be further divided based on the type of financial claim: equity or debt.
Several factors have lead to the better integration of financial markets throughout the world. We can classify
these factors as follows:
(1) Deregulation or liberalization of capital markets and activities of market participants in key financial
centers of the world;
(2) Technological advances for monitoring world markets, executing orders, and analyzing financial
opportunities; and,
(3) Increased institutionalization of capital markets. These factors are not mutually exclusive.
 Some market observers and compilers of statistical data on market activity refer to the external market as
consisting of the foreign market and the Euromarkets.
II.Foreign Exchange Markets (FX)
 Money represents purchasing power, but usually only in one country.  Alternatively, different countries
have different currency and the settlement of all business transactions within a country is done/ preferred
local currency. For instance, $, £, or € have no purchasing power in Ethiopia. 

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 The foreign exchange market provides a forum where the currency of one country is traded for the currency
of another country. Exchanging one currency for another takes place in the FX market; (converting
purchasing power from one currency into another). The exchange rate is just the price of one currency in
terms of another currency. For instance, a rate of Br. 30.70 per US $ implies that one US dollar costs Birr
30.70.
 FX market deal with a large volume of funds and a large number of currencies belonging to various
countries. For this reason, FX market is not only worldwide market but also is world's largest financial
market. 
Function and structure of FX markets
 Trading in the foreign exchange market is mainly to facilitate international trade and international
investment - the buying and selling of foreign goods, services and financial assets.  Think of the three
functions of money - unit of account, medium of exchange and store of value.  
 Foreign goods are usually priced in foreign currency - German wine/beer is priced in euro for example.  The
unit of account is the euro; the medium of exchange is the euro.  American liquor distributors need euro to
buy the German wine/beer. 
 Also, American investors may consider the euro as a better store of value than the US dollar.  They could
buy a certificate of deposit from a German bank denominated in euro, instead of putting money in a U.S.
bank.  Or American investors want to buy stock of a company in UK, Brazil or Turkey. They need foreign
currency to buy foreign assets.

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