GBF Unit - IV

8/4/2019 GBF Unit - IV

1/50

4Unit IVForeign Exchange

Markets

Dr. K. SrinivasanDepartment of Management Studies

Christ University, Bangalore.


2/50

Introduction

The recent trends in LPG has given rise to internationaltrade and investment to grow tremendous pace in the lastdecades.

The flow of goods, services & capital goods across variousnational boundaries is possible only if there is a goodfunctioning monetary system.

FOREX market is the largest financial market in the world

by virtually any standard. In 2001, triennial central bank survey compiled by the BIS

places worldwide daily trading of spot & forward FOREXat $1.2 trillion dollars per day.


3/50

Continued..

The survey conducted by BIS is equal to nearly $200 intransactions for every person on earth.

London remains the worlds largest FOREX trading centre.

According to the survey, the U.K & the U.S were theleading participants with 33% & 17%, respectively. Broadly defines Foreign Exchange encompasses theconversion of purchasing power from one currency into

another, bank deposits of foreign currency, the extension ofcredit denominated in a foreign currency, foreign tradefinancing, trading in foreign currency options, futurescontracts and currency swaps.


4/50

Function & Structure ofFOREX MarketStructure of FOREX Market

The main players in FOREX market are Commercial Bank,FOREX Brokers, Large Corporations & RBI.

Normally, the RBI enter into the market to smoothen outfluctuations in the exchange rate.

The currency prevailing in FOREX market are numerous innature. So, it is very difficult for a player to keep all the

track of all quotes available in the market. In case of FOREX brokers, they wont buy or sell any

currency. But, they work for bringing buyers & sellers

together


5/50

Continued.

Australia, Europe & North America are the major segments ofFOREX market. Australia includes the trading centers like Sydney, Tokyo, Hong

Kong, Singapore & Bahrain. Europe includes Zurich, Frankfurt, Paris, Amsterdam & London. North America includes New York, Montreal, Toronto, Chicago,

San Francisco & Los Angeles.

Most trading rooms operates over 9 to 12 hours working day,

although some banks experimented with operating three eight-hour shifts in order to trade the clock.

Therefore, the trading takes place when the trading hours of thethree centers overlap


6/50

Function of FOREXMarketFunction of the FOREX Market

FX Market Participants Correspondent Banking Relationships

The Spot Market Spot Rate Quotations The Bid-Ask Spread

Spot FX Trading Cross Exchange Rate Quotations Triangular Arbitrage Spot Foreign Exchange Market Microstructure


7/50

Continued.

The Forward Market Forward Rate Quotations

Long and Short Forward Positions

Forward Cross-Exchange Rates

Swap Transactions

Forward Premium


8/50

FOREX Market Participants

The FOREX market is a two-tiered market: Interbank Market (Wholesale)About 700 banks worldwide stand ready to make

a market in Foreign exchange.There are FX brokers who match buy and sell

orders but do not carry inventory and FXspecialists.

Client Market (Retail)Market participants include international banks,

their bank customers, nonbank dealers, FOREXbrokers, and central banks.


9/50

Continued.

International Banks: Make a Market & Willing tobuy or sell foreign currency for their own retailcustomers.

Bank Customers: Making investment in Internationally.Apart from this, MNCs, Money Managers & PrivateSpeculator.

Nonbank Dealers: Refers to NBFCs. Nonbank dealersrecords about 28% of interbank trading volume. Themain works are inventory position, Arbitrage &Speculative transactions with Market Psychology.


10/50

FX Brokers: Match dealers for a fee, but do not takeposition. In recent years, their participation in market isvery less.

Central Bank: Intervening the value of one currencyagainst a trading partner may reduce Export & increaseImport. Central bank intervening in currency market

often lose bank reserves in attempting to achieve theirgoal. However, there is a little evidence that massiveintervention can materially affect exchange rates.

Continued.


11/50

Correspondent BankingRelationships

Large commercial banks maintain demand deposit accountswith one another which facilitates the efficient functioningof the forex market.

International commercial banks communicate with oneanother with:

SWIFT: The Society for Worldwide Interbank FinancialTelecommunications. Private Nonprofit message transfersystem with headquarters in Brussels, with intercontinentalswitching centers in the Netherlands &Virginia.


12/50

Continued.

CHIPS: Clearing House Interbank Payments System incooperation with U.S Federal Reserve Bank System, calledFedwire. Provides a clearinghouse for the interbank settlementof U.S$ payments between international bank.

ECHO: In August 1995, Exchange Clearing House Limited,the first global clearinghouse for settling interbank FOREXtransactions. ECHO was a multilateral netting system, where

the settlement date of clients payment & receipts arerecorded, this eliminates the risk & inefficiency of individualsettlement. In 1997, CLS Service Ltd merged with ECHO.Currently, operations of the system has been suspended.


13/50

The Spot Market

In case of USD & Non North American currency, thetransaction of cash settlement will be made in two days.But, the settlement for regular spot trades between the USD

& the Mexican Peso or Canadian Dollar will takes only onebusiness days.1. Spot Rate Quotations2. The Bid-Ask Spread

3. Spot FX trading4. Cross Exchange Rate Quotations5. Triangular Arbitrage6. Spot Foreign Exchange Market Microstructure


14/50

Spot Rate Quotations

Direct Quotation:The U.S. dollar equivalent

Ex:A Japanese Yen is worth about a pennyIndirect Quotation:The price of a U.S. dollar in the foreign

currency

Ex: You get 100 yen to the dollar.


15/50

The New Y ork foreign exchange sel ling rates belo w apply totrading among banks in amounts of $1 milli on and more, as quotedat 4 p.m. Eas tern time by Dow Jones T elerate Inc. and other sources.Retail transactions provide fewer units of foreign currency perdollar.

Special Drawing Rights (SDR) are based on exchange rates forthe U.S., German, British, French, and Japanese currencies. Source:International Monetary Fund.

European Currency Unit (ECU) is based on a basket of communitycurrencies.

a-fixing, Moscow Interbank Currency Exchange.

EXCHANGE RAT ES

CountryArgentina (Peso)Australia (Dollar)Austria (Schilling)Bahrain (Dinar)

Belgium (Franc)Brazil (Real)Britain (Pound)

30-Day Forward90-Day Forward180-Day Forward

Canada (Dollar)30-Day Forward90-Day Forward180-Day Forward

Chile (Peso)China (Renminbi)Colombia (Peso)Czech. Rep (Krouna)

Commercial rateDenmark (Krone)Ecuador (Sucre)

Floating rateFinland (Markka)France (Franc)

30-Day Forward

90-Day Forward180-Day Forward

Germany (Mark)30-Day Forward90-Day Forward180-Day Forward

Greece (Drachma)Hong Kong (Dollar)Hungary (Forint)India (Rupee)Indonesia (Rupiah)Ireland (Punt)Israel (Shekel)Italy (Lira)

Wed.1.0012

.7805.090432.6525

.03080.96071.68801.68691.68431.6802

.7399

.7414

.7442

.7479.002352

.1201.0009985

.....03662

.1663....

.0002766.2121.1879.1882

.1889

.1901

.6352

.6364

.6389

.6430.004049

.1292.006139.02787

.00042331.6664

.3079.0006483

Tues.1.0012

.7902.091012.6525

.03105.96151.69461.69351.69101.6867

.7370

.7386

.7413

.7450.002356

.1201.0009985

.....03677

.1677....

.0002787.2135.1893.1896

.1903

.1914

.6394

.6407

.6432

.6472.004068

.1292.006164

.02786.0004233

1.6714.3085

.0006510

Wed..9988

1.281211.058.3770

32.4701.0409.5924.5928.5937.5952

1.35161.34881.34371.3370425.258.3272

1001.50....

27.3076.0118

....3615.00

4.71505.32205.3126

5.29355.26171.57441.57141.56521.5552246.987.7390162.8935.875

2362.15.6001

3.24741542.50

Tues..9988

1.265510.988

.3770

32.2051.0401.5901.5905.5914.5929

1.35681.35391.34891.3422424.408.3276

1001.50....

27.1945.9633

....3587.504.68415.28385.2741

5.25585.22431.56391.56071.55471.5450245.807.7390162.2335.890

2362.63.5983

3.24121536.00

U.S. $ equiv. per U.S. $Currency

CountryJapan (Yen)


Jordan (Dinar)Kuwait (Dinar)Lebanon (Pound)Malaysia (Ringgit)Malta (Lira)Mexico (Peso)

Floating rateNetherland (Guilder)New Zealand (Dollar)Norway (Krone)Pakistan (Rupee)Peru (new Sol)Philippines (Peso)Poland (Zloty)Portugal (Escudo)Russia (Ruble) (a)Saudi Arabia (Riyal)Singapore (Dollar)Slovak Rep. (Koruna)South Africa (Rand)South Korea (Won)Spain (Peseta)Sweden (Krona)Switzerland (Franc)


Taiwan (Dollar)Thailand (Baht)Turkey (Lira)

United Arab (Dirham)Uruguay (New Peso)Financial

Venezuela (Bolivar)

SDRECU

Wed..008639.008676.008750.0088651.40753.3367

.0006445.4018

2.7624....

.1278

.5655

.7072

.1540.02529

.3814.03800

.3460.006307

.0001787.2666.7116

.03259.2141

.001184

.007546.1431.7334.7357.7401.7470

.03638

.03902.00000911

.2723....

.1145.002098

- - -1.43151.2308

Tues..008681.008718.008791.008907

1.40753.3389

.0006445.4002

2.7701....

.1277

.5699

.7106

.1548.02529.3840

.03802.3475

.006369.0001788

.2667

.7124.03259.2142

.001184

.007603.1435.7387.7411.7454.7523

.03637

.03906.00000915

.2723....

.1145.002096

1.43261.2404

Wed.115.75115.26114.28112.80

.7105

.29971551.502.4885

.3620....

7.82201.76851.41406.492639.5402.621826.3182.8900158.55

5595.003.75031.405330.6884.6705844.75132.526.98651.36351.35931.35111.338627.48925.625

109755.00

3.6720....8.7300476.70

.6986..........

Tues.115.20114.71113.76112.28

.7105

.29951551.502.4990

.3610....

7.83301.75471.40736.459939.5402.603926.3002.8780157.02

5594.003.75021.403730.6884.6690844.65131.536.96971.35371.34941.34161.329327.49325.605

109235.00

3.6720....8.7300477.12

.6980...........

U.S. $ equiv.Currencyper U.S. $Wednes day, January 8, 1997

Spot Rate Quotations(Direct)

The DirectQuote forBritish Pound

is:

1 = $1.688


16/50





EXCHANGE RAT ES

CountryArgentina (Peso)Australia (Dollar)Austria (Schilling)Bahrain (Dinar)

Belgium (Franc)Brazil (Real)Britain (Pound)






30-Day Forward




Wed.1.0012

.7805.090432.6525

.03080.96071.68801.68691.68431.6802

.7399

.7414

.7442

.7479.002352

.1201.0009985

.....03662

.1663....

.0002766.2121.1879.1882

.1889

.1901

.6352

.6364

.6389

.6430.004049

.1292.006139.02787

.00042331.6664

.3079.0006483

Tues.1.0012

.7902.091012.6525

.03105.96151.69461.69351.69101.6867

.7370

.7386

.7413

.7450.002356

.1201.0009985

.....03677

.1677....

.0002787.2135.1893.1896

.1903

.1914

.6394

.6407

.6432

.6472.004068

.1292.006164

.02786.0004233

1.6714.3085

.0006510

Wed..9988

1.281211.058.3770

32.4701.0409.5924.5928.5937.5952

1.35161.34881.34371.3370425.258.3272

1001.50....

27.3076.0118

....3615.00

4.71505.32205.3126

5.29355.26171.57441.57141.56521.5552246.987.7390162.8935.875

2362.15.6001

3.24741542.50

Tues..9988

1.265510.988

.3770

32.2051.0401.5901.5905.5914.5929

1.35681.35391.34891.3422424.408.3276

1001.50....

27.1945.9633

....3587.504.68415.28385.2741

5.25585.22431.56391.56071.55471.5450245.807.7390162.2335.890

2362.63.5983

3.24121536.00


CountryJapan (Yen)



Floating rateNetherland (Guilder)New Zealand (Dollar)Norway (Krone)Pakistan (Rupee)Peru (new Sol)Philippines (Peso)Poland (Zloty)Portugal (Escudo)Russia (Ruble) (a)Saudi Arabia (Riyal)Singapore (Dollar)Slovak Rep. (Koruna)South Africa (Rand)South Korea (Won)Spain (Peseta)Sweden (Krona)Switzerland (Franc)


Taiwan (Dollar)Thailand (Baht)Turkey (Lira)

United Arab (Dirham)Uruguay (New Peso)Financial

Venezuela (Bolivar)

SDRECU

Wed..008639.008676.008750.0088651.40753.3367

.0006445.4018

2.7624....

.1278

.5655

.7072

.1540.02529

.3814.03800

.3460.006307

.0001787.2666.7116

.03259.2141

.001184

.007546.1431.7334.7357.7401.7470

.03638

.03902.00000911

.2723....

.1145.002098

- - -1.43151.2308

Tues..008681.008718.008791.008907

1.40753.3389

.0006445.4002

2.7701....

.1277

.5699

.7106

.1548.02529.3840

.03802.3475

.006369.0001788

.2667

.7124.03259.2142

.001184

.007603.1435.7387.7411.7454.7523

.03637

.03906.00000915

.2723....

.1145.002096

1.43261.2404

Wed.115.75115.26114.28112.80

.7105

.29971551.502.4885

.3620....

7.82201.76851.41406.492639.5402.621826.3182.8900158.55

5595.003.75031.405330.6884.6705844.75132.526.98651.36351.35931.35111.338627.48925.625

109755.00

3.6720....8.7300476.70

.6986..........

Tues.115.20114.71113.76112.28

.7105

.29951551.502.4990

.3610....

7.83301.75471.40736.459939.5402.603926.3002.8780157.02

5594.003.75021.403730.6884.6690844.65131.536.96971.35371.34941.34161.329327.49325.605

109235.00

3.6720....8.7300477.12

.6980...........


Spot Rate Quotations(Indirect)

The IndirectQuote forBritish Pound

is:

.5924 = $1


17/50





EXCHANGE RAT ES

CountryArgentina (Peso)Australia (Dollar)Austria (Schilling)Bahrain (Dinar)Belgium (Franc)Brazil (Real)Britain (Pound)







180-Day ForwardGermany (Mark)



Wed.1.0012

.7805.090432.6525.03080

.96071.68801.68691.68431.6802

.7399

.7414

.7442

.7479.002352

.1201.0009985

.....03662

.1663....

.0002766.2121.1879.1882.1889

.1901

.6352

.6364

.6389

.6430.004049

.1292.006139.02787

.00042331.6664

.3079.0006483

Tues.1.0012

.7902.091012.6525.03105

.96151.69461.69351.69101.6867

.7370

.7386

.7413

.7450.002356

.1201.0009985

.....03677

.1677....

.0002787.2135.1893.1896.1903

.1914

.6394

.6407

.6432

.6472.004068

.1292.006164

.02786.0004233

1.6714.3085

.0006510

Wed..9988

1.281211.058.3770

32.4701.0409.5924.5928.5937.5952

1.35161.34881.34371.3370425.258.3272

1001.50....

27.3076.0118

....3615.00

4.71505.32205.31265.2935

5.26171.57441.57141.56521.5552246.987.7390162.8935.875

2362.15.6001

3.24741542.50

Tues..9988

1.265510.988

.377032.2051.0401

.5901

.5905

.5914

.59291.35681.35391.34891.3422424.408.3276

1001.50....

27.1945.9633

....3587.504.68415.28385.27415.2558

5.22431.56391.56071.55471.5450245.807.7390162.2335.890

2362.63.5983

3.24121536.00


CountryJapan (Yen)



Floating rateNetherland (Guilder)New Zealand (Dollar)Norway (Krone)Pakistan (Rupee)

Peru (new Sol)Philippines (Peso)Poland (Zloty)Portugal (Escudo)Russia (Ruble) (a)Saudi Arabia (Riyal)Singapore (Dollar)Slovak Rep. (Koruna)South Africa (Rand)South Korea (Won)Spain (Peseta)Sweden (Krona)Switzerland (Franc)


Taiwan (Dollar)Thailand (Baht)Turkey (Lira)United Arab (Dirham)

Uruguay (New Peso)FinancialVenezuela (Bolivar)

SDRECU

Wed..008639.008676.008750.0088651.40753.3367

.0006445.4018

2.7624....

.1278

.5655

.7072

.1540.02529

.3814.03800

.3460.006307

.0001787.2666.7116

.03259.2141

.001184

.007546.1431.7334.7357.7401.7470

.03638

.03902.00000911

.2723

.....1145.002098

- - -1.43151.2308

Tues..008681.008718.008791.008907

1.40753.3389

.0006445.4002

2.7701....

.1277

.5699

.7106

.1548.02529

.3840.03802.3475

.006369.0001788

.2667

.7124.03259.2142

.001184

.007603.1435.7387.7411.7454.7523

.03637

.03906.00000915

.2723

.....1145.002096

1.43261.2404

Wed.115.75115.26114.28112.80

.7105

.29971551.502.4885

.3620....

7.82201.76851.41406.492639.540

2.621826.3182.8900158.55

5595.003.75031.405330.6884.6705844.75132.526.98651.36351.35931.35111.338627.48925.625

109755.003.6720

....8.7300476.70

.6986..........

Tues.115.20114.71113.76112.28

.7105

.29951551.502.4990

.3610....

7.83301.75471.40736.459939.540

2.603926.3002.8780157.02

5594.003.75021.403730.6884.6690844.65131.536.96971.35371.34941.34161.329327.49325.605

109235.003.6720

....8.7300477.12

.6980...........


Quoted Spot Rate

Note that theDirect Quote

is thereciprocal ofthe indirect

quote:

5924.

1688.1


18/50

The Bid-Ask Spread

FX traders buy currency for inventory at the bidprice and sell from inventory at the higher offer or askprice

The bid price is the price a dealer is willing to pay youfor something.

The ask price is the amount the dealer wants you to pay

for the thing. The bid-ask spread is the difference between the bid

and ask prices.


19/50

Spot FX Trading

In interbank transaction, the standard amount from one bank toanother will be based on major currencies (i.e.) U.S. $10 million.

Dealers quote both the bid and the ask, willing to either buy or

sell the quoted value. Spot quote are good for only few seconds& traders should respond immediately

Interbank trading rooms are typically organized with individualtraders dealing in particular currency. So, the trading room is a

noisy, active place. Currency traders are capable of interpreting new information

quickly & making high stakes decisions. Particularly, the longterm is about 10 minutes.


20/50

Cross Rates

Cross exchange rate is an exchange rate between a currencypair where neither currency is the U.S dollar. Moreover, thecross-exchange rate can be calculated from the U.S Dollarexchange rates for the two currencies, using either European orAmerican term quotations.Ex: and Cross-rate can be calculated from American termquotations as follows

Suppose $(/

) = ($/

)/($/)100$1or.01)/($

100

1$

50

1

2

1$

,

$

$since

SDM

DM

DM

DM


21/50

Triangular Arbitrage

$

Credit Lyonnais

S(/$)=1.50

Credit Agricole

S(/)=85

Barclays

S(/$)=120

Suppose weobserve these

banks posting theseexchange rates.

First calculate the

implied cross ratesto see if an

Arbitrage exists.


22/50

Continued.

$

Credit Lyonnais

S(/$)=1.50

Credit Agricole

S(/)=85

Barclays

S(/$)=120

80

1

120

1$

1$

50.1

The implied S(/) crossrate is S(/) = 80

Credit Agricole hasposted a quote of

S(/)=85 so there is an

arbitrage opportunity.

So, how can we make money?


23/50

$

Credit Lyonnais

S(/$)=1.50

Credit Agricole

S(/)=85

Barclays

S(/$)=120

80

1

120

1$

1$

50.1

As easy as 123:

1. Sell our $ for ,

2. Sell our for ,

3. Sell those for $.

Continued.


24/50

Sell $100,000 for at S(/$) = 1.50

receive 150,000

Sell 150,000 for at S(/) = 85receive 12,750,000

Sell 12,750,000 for $ at S(/$) = 120

receive $106,250

Profit per round trip = $ 106,250- $100,000 = $6,250

Continued.

S t F i E h


25/50

Spot Foreign ExchangeMicrostructure

Market Microstructure refers to the basic mechanics ofhow a marketplace operates.

Bid-Ask spread in the spot FX market increase with FXexchange rate volatility and decrease with dealercompetition.

Dealers competition is a fundamental determinant of

the spot FX bid-ask spread. Private information is an important determinant of

spot exchange rates.


26/50

The Forward Market

A forward contract is an agreement to buy or sell anasset in the future at prices agreed upon today.

Forward exchange rates are quoted on most major

currencies for a variety of maturities. Bank Quotes for maturities of 1, 3, 6, 9 & 12 months

are readily available.

Quotations on nonstandard or Broken term maturitiesare also available Maturities extending beyond one year are becoming

more frequent and good for the bank customers


27/50

Continued

Forward Rate Quotations

Forward Cross Exchange Rates

Forward Premium

Long and Short Forward Positions

Swap Transactions


28/50

Forward Rate Quotations

Forward Rate Quotes are either direct or indirectDirect Quotes:S ($/SF) = .6653

F1($/SF) = .6660F2($/SF) = .6670F3($/SF) = .6684Indirect Quotes:S (SF/$) = 1.5030F1(SF/$) = 1.5016F2(SF/$) = 1.4993F3(SF/$) = 1.4961


29/50





EXCHANGE RAT ES

CountryArgentina (Peso)Australia (Dollar)Austria (Schilling)Bahrain (Dinar)Belgium (Franc)Brazil (Real)

Britain (Pound)30-Day Forward90-Day Forward180-Day Forward








Wed.1.0012

.7805.090432.6525.03080

.9607

1.68801.68691.68431.6802

.7399

.7414

.7442

.7479.002352

.1201.0009985

.....03662

.1663....

.0002766.2121.1879.1882.1889.1901.6352.6364.6389.6430

.004049.1292

.006139.02787

.00042331.6664

.3079.0006483

Tues.1.0012

.7902.091012.6525.03105

.9615

1.69461.69351.69101.6867

.7370

.7386

.7413

.7450.002356

.1201.0009985

.....03677

.1677....

.0002787.2135.1893.1896.1903.1914.6394.6407.6432.6472

.004068.1292

.006164.02786

.00042331.6714

.3085.0006510

Wed..9988

1.281211.058.3770

32.4701.0409

.5924.5928

.5937.5952

1.35161.34881.34371.3370425.258.3272

1001.50....

27.3076.0118

....3615.00

4.71505.32205.31265.29355.26171.57441.57141.56521.5552246.987.7390162.8935.875

2362.15.6001

3.24741542.50

Tues..9988

1.265510.988

.377032.2051.0401

.5901.5905

.5914

.59291.35681.35391.34891.3422424.408.3276

1001.50....

27.1945.9633

....3587.504.68415.28385.27415.25585.22431.56391.56071.55471.5450245.807.7390162.2335.890

2362.63.5983

3.24121536.00


CountryJapan (Yen)



Floating rateNetherland (Guilder)New Zealand (Dollar)Norway (Krone)Pakistan (Rupee)

Peru (new Sol)Philippines (Peso)Poland (Zloty)Portugal (Escudo)Russia (Ruble) (a)Saudi Arabia (Riyal)Singapore (Dollar)Slovak Rep. (Koruna)South Africa (Rand)South Korea (Won)Spain (Peseta)Sweden (Krona)Switzerland (Franc)


Taiwan (Dollar)Thailand (Baht)Turkey (Lira)United Arab (Dirham)Uruguay (New Peso)

FinancialVenezuela (Bolivar)

SDRECU

Wed..008639.008676.008750.0088651.40753.3367

.0006445.4018

2.7624....

.1278

.5655

.7072

.1540.02529

.3814.03800

.3460.006307

.0001787.2666.7116

.03259.2141

.001184

.007546.1431.7334.7357.7401.7470

.03638

.03902.00000911

.2723....

.1145.002098

- - -1.43151.2308

Tues..008681.008718.008791.008907

1.40753.3389

.0006445.4002

2.7701....

.1277

.5699

.7106

.1548.02529

.3840.03802

.3475.006369

.0001788.2667.7124

.03259.2142

.001184

.007603.1435.7387.7411.7454.7523

.03637

.03906.00000915

.2723....

.1145.002096

1.43261.2404

Wed.115.75115.26114.28112.80

.7105

.29971551.502.4885

.3620....

7.82201.76851.41406.492639.540

2.621826.3182.8900158.55

5595.003.75031.405330.6884.6705844.75132.526.98651.36351.35931.35111.338627.48925.625

109755.003.6720

....

8.7300476.70

.6986..........

Tues.115.20114.71113.76112.28

.7105

.29951551.502.4990

.3610....

7.83301.75471.40736.459939.540

2.603926.3002.8780157.02

5594.003.75021.403730.6884.6690844.65131.536.96971.35371.34941.34161.329327.49325.605

109235.003.6720

....

8.7300477.12

.6980...........


Spot Rate Quotations

Clearly themarket

participants

expect thatthe yen willbe worth

MORE in

dollars in sixmonths.

F d C E h


30/50

Forward Cross ExchangeRates

Forward cross - exchange rate quotations arecalculated in an analogous manner to spot cross - rates.Its just an delayed example of the spot cross rate

discussed above. In generic terms

($ / )( / )

($ / )

and

($ / )( / )

($ / )

NN

N

NN

N

F JapanF German Japan

F German

F GermanF Japan German

F Japan


31/50

Forward Premium

The interest rate differential implied by forwardexchange is termed as premium or discount.

Apart from this, the comparison is useful for interest

rate differential between two countries. The forward premium can be expressed in American or

European terms

01375.5235.

5235.5307.

180

360

)/($

)/($)/($180$,180

DMS

DMSDMFf

DMv

Long and Short Forward


32/50

Long and Short ForwardPositions

If you have agreed to Sell anything (spot orforward), you are Short.

If you have agreed to Buy anything (forward orspot), you are Long. If you have agreed to Sell forex forward, you are

Short. If you have agreed to Buy forex forward, you areLong.


33/50

Payoff Profiles

0S180($/)

F180($/) = .009524

Short PositionLoss

ProfitIf you agree to sell anythingin the

future at a set price and the spot pricelater falls then you Gain.

If you agree to sell anythingin thefuture at a set price and the spot price

later rises then you Lose.


34/50

Payoff Profiles

Loss

0 S180(/$)

F180

(/$) = 105

-F180(/$)

Profit

The payoff profile slopes up or

down depends upon whether youuse the Direct or Indirect quote:

F180(/$) = 105 or F180($/) =.009524.

Short Position


35/50

Payoff Profiles

Loss

0S180(/$)

F180

(/$) = 105

-F180(/$)

When the short entered into this forward contract, heagreed to sell in 180 days at F180(/$) = 105

ProfitShort Position


36/50

Payoff Profiles

Loss

0S180(/$)

F180

(/$) = 105

-F180(/$)

120

If, in 180 days, S180(/$) = 120, the short will make aprofit by buying at S180(/$) = 120 and delivering

at F180(/$) = 105.

15

ProfitShort Position


37/50

Payoff Profiles

Loss

0S180(/$)

F180

(/$) = 105

Long position-F180(/$)

F180(/$)Short Position

ProfitSince this is a zero-sum game, the

long position payoff is the oppositeof the short.


38/50

Payoff Profiles

Loss

0S180(/$)

F180

(/$) = 105

Long Position

-F180(/$)

Profit The long in this forward contract agreed to BUY in180 days at F180(/$) = 105

If, in 180 days, S180(/$) = 120, the long will

loseby having to buy at S180(/$) = 120 anddelivering at F180(/$) = 105.

120

15


39/50

SWAPS

A swap is an agreement to provide a counterpartywith something he wants in exchange for something

that you want. Swap transactions account for approximately 51

percent of interbank FX trading, whereas outright

trades are less than 9 percent. A swap can be viewed as a portfolio of spot and

forward positions.

Comparative Advantage on


40/50

Comparative Advantage onSwaps

Consider two firms A and B: Firm A is a U.S Basedmultinational and firm B is a U.K Based multinational.

Both firms wish to finance a project in each others

country of the same size. Their borrowingopportunities are given in the table below.

$

Company A 8.0% 11.6%

Company B 10.0% 12.0%


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A is the more credit-worthy of the two firms.

A pays 2% less to borrow in dollars than B and A pays.4% less to borrow in pounds than B:

Continued

$


Company B 10.0% 12.0%

A has a comparative advantage in borrowing in dollars

B has a comparative advantage in borrowing in pounds.

F ibl S


42/50

Feasible Swap

Company

A

Swap

Bank

$8% 12%

$8%

11.6%12%

$10.0%

$


Company B 10.0% 12.0%

Company

B

C i d


43/50

$8% 12%

$8%

11.6%12%

$10.0%

As net position is to

borrow at 11.6%

Continued

$


Company B 10.0% 12.0%

Company

A

Swap

Bank

Company

B

C i d


44/50

$8% 12%

$8%

11.6%12%

$10.0%

Bs net position is to

borrow at $10.0%

Continued

$


Company B 10.0% 12.0%

Company

A

Swap

Bank

Company

B

C ti d


45/50

$8% 12%

$8%

11.6%12%

$10.0%

Continued

$


Company B 10.0% 12.0%

Company

A

Swap

Bank

Company

B

A saves 1.6%

C ti d


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$8% 12%

$8%

11.6%12%

$10.0%

B saves $4.0%$


Company B 10.0% 12.0%

Continued

Company

A

Swap

Bank

Company

B

A saves 1.6%

C ti d


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$8% 12%

$8%

11.6%12%

$10.0%

B saves $4.0%

Continued

$


Company B 10.0% 12.0%

Company

A

Swap

Bank

Company

B

A saves 1.6%

The Swap Bank

makes money too.

P bl


48/50

Problem: 1

Determine the spread in the two currencies and and determine which currency is the better currency.Currency Bid Rate Ask Rate

$ 1.55 1.60

$0.0070 0.0075

Problem: 2

The following are the quotes given by SBI Bank in Delhi.Find out the bid rate, Ask (Offer) rate, spread and spread in %a) INR/$ 48.7048.90b) INR/GBP 78.8078.90

P bl 3


49/50

Problem: 3

Given the following forward rate is 1.030 1$ and thespot rate is 1.0200 1$. Find the forward premium or discount for3 months.

Problem: 4

The USD is quoted at GBP 1.1125/1.2225 and the INR

is quoted at GBP 0.5225/0.5325. What is the direct quotebetween USD and INR?

Problem: 5


50/50

Assume the following spot exchange rate exists.

$0.60/DM

$0.15/FFrFFr 4/DMAssuming no transaction costs, based on these

exchange rates, can triangular is used to earn profitExplain.

Problem: 5

GBF Unit - IV

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Transcript of GBF Unit - IV