The Market for Foreign
Exchange
5
Chapter Five
Chapter Objective:
This chapter introduces the institutional
framework within which exchange rates are
determined.
determined
It lays the foundation for much of the discussion
throughout the remainder of the text, thus it
deserves your careful attention.
5-1
Outline
z
Spot Market for Foreign Exchange
» Market characteristics
» Interpreting quotes
» Cross exchange rates
z
Forward Market for Foreign Exchange
» Why is it used
» Market characteristics
» Estimating forward premium and discount
2
1
The Spot Market
FX Market Structure
z Spot Rate Quotations
z The Bid-Ask Spread
z Spot FX trading
z Cross Rates
z
5-3
FX Trading Levels
Source: www.bis.org
2
FX Market Participants
z
The FX market is a two-tiered market:
» Interbank Market (Wholesale)
– About 100-200 banks worldwide stand ready to make a
market in foreign exchange.
– Nonbank dealers account for about 40% of the market.
– There are FX brokers who match buy and sell orders but
do not carry inventory and FX specialists.
»C
Client
e t Market
a et ((Retail)
eta )
z
Market participants include international
banks, their customers, nonbank
dealers, FX brokers, and central banks.
5-5
Function and Structure of the FX
Market
FX Market Participants
z Correspondent Banking Relationships
z
5-6
3
Correspondent Banking
Relationships
z
International commercial banks
communicate with one another with:
» SWIFT: The Society for Worldwide
Interbank Financial Telecommunications.
» CHIPS: Clearing House Interbank
P
Payments
t System
S t
» ECHO Exchange Clearing House Limited,
the first global clearinghouse for settling
interbank FX transactions.
5-7
FX Market Share: By Countries
5-8
4
FX Market Share: By Currencies
5-9
FX Market Trading Hours
1 2 3 4 5 6 7 8 9
1 1 1 1 1 1 1 1 1 1 2 2 2 2 2
0 1 2 3 4 5 6 7 8 9 0 1 2 3 4
London
New York
Sydney
Tokyo
New York opens at 8:00 am to 5:00 pm EST
Tokyo opens at 7:00 pm to 4:00 am EST
Sydney opens at 5:00 pm to 2:00 am EST
London opens at 3:00 am to 12:00 noon EST
The best time to trade is when the market is the most
active and therefore has the biggest volume of trades.
5-10
5
Circadian Rhythms of the FX
Market
Electronic Conversations per Hour
average
peak
45000
40000
35000
30000
25000
20000
15000
10000
5000
0
1:00
3:00 5:00 07:00 9:00
10 am in Lunch Europe
Asia
Tokyo hour in coming in
going out
Tokyo
11:00 1:00 15:00 5:00 19:00 9:00 11:00
Lunch Americas
London
New 6 pm in
hour in coming in
going out
Zealand NY
London
coming in
5-11
Spot Market
z
z
z
z
z
z
Transactions at the same point in time.
The market is a network
Large money center banks are wholesalers
Major currencies: USD; Yen ; Euros; British Pounds,
Swiss Francs; Australian Dollars; Canadian Dollars
Spot Rate : The price at which a foreign currency can
be bought/sold, today.
Each spot exchange rate can be expressed in two
ways:
» Direct quote: price of the foreign currency expressed in
units of the home currency (example: 1BP = USD 2.00)
» Indirect quote: price of one unit of the home currency
expressed in units of the foreign currency (example: 1USD =
BP 0.50)
12
6
Currency Symbols
z
In addition to the familiar currency symbols
((e.g.
g £,, ¥,, €,, $) there are three-letter codes
for all currencies. It is a long list, but
selected codes include:
CHF Swiss francs
GBP British pound
CNY Chinese yuan
CAD Canadian dollar
JPY Japanese yen
MXN Mexican peso
5-13
FX Price Quote (September 27, 2010)
Source: http://finance.yahoo.com/currency
14
7
Spot Foreign Exchange Quotes
z
Direct Quote: U.S.
US
dollar equivalent
»
Online Quotes
GBP: 1 BP = $1.5850
JPY: 1 JY = $0.0119
»
Direct quote = 1 / Indirect
quote
GBP: 1 BP = 1 / 0.6309 = $1.5850
JPY: 1 JY = 1 / 84.285 = $0.0119
z
Indirect Quote: Currency
per USD
»
Online Quotes
GBP: 1 USD = BP0.6309
JPY: 1 USD = JY84.285
»
Indirect quote = 1 / Direct
quote
GBP: 1 USD = 1 / 1.5850 = BP0.6309
JPY: 1 USD = 1 / 0.0119 = JY84.285
15
Long-term FX Rates: USD & Yen (Direct Quote)
16
8
Long-term FX Rates: USD & Yen (Indirect Quote)
17
Long Term FX Rates: USD & Major World
Currencies
Source: http://research.stlouisfed.org/fred2
9
Applying Direct and Indirect
Quotes to Convert Currency
Currency Conversion Formulas:
Converting USD into FC Converting FC into USD
Using DQ USD / DQ = FC
FC * DQ = USD
Using IQ USD * IQ = FC
FC / IQ = USD
DQ = Direct quote
IQ = Indirect quote
USD = US Dollars
FC = Foreign currency
19
Bid and Ask Quotes and Spread
z
Ask Quote (currency dealer
dealer’ss selling price)
»
z
Bid Quote (currency dealer’s buying price)
»
z
z
z
$ 1.3472 / 1 Euro
$ 1.3463 / 1 Euro
Ask price > Bid price
Bid A k Q
Bid-Ask
Quotes:
t $1
$1.3463-72
3463 72 or jjustt 63
63-73
73
Bid-Ask Spread (in %) = 100 * (Ask - Bid) / Ask
»
100 * (1.3472 - $ 1.3463) / 1.3472 = 0.0668%
20
10
Indirect Price Quotes (Foreign Currency / USD)
Direct quotes
Indirect quotes
S b l
Symbol
C
Currency
Bid
A k
Ask
Bid
A k
Ask
JPY
Yen
0.01184
0.01189
84.10429
84.45946
EUR
Euro
1.3463
1.3472
0.74230
0.74280
GBP
British
Pound
1.5810
1.5823
0.63200
0.63250
MXN
Mexican
Peso
0.07937
0.08036
12.44332
12.5997
CHF
Swiss
Franc
1.01564
1.01609
0.98416
0.98460
21
Percentage Change: Direct Quotes
Formula: % change in DQ = 100*(DQ1– DQ0) / DQ0
DQ0 = Direct quote
quote, at the beginning of the period
DQ1 = Direct quote, at the end of the period
Interpretation: Measures appreciation or depreciation of the
foreign currency, in terms of the USD. As seen from the US
viewpoint
Example: On 1/1/X1 the DQ for SF was $0.50, on 1/1/X2 it
was $0.60, and on 1/1/X3 it was $0.57
Period
Percentage Change in DQ
20X1 - 20X2 100*(0.60-0.50) / 0.50 = 20.00%
20X2 - 20X3 100*(0.57-0.60) / 0.60 = - 5.00 %
Interpretation
SF appreciated by 20%
SF depreciated by 5%
22
11
Percentage Change: Indirect Quotes
Formula: % change in IQ = 100*(IQ1 – IQ0) / IQ0
IQ0
Q0 = Indirect
d ec quo
quote,
e, a
at the
e beg
beginning
go
of the
e pe
period
od
IQ1 = indirect quote, at the end of the period
Interpretation: Measures appreciation or depreciation of the
USD, in terms of the foreign currency. As seen from the
foreign country’s viewpoint
Example: On 1/1/X1 the IQ for MP was 10.00, on 1/1/X2 it
was 9.00, and on 1/1/X3 it was 11.25
Period
Percentage Change in IQ
Interpretation
20X1 - 20X2 100*(9.00-10.00) / 10.00= -10.00% USD depreciated by 10%
20X2 - 20X3 100*(11.25-9.00) / 9.00= 25.00% USD appreciated by 25%
23
Percentage Change in Direct Quotes:
Using Indirect Quotes
% change in DQ =
100*[100 / (100 + % change
h
in
i IQ) - 1]
Example: Suppose, on 1/1/X1 the IQ for JY was 120, and on
1/1/X2 it was 100. It means that during this period, USD
depreciated by 20% from the Japanese viewpoint. What
was the % change in the value of JY from the US viewpoint?
Solution: During the 20X1-X2, IQ for JY changed by – 20%
Percentage in DQ (over the same period):
100* [100 / (100 – 20) – 1] = 100* [(100/80) – 1] = + 25%
During this period, JY appreciated by 25% (from US view
point)
24
12
Percentage Change in Indirect Quotes:
Using Direct Quotes
% change in IQ =
100*[100 / (100 + % change
h
in
i DQ) - 1]
Example: Suppose, on 1/1/X1 the DQ for SF was $0.50, and
on 1/1/X2 it was $0.55. It means that during this period, SF
appreciated by 10% from the US viewpoint. What was the
% change in the value of USD from the Swiss viewpoint?
Solution: During 20X1-X2, DQ for SF changed by + 10%
Percentage in IQ (over the same period):
100* [100 / (100 + 10) – 1] = 100* [(100/110) – 1] = - 9.09%
During this period, USD depreciated by 9.09% from the Swiss
viewpoint
25
Cross Exchange Rates Quotes
z
Deriving the exchange rates between two
currencies from their respective direct quotes
» Example: Use the direct dollar quotes for SF and BP to
calculate:
– how many SF per BP
– how many BP per SF
» Direct dollar quotes: (SF= $ 1.0166, BP = $ 1.5850)
» Cross exchange rates:
– The price of BP in terms of SF = (DQ of BP / DQ of SF)
z (1.5850 / 1.0166) = SF 1.5591/ BP
z One BP = SF 1.5591
– The price of SF in terms of BP = (DQ of SF / DQ of BP)
z (1.0166 / 1.5850) = BP 0.6414 / SF
z One SF = BP 0.6414
26
13
Cross Exchange Rates Quotes:With
Bid and Ask Quotes
z
Direct dollar quotes:
»
z
z
For Swiss Francs:
Bid price: $ 1.01564
Ask price: $ 1.01609
– Quote: $1.01564-609
»
For Euro:
– Bid price = $ 1.3463
– Ask Price = $1.3472
– Quote: $1
$1.3463-72
3463 72
z
Cross exchange rates: Find the direct bid-ask quote
for Swiss Francs in terms of Euros.
27
LOCATIONAL ARBITRAGE
z
Buy low in one location & sell high in another
l
location
ti
»
In the FX market
–
z
The buying price (ask price) in one bank is lower than the
selling price (bid price) of another bank
Market adjustments which will eliminate
locational arbitrage
g
»
In the FX market:
–
–
The ask price will rise and bid price will fall
Till ask price (of one bank) is greater than or equal to bid
price (of another bank)
28
14
LOCATIONAL ARBITRAGE
PROFIT
z
Case 1: No
Arbitrage Possible
z
Case 2: Arbitrage
Possible
z
New York Bank Quotes
» Ask $1.581 / 1 BP
» Bid $1.583 / 1 BP
London Bank Q
Quotes
» Ask $1.582 / 1 BP
» Bid $1.586 / 1 BP
z
Chicago Bank Quotes
» Ask $1.347 / 1 euro
» Bid $1.346 / 1 euro
Frankfurt Bank Q
Quotes
» Ask $1.350 / 1 euro
» Bid $1.348 / 1 euro
z
29
Triangular Arbitrage: When Implied & Actual Cross
Rates are Different
1 BP = $1.50
1 SF = $
$0.50
Implied cross rate: 1 BP = 1.5/0.5 = 3.0 SF
If actual cross rate: 1 BP = 3.50 SF
(It is better to sell BP in return for SF)
If actual cross rate: 1 BP = 2.50 SF
(It is better to buy BP with SF)
$
BP
$
SF
BP
SF
30
15
Triangular Arbitrage: When Implied Cross
Rate is Less than Actual Cross Rate
1 BP = $1.50
$0.50
1 SF = $
Implied cross rate: 1 BP = 1.5/0.5 = 3.0 SF
If actual cross rate: 1 BP = 3.50 SF. Have $1,000
$ 1,000
$1,166.67
BP 666.67
666.67 X 3.5
SF 2,333.33
31
Triangular Arbitrage: When Implied Cross
Rate is Less than Actual Cross Rate
z
$ exchanged for BP
»
z
The price of BP falls against SF: (SF 3.50/BP
)
SF exchanged for $
»
z
)
BP exchanged for SF
»
z
The price of BP rises against the $: ($1.50 /BP
The price of SF falls against the $: ($ 0.50/SF
)
The implied
Th
i li d cross rate
t approaches
h the
th actual
t l cross
rate
32
16
Triangular Arbitrage: When Implied Cross
Rate is Greater than Actual Cross Rate
1 BP = $1.50
$0.50
1 SF = $
Implied cross rate: 1 BP = 1.5/0.5 = 3.0 SF
If actual cross rate: 1 BP = 2.50 SF. Have $1,000
$ 1,200
$1,000
BP 800
2,000 / 2.5
SF 2,000
33
Triangular Arbitrage: When Implied Cross
Rate is Greater than Actual Cross Rate
z
$ exchanged for SF
»
z
The price of BP rises against SF: (SF 2.50/BP
)
BP exchanged for $
»
z
)
SF exchanged for BP
»
z
The price of DM rises against the $: ($0.50 /SF
The price of BP falls against the $: ($ 1.50/BP
)
The implied
Th
i li d cross rate
t approaches
h the
th actual
t l cross
rate
34
17
Triangular Arbitrage: Eaxmple
Bank Quotations
Bid
Ask
D
Deutsche
h B
Bank
k ££:$
$
$1 9712
$1.9712
$1 9717
$1.9717
Credit Lyonnais €:$
$1.4738
$1.4742
Credit Agricole £:€
€1.3310
€1.3317
“No Arbitrage” £:€ €1.3371
€1.3378
Byy going
g g through
g Deutsche Bank and Credit Lyonnais,
y
we
can sell pounds for €1.3371.
$1.9712
= €1.3371
Bid price for £ in terms of € =
$1.4742
The arbitrage is to buy those pounds (at ask price) from
Credit Agricole for €1.3317
5-35
Triangular Arbitrage
Bank Quotations
Bid
Ask
Deutsche Bank £:$
$1.9712
$1.9717
Credit Lyonnais €:$
$1.4738
$1.4742
Credit Agricole £:€
€1.3310
€1.3317
Start with £1m: sell £ to Deutsche Bank for $1,971,200.
$1.9712
= $1,971,200.
£10,000,000 ×
£1 00
£1.00
Buy euro from Credit Lyonnais receive €1,337,132
€1.00
$1,971,200 ×
= €1,337,132.
$1.4742
Buy £ from Credit Agricole receive £1,004,078.89
5-36
18
The Forward Market
Forward Rate Quotations
z Forward Premium
z Long and Short Forward Positions
z Motivations for using Forward contracts
z
» Speculation
» Hedging
5-37
Forward Currency Market
Market where Forward Contracts by traded
z Forward Contracts are agreements to deliver
(or take delivery of) a specified amount of
foreign currency at a fixed future date and at
a fixed exchange rate.
z Used by businesses and currency traders to:
z
Hedge against currency (exchange rate) risk
» Speculate (make trading profits)
»
38
19
Forward Exchange Rate
z
The dollar price at which a foreign
currency can be bought and sold at
future date. This rate is set at the time
when the contract is signed. No money
is exchanged at this time.
39
Forward Rate Quotes
z
Direct Dollar Quotes from WSJ (attached):
» Swiss Franc (FF)
– spot rate (direct quote): $0.8401
– 6-months forward rate (direct quote): $0.8492
» Japanese Yen (JY)
– spot rate (direct quote): $0.009646
– 6-months forward rate (direct quote): $0.009788
40
20
Using Forward Contracts
z
Two major applications of forward contracts:
» Hedging
» Speculation
41
5-42
21
5-43
Forward Rate Quotations
Consider these
exchange
h
rates:
t
for
f
British pounds, the
spot exchange rate is
$1.9717 = £1.00
while the 180-day
180 day
forward rate is
$1.9593 = £1.00
zWhat does that
mean?
5-44
Country/currency
in US$ per
US$
UK pound
1.9717
.5072
1-mos forward
1.9700
.5076
3-most forward
1.9663
.5086
6-mos forward
1.9593
.5104
Clearly market
participants expect that
the pound will be worth
less in dollars in six
months.
22
Forward Rate Quotations
z
Consider the (dollar) holding period return
of a dollar-based investor who buys £1
million at the spot exchange rate and sells
them forward:
gain $1,959,300 – $1,971,700 –$12,400
$HPR=
=
=
$1,97,1700
$1,971,700
ppain
$HPR = –0.00629
Annualized dollar HPR = –1.26% = –0.629% × 2
5-45
Forward Premium
z
z
The interest rate differential implied by forward
premium or discount.
discount
Annualized % premium (discount)
» [(Forward rate – Spot rate ) / Spot rate ] * [ 360/ Days to Maturity]
* 100
For example, suppose the € is appreciating from
S($/€)
($ ) = 1.55 to F180($
($/€)) = 1.60
z The 180-day forward premium is given by:
1.60 – 1.55
360
F180($/€) – S($/€)
=
×2
f180,€v$ =
×
1.55
180
S($/€)
= 0.0645
or 6.45%
z
5-46
23
Long and Short Forward
Positions
If you have agreed to sell anything (spot
or forward), you are “short”.
z If you have agreed to buy anything
(forward or spot), you are “long”.
z If y
you have agreed
g
to sell FX forward,,
you are short.
z If you have agreed to buy FX forward,
you are long.
z
5-47
Payoff Profiles
profit
If you agree to sell anything in the
future at a set price and the spot
price later falls then you gain.
S180($/¥)
0
F180($/¥) = .009524
If you agree to sell anything in the
future at a set price and the spot
loss price later rises then you lose.
Short position (DQ)
5-48
24
Payoff Profiles
profit
short position (IQ)
0
F180(¥/$) = 105
Whether
h h the
h
payoff profile
slopes up or
down depends
upon whether
S180((¥/$))
you use the
direct or indirect
quote:
F180(¥/$) = 105 or
F180($/¥) =
.009524.
-F180(¥/$)
loss
5-49
Payoff Profiles
profit
short position
S180(¥/$)
0
F180(¥/$) = 105
-F180(¥/$)
loss
When the short entered into this forward contract,
he agreed to sell ¥ in 180 days at F180(¥/$) = 105
5-50
25
Payoff Profiles
profit
short position
15¥
S180(¥/$)
0
F180(¥/$) = 105
-F180(¥/$)
loss
120
If, in 180 days, S180(¥/$) = 120, the short will
make a profit by buying ¥ at S180(¥/$) = 120 and
delivering ¥ at F180(¥/$) = 105.
5-51
Payoff Profiles
profit
F180(¥/$)
Since this is a zero-sum
zero sum game,
the long position payoff is the
opposite of the short.
short position
S180(¥/$)
0
F180(¥/$) = 105
-F180(¥/$)
loss
Long position
5-52
26
Payoff Profiles
profit
-F
F180(¥/$)
The longg in this forward contract agreed
g
to BUY
¥ in 180 days at F180(¥/$) = 105
If, in 180 days, S180(¥/$) = 120, the long will
lose by having to buy ¥ at S180(¥/$) = 120
and delivering ¥ at F180(¥/$) = 105.
S180(¥/$)
0
120
F180(¥/$) = 105
–15¥
Long position
loss
5-53
Forward Market Hedge
If you are going to owe foreign currency
in the future, agree to buy the foreign
currency now by entering into long
position in a forward contract.
z If you are going to receive foreign
currency in the future, agree to sell the
foreign currency now by entering into
short position in a forward contract.
z
5-54
27
Forward Market Hedge: an
Example
You are a U.S.
U S importer of British woolens
and have just ordered next year’s
inventory. Payment of £100M is due in
one year.
Question: How can you fix the cash
Answer:
Oneinway
is to put yourself in a position
outflow
dollars?
that delivers £100M in one year—a long
forward contract on the pound.
5-55
Forward Market Hedge: an Example
0
Step 1
Order Inventory; agree to
pay supplier £100 in 1 year.
Step 2
Take a Long position in
a Forward Contract on
£100 million.
1
Step 3
Fulfill your contractual
obligation to forward contract
counterparty and buy £100
million for $195 million.
million
Step 4
Pay supplier £100 million
(Suppose that the forward rate is $1.95/£.)
5-56
28
Forward Market Hedge
Suppose the
forward exchange
rate is $1.95/£.
$30m
If he does not
hedge the £100m
payable, in one $0
year his gain
(loss) on the –$30m
unhedged
position is shown
in green.
The importer
p
will be better off
if the pound depreciates: he
still buys £100m but at an
exchange rate of only $1.65/£
he saves $30 million relative to
$1.95/£
Value of £1 in $
$1.65/£ $1.95/£ $2.25/£
in one year
But he will be worse off if
the pound appreciates.
Unhedged
payable
5-57
Forward Market Hedge
If he agrees
to buy £100m
in one year at
$30m
$1.95/£ his
gain (loss) on
the forward
$0
are shown in
blue.
–$30m
If you agree to buy £100
million at a price of
$1.95 per pound, you
will make $30 million if
the price of a pound
reaches $2.25.
Long
forward
Value of £1 in $
$1.65/£ $1.95/£ $2.25/£
in one year
If you agree to buy £100 million at a
price of $1.95 per pound, you will lose
$30 million if the price of a pound is
only $1.65.
5-58
29
Forward Market Hedge
The red line
shows the
payoff of the
$30
hedged
m
payable. Note
that gains on
$0
one position
are offset by
losses on the –$30 m
other position.
Long
forward
Hedged payable
Value of £1 in $
in one year
$1.65/£ $1.95/£ $2.25/£
Unhedged
payable
5-59
Using Forward Contracts for
Hedging: Theory
z
Buy Forward Contracts (take a Long Position in the FM):
» When yyou expect
p
to make a p
payment
y
in Foreign
g currency,
y, at a
future date:
– You gain when the spot rate at the future date is higher than the
forward exchange rate
– You lose when the spot rate at the future date is lower than the
forward exchange rate
z
Sell Forward Contracts (take a Short Position in the FM):
» When you expect to receive a payment in Foreign currency,
currency at a
future date:
– You gain when the spot rate at the future date is lower than the
forward exchange rate
– You lose when the spot rate at the future date is higher than the
forward exchange rate
60
30
Using Forward Contracts for
Speculation: Theory
z
Buy Forward Contracts (take a Long Position in the FM):
» When yyou expect
p
the future spot
p rate to be higher
g
then the
current forward rate:
– You will gain when the future spot rate is higher than the current
forward exchange rate
– You will lose when the future spot rate is lower than the current
forward exchange rate
z
Sell Forward Contracts (take a Short Position in the FM):
» When you expect the future spot rate to be lower then the current
forward rate:
– You will gain when the future spot rate is lower than the current
forward exchange rate
– You will lose when the future spot rate is higher than the current
forward exchange rate
61
Using Forward Contracts for
Speculation: Examples
z
Today, the 6-month forward rate on SF is $0.8492
» If you expect that 6-months from today
today, the spot rate of
SF will be greater than $0.8492:
– The you should BUY SF forward contracts
z
z
If 6-months latter, the SR for SF is $0.8495:
» you make (0.8495 – 0.8492) = $0.0003 / SF (profit)
If 6-months latter, the SR for SF is $ 0.8485:
» you make (0.8485 – 0.8492) = - $0.0007 / SF (loss)
» If you expectt that
th t 6-months
6
th from
f
today,
t d
the
th spott rate
t off
SF will be less than $0.8492:
– Then you should SELL SF forward contracts
z
z
If 6-months latter, the SR for SF is $0.8495:
» you make (0.8492 – 0.8495) = - $0.0003 / SF (loss)
If 6-months latter, the SR for SF is $0.8485:
» you make (0.8492 – 0.8485) = $0.0007 / SF (profit)
62
31
Currency Conversion Problem Set #1
Please use the following quotes, to answer the questions listed below:
Currency
Quotes
Swiss francs
1 SF for $0.50
Mexican pesos
10 MP for 1 USD
British pounds
0.75 BP for 1 USD
Direct or Indirect ?
1. $3,000,000 can be converted into ______________ British pounds
2. SF 1,500,000 can be converted into ____________ USD
3. MP 600,000 can be converted into __________ Swiss francs
4a. How many SF does it take to buy 1 BP?
4b. How many BP does it take to buy 1 SF?
Currency Conversion Problem Set #2
1/1/X0
1/1/X1
BP quotes
$2.00 per BP
$2.18 per BP
SF quotes
SF 2.50 per USD SF 2.00 per USD
JY quotes
JY100 per USD
JY 120 per USD
For the time period: 1/1/X0 - 1/1/X1, please calculate:
1. The percentage appreciation / depreciation of BP in terms of the USD
2. The percentage appreciation / depreciation of USD in terms of SF
3. The percentage appreciation / depreciation of JY from the US viewpoint
4. Suppose during this time period the indirect quote for MP decreased by 15%.
(i) By what % did the MP appreciate/depreciate from the US viewpoint?
(ii) By what % did the USD appreciate/depreciate from the Mexican viewpoint?
Currency Conversion Problem Set #3
Currency
Quotes on 1/1/X1
Quote on 1/1/X2
1 CD = $0.50
1 CD = $0.54
Swiss francs
SF 1.80 = 1 USD
SF 1.90 = 1 USD
Japanese yen
1 USD = JY 100
1 USD = JY 120
Canadian dollars
a. Based on the 1/1/X2 quote, convert 8,000,000 Canadian dollars into US dollars:
b. Based on the 1/1/X2 quotes, convert $25,000,000 into Swiss francs:
c. During the one-year period, what was the percentage appreciation / depreciation
of the Japanese yen from the US point of view ?
d. During the one-year period, what was the percentage appreciation / depreciation
of the US dollar from the Swiss point of view?
Bid-Ask Spread Problem Set #1
The following table presents bid and ask quotes for BP from currency dealers in
New York and London:
Currency Dealer in
New York
London
Bid Quote for BP
$ 1. 58
$ 1.65
Ask Quote for BP
$ 1. 68
$ 1.70
1. Assume that you dealt with the New York currency dealer only. You converted
$100,000 into pounds, and immediately afterwards sold the pounds for dollars.
Estimate the dollar amount you lost in this round trip transaction.
2. Assume that you dealt with the London currency dealer only. What is the
percentage bid-ask spread for this dealer?
3. Which dealer (s) would you buy from, and sell to ?
Cross Exchange Rates Quotes With Bid
and Ask Quotes: In-Class Exercise
•
Direct dollar quotes:
–
For Swiss Francs:
• Bid-Ask Quote: $0.5205-50
–
For Canadian Dollar:
• Bid-Ask Quote: $0.8510-95
•
Cross exchange rates: Find the direct bid-ask quote
for Canadian dollars, stated in Swiss Francs
1
EXAMPLE: FX FORWARD MARKET BASICS
Today: 1/1/XX
Spot Rate for BP = $1.50
6-Month Forward Rate for BP = $1.60
FC BUYER / LONG POSITION HOLDER:
6-Month Forward Contract for BP 1,000,000
Current Financial Obligations: None
Six Months Latter: 6/1/XX
Financial Obligations of Forward Contract Buyer:
Pay: 1.60 x 1,000,000 = $1,600,000
Receive: BP 1,000,000
Suppose on 6/1/XX
SR = $1.63
Then for BP 1,000,000
You have paid: $1,600,000
And it is worth: $1,630,000
Your profit/loss: $ 30,000
FC SELLER / SHORT POSITION HOLDER:
6-Month Forward Contract for BP 1,000,000
Current Financial Obligations: None
SR = $1.58
Then for BP 1,000,000
You have paid: $1,600,000
And it is worth: $1,580,000
Your profit/loss: - $ 20,000
Financial Obligations of Forward Contract Seller:
Pay: BP 1,000,000
Receive: 1.60 x 1,000,000 = $1,600,000
Suppose on 6/1/XX
SR = $1.63
Then for BP 1,000,000
You have received: $1,600,000
And it is worth: $1,630,000
Your profit/loss: - $ 30,000
SR = $1.58
Then for BP 1,000,000
You have received: $1,600,000
And it is worth: $1,580,000
Your profit/loss: $ 20,000
EXERCISE: FX FORWARD MARKET BASICS
Today: 1/1/XX
Spot Rate for Euro = $1.15
6-Month Forward Rate for E = $1.20
Six Months Latter: 6/1/XX
FC BUYER / LONG POSITION HOLDER:
6-Month Forward Contract for E 5,000,000
Current Financial Obligations:
Financial Obligations of Forward Contract Buyer:
Pay:
Receive:
Suppose on 6/1/XX
E = $1.13
Then for E 5,000,000
You have paid: $
And it is worth: $
Your profit/loss: $
FC SELLER / SHORT POSITION HOLDER:
6-Month Forward Contract for E 5,000,000
Current Financial Obligations:
E = $1.25
Then for E 5,000,000
You have paid: $
And it is worth: $
Your profit/loss: $
Financial Obligations of Forward Contract Seller:
Pay:
Receive:
Suppose on 6/1/XX
E = $1.13
Then for E 5,000,000
You have received: $
And it is worth: $
Your profit/loss: $
E = $1.25
Then for E 5,000,000
You have received: $
And it is worth: $
Your profit/loss: $
FX Spot / Forward Market Transactions Problem Set #1
Forward and Spot Prices Quotes for Foreign Currencies: From Wall Street Journal
Today: 01/15/XX (Wednesday)
1-month latter: 02/15/XX (Tuesday)
6-months latter: 07/15/XX (Monday)
1. Today (1/15/XX), you bought 100 million JY in the spot market from Credit Suisse First Boston (CSFB), and sold it back to CSFB one month latter:
Your cash flows today, are:
Your cash flows on 2/15/XX are:
Your profit/loss is:
CSFB’s cash flows today, are:
CSFB’s cash flows on 2/15/XX are:
CSFB’s profit/loss:
2. Today (1/15/XX), you bought a one-month forward contract for 100 million JY from Credit Suisse First Boston (CSFB) :
Your cash flows today, are:
Your cash flows on 2/15/XX are:
Your profit/loss (in the FM) is:
CSFB’s cash flows today, are:
CSFB’s cash flows on 2/15/XX are:
CSFB’s profit/loss (in the FM) is:
FX Spot / Forward Market Transactions Problem Set #1 (Contd.)
3. Today (1/15/XX), you sold a six-month forward contract for 100 million JY to Credit Suisse First Boston (CSFB) :
Your cash flows today, are:
Your cash flows on 7/15/XX are:
Your profit/loss (in the FM) is:
CSFB’s cash flows today, are:
CSFB’s cash flows on 7/15/XX are:
CSFB’s profit/loss (in the FM) is:
4. Today (1/15/XX), you bought a one-month forward contract for 1 million BP from Credit Suisse First Boston (CSFB) :
Your cash flows today, are:
Your cash flows on 2/15/XX are:
Your profit/loss (in the FM) is:
CSFB’s cash flows today, are:
CSFB’s cash flows on 2/15/XX are:
CSFB’s profit/loss (in the FM) is:
5. Today (1/15/XX), you sold a six-month forward contract for 10 million SF to Credit Suisse First Boston (CSFB) :
Your cash flow today, is:
Your cash flows on 7/15/XX is:
Your profit/loss (in the FM) is:
CSFB’s cash flow today, is:
CSFB’s cash flows on 7/15/XX is:
CSFB’s profit/loss (in the FM) is:
Formula: Currency Conversion
Quotes: DQ (direct quote): The dollar price of one unit of foreign currency (FC)
IQ (indirect quote): Number of units of FC per one dollar; DQ = 1 / IQ and IQ = 1 / DQ
DQ0 = DQ now; DQ1 = DQ 1-year later; IQ0 = IQ now; IQ1 = IQ 1-year later
Calculating Percentage Change in DQ and IQ:
% change in DQ = 100 * (DQ1 - DQ0) / DQ0 = 100*[100 / (100 + % change in IQ) - 1]
% change in IQ = 100 * (IQ1 - IQ0) / IQ0 = 100*[100 / (100 + % change in DQ) - 1
Currency Conversion:
Converting USD into FC
Converting FC into USD
Using DQ
USD / DQ = FC
FC * DQ = USD
Using IQ
USD * IQ = FC
FC / IQ = USD
Ask Price (A): The buying price for one unit of FC from the currency dealer;
Bid Price (B): The selling price for one unit of FC to the currency dealer;
Bid-Ask Spread = 100* (A – B) / A
Cross-Quotes: DQ1= $ price of FC1; DQ2 = $ price of FC2;
The price of FC1 in terms of FC2 (how many unit of FC2 does it take to buy one FC1) = DQ1 / DQ2
The price of FC2 in terms of FC1 (how many unit of FC1 does it take to buy one FC2) = DQ2 / DQ1
Forward Premium or Discount: [(forward rate – spot rate) / spot rate] * [360/days to maturity] * 100