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Markets
TOPIC 7
MAF306 International Finance
and Investments
(measured in billions of USD, BIS Dec 2007, see Figure 7.4B, p 263 for
updated figure)
10
11
Forward Market:
12
13
14
currencies are quoted in the following manner:1 unit of a currency = x units of another
currency
Example: 1 unit of US$ = JPY122.65
This quotation means that it costs JPY122.65
to buy one US$ or if one wishes to convert 1
US$ into JPY one would receive JPY122.65.
15
Depreciation/Appreciatio
n
FX quotation conventions
American Terms
USD price per unit of
foreign currency
for example, USD
1.09/AUD1
A Direct quote in the US
An Indirect quote
outside the U.S. (e.g. in
Australia)
European Terms
Reciprocal Rates
The reciprocal rate is the inverse/reciprocal of
a conventional quote.
Examples:
1 US$ = SGD 1.7650
Reciprocal rate is:
21
Ask Bid
PS
x100
Ask
23
or
0.7850-60 (BID)(ASK)
(BID)
(ASK or
Sell)
What does this mean (see next
slide)?
24
Further explanation
1. For bid/buy transaction: buy AU$10,000 (i.e., pay/sell
US$) = 10000 x 0.785 = US$7850 (pay less)
2. For offer/sell transaction: sell AU$10,000 (i.e.,
receive/buy US$) = 10000 x 0.786 = US$7860 (receive
more)
In the buy transaction, the dealer wants to give/pay less
In the sell transaction, the dealer wants to receive more
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FE Spread
The spread = difference between the bid rate
and the offer rate.
In the above US$/A$1 price, the spread is 10
points or 10 pips i.e 0.7860 - 0.7850 = 0.0010
or 10 pips
A pip/point refers to one unit in the final
decimal place to which a given exchange rate
is conventionally quoted.
In the above example, the spread is = 10000 x
(0.7860 0.7850) = US$10
26
Why is the interbank market spread is narrow
than the retail market? (Answer: see the
topic: International financial markets)
(a)
(b)
(c)
(d)
SF2.40/
$1.50/
0.55/
$0.90/
Ans C
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28
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A$/US$
SSell
S
Supply (Public)
A$1.316
So
R
E
A
D
Demand (Public)
Sbuy
A$1.300
Qty of US$
A$1.316/US$ = US$0.76/AU$
A$1.300/US$ = US$0.77/AU$
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supply
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Exercise 1
Bank of Tokyo (the market maker) quotes the
following rates for: JPY/US$1 = 81.55/81.58
If you are a buyer/seller of JPY, what is the rate you
choose if you wish to buy/sell JPY?
If you are a buyer/seller of US$, what is the rate you
choose if you wish to buy/sell US$?
3
1
Exercise 1
Bank of Tokyo (the market maker) quotes the following
rates for: JPY/US$1 = 81.55/81.58
If you are a buyer/seller of JPY, what is the rate you
choose if you wish to buy/sell JPY?
(Hint: Reverse and invert to get buy/sell rates for Yen (see
p 265-266)so 1/81.58 (0.01225 US cents/1 Yen) becomes
buy rate for Yen and 1/81.55 becomes sell rate (0.01226 US
cents /1 Yen)
BoT Buyer of Yen = 0.01225 US cents
BoT Sell Yen = 0.01226 US cents
If you are a buyer/seller of US$, what is the rate you
choose if you wish to buy/sell US$?
Buyer of US$ = 81.55 yen to buy US$1
Sell US$ = 81.58 yen received for each US$ sold
3
1
Cross rates
Monday, September 10, 2012, listed the
yendollar and eurodollar rates as 78.56
and 0.7802, respectively. Suppose you
want to know the euroyen exchange rate,
how do you get this rate? i.e.
USD USD
USD EUR
EUR
37
USD USD
USD GBP
GBP
EUR GBP
EUR USD
EUR
38
and
1 US$ = 1.4610 CHF
CHF = Swiss Franc
Q:
What is the cross rate for A$ in terms of CHF?
Q:
3
6
Given
and
Therefore,
USD
USD
GBP
GBP EUR
GBP
EUR
USD
EUR
SGD/US$1
1.2835
US$/ 1
1.2165
3
7
SGD/US$1
1.2835
US$/ 1
1.2165
3
7
Currency Arbitrage
if cross rates differ from one financial
centre to another, then profit
opportunities exist
buy cheap in one I/N market, sell at a
higher price in another
the critical role of available information
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45
Use of a Forward:
- Hedging: reducing/eliminating exchange rate risk
for existing FX position
- Speculation: taking open positions in the FX
market
46
Forward discount
A currency value in the forward exchange market is lower
than in the spot exchange market
Quoted in the interbank market as a discount or premium
to the spot rate
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f1 e0 360
*
*100
e0
n
where
e f 360
*
*100
'
f1
n
'
0
'
1
n=
the number of days in the forward
contract
49
where
S=
n=
contract
F-S x 12 x 100
n
F=
the forward rate of exchange
the spot rate of exchange
the number of months in the
forward
Percentage Forward
Premium/Discounts
Allows % comparison of annualised premium and discounts
in the forward market with i/r differentials (will utilise
with IRP, topic 8)
Note:
both
formulas
calculate
the
forward
premium/discount of the foreign currency relative to the
domestic currency.
Regardless of using direct or indirect quotes, the
calculation of the premium should be the same, provided
that the currency quote is consistent with the formula
used, i.e., direct quote use direct formula, indirect quote
use indirect formula.
What if you are given indirect quote and direct formula?
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52
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f1 e0 360
*
*100
e0
n
0.5756 0.5839 360
*
*100
0.5839
180
2.84%
Again, SFr is selling at a forward discount of 2.84%
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56
f1 e0 360
*
*100
e0
n
1.3402 1.3310 360
*
*100
1.3310
180
1.38%
3. Answer (d)
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