Professional Documents
Culture Documents
Foreign Exchange Rate Market
Foreign Exchange Rate Market
objective:
examines the functions, actual operation of
the FOREX markets including exchange
rate and international financial markets.
Outline
1.Foreign
Exchange Market
2.Foreign Exchange Rates
3.Spot and Forward Rates, Currency Swaps,
Futures and Options
4.Foreign Exchange Risks, Hedging, and
Speculation
5.Interest Arbitrage
6.Offshore Financial Markets
1. FOREX Market
(1)concept
(2)Function and Structure
(1) concept
FOREX
the
exchange rates
(2)Foreign exchange rate quotations
(3) Exchange rates categories
(4)Arbitrage
Million /day
Appreciation and Depreciation
S($/)=1.5683
S($/ )= 0.5235
then /
S( /)= S($/)/S($/ )
= 1.5683 / 0.5235=2.9958
(4)Arbitrage
Make
a profit
Two-point arbitrage:The exchange rate between any two
currencies is kept the same in different monetary centers.
example: in the same time
in Hong Kong $100=HKD778.07
in New York $100=HKD775.07
one Hong Kong bank sold 1million dollars in Hong Kong,
and in New York sold 7.7507million Hong Kong dollars,
gained 1 million dollars. Profit:30 thousand HKD
(4)Arbitrage
Triangular
(4)Arbitrage
Suppose
(4)Arbitrage
Remember:
The
(2)Currency Swap
An
(2)Currency Swap
Be
Futures
Organized exchange
Standardized amount
Daily settlement done by
the clearinghouse through
the participants margin
account
Standardized delivery date
Delivery seldom made,
reversing trade is transacted
to exit the market
For small firms
Forward
OTC
Tailor-made
Buy or sell at maturity at the
forward price
Meets the needs of investor
Commonly made
For large financial institutions,
business firms and wholesale
banking activities
1)Futures:Daily Resettlement
Suppose
Japan (yen)
1-month forward
3-months forward
6-months forward
U.S. $ equivalent
Wed
Tue
0.007142857 0.007194245
0.006993007 0.007042254
0.006666667 0.006711409
0.00625 0.006289308
Currency per
U.S. $
Wed
Tue
140
139
143
142
150
149
160
159
$1
$3,355.70 .04 12,500,000
Your broker will let you slide until you
149
run through
your maintenance margin. Then you must post
additional funds or your position will be closed out.
This is usually done with a reversing trade.
1)Futures:reversing trade
If
Long call
E
loss
St
E
Short call
Loss
E
Short put
2)options: example1
Example1:
2)options: example1
Call
option
Exercise price:
$0.7500/CD
Current premium: c0.84/CD
Spot rate:
$0.7564/CD
CD50,000
Exercise value:
$320
2)options: example1
profit
E=75
ST
-0.84
ST=E+Ca =75+0.84
=75.84
Call option :
Buyers perspective
2)options: example1
Call
ST
2)options: example1
At
Example 2
expiration
2)options: example2
Put
option
Exercise price:
Current premium:
Spot rate:
EUR62,500
Exercise
If spot rate:
Not exercise:
$1.04/EUR
c2.47/EUR
$1.0307/EUR
1.04-1.0307= 0.93
$1.0425/EUR
1.04-1.0425=-0.0025
2)options: example2
Profit
E-Pa=104- 2.47
=101.53
E=104
Put
option: writers
perspective
Profit
ST
-2.47
104-2.47=101.53
2.47
exchange risks
(2)Hedging
(3)Speculation
Exposure
Exchange rate risk as applied to the firms
competitive position.
2)Transaction Exposure
Exchange rate risk as applied to the firms
home currency cash flows.
3)Translation Exposure
Exchange rate risk as applied to the firms
consolidated financial statements.
Cash
SAR1,000,000
Accounts receivable
3,000,000
Plant and equipment
5,000,000
Inventory
2,000,000
SAR11,000,000
Dollar translation on May 31, SAR4=$1
Cash
$250,000
Accounts receivable
750,000
Plant and equipment
1,250,000
Inventory
500,000
$2,750,000
Dollar translation on June 31, SAR5=$1
Cash
$200,000
Accounts receivable
600,000
Plant and equipment
1,000,000
Inventory
400,000
$2,200,000
Debit
Equity
SAR5,000,000
6,000,000
SAR11,000,000
Debt
Equity
$1,250,000
1,500,000
$2,750,000
Debt
Equity
$1,000,000
1,200,000
$2,200,000
(2)Hedging
Hedging
Money
Market Hedge
Forward Market Hedge
Options Market Hedge
Futures Market Hedge
Cross-Hedging Minor Currency Exposure
Hedging Contingent Exposure
Hedging Recurrent Exposure with Swap Contracts
(2)Hedging
Hedging
S($/) = $1.25/
F360($/) = $1.20/
i$ = 7.10%
i =
11.56%
100
89.64
1.1156
How many dollars will it take to acquire 89.64 million
at the start of the year if the spot rate S($/) = $1.25/?
$1.00
$112.05 89.64
1.25
Example
Example
Forward
market hedge
Gain=(F-ST)10 million
Money
market hedge
The firm may borrow (lend) in foreign
currency to hedge its foreign currency
receivables (payables), thereby matching its
assets and liabilities in the same currency.
Example
Money
market hedge
Borrow 9,174,312= 10/1.09 in the U.K.
Convert 9,174,312 into $13,761,468 at the spot
rate of $1.5/
Invest $13,761,468 in the U.S.
Collect 10million receivable and use it to repay
the pound loan
Receive the maturity value of dollar investment,
$14,800,918= $13,761,468 1.061
Example
Option
market hedge
buy a put option with an exercise price of $1.46
Assume premium was $0.02 per pound, $200,000
Under the options hedge, the net dollar proceeds
from the British sale become:
$14,387,800=$14,600,000-$200,0001.061
Cross-Hedging
Minor Currency Exposure
The
Cross-Hedging
Minor Currency Exposure
Cross-Hedging
Hedging
Exposure Netting
A multinational
Exposure Netting
Even if its not a perfect hedge, it may be too
$60
$25
$10
$20
$30
$30
$40
$15
$40
Type of product
Forward
Foreign currency swaps
Foreign currency futures
Exchange-trade currency options
Exchange-trade futures options
OTC currency options
heard of
100%
98.8
98.8
96.4
95.8
93.5
used
93%
52.6
20.1
17.3
8.9
48.8
(3)Speculation
The
(3)Speculation
Speculative
forward position
It is July 6,1999. Suppose the $/SF trader has
heard the dollar will likely appreciate in value
against Swiss franc to level less than the forecast
rate over the next three months. He will short the
90-day $/SF contract. If the trader sells
SF5,000,000 forward, suppose the forward has
proven correct, on Oct.6, 1999, spot $/SF is trade
at $0.6400.
(3)Speculation
And
(3)Speculation
P/L(profit/loss)
long position
0.6453
0.0053
S90 ($/SF)
0.6400
0.6500
-0.0047
Short position
short position
5.Interest Arbitrage
1)uncovered
interest arbitrage
2)covered interest arbitrage
3)covered interest arbitrage parity
4)covered interest arbitrage margin
5)efficiency of FOREX market
5.Interest Arbitrage
Arbitrage:
S($/) = $1.25/
F360($/) = $1.20/
i$ = 7.10%
i =
11.56%
If
The
(F/S)(1 + i ) = (1 + i$)
or if you prefer,
1 i$ F
1 i S
(F- S)
(i$ -i )
S
i$ ( F / S )(1 i ) 1
i$ (d 1)(1 i ) 1
i$ d i di
i$ d i
Transactions Costs
The interest rate available to an arbitrageur for
(Fb/Sa)(1 + il) (1 + i b) 0
Capital
Controls
Market
Whats the Eurocurrency?
Offshore market
2)Reasons for its Development
Political
Credit and deposit rate
3)Eurobonds and Euronotes
Products
Eurobonds
FRNs
Euronotes
among
CP
EMTNs
NIFs
Syndicated Euro-loans
82 88
94
71.7 225.5 422.1
12.6
23.1 92.7
2.3
76.4 193.3
0
58.25 36.4
0
19.196 157
2.3
3.7
0.5
100.5 102
248.6
Key Words