Transcript The Foreign Exchange Market

Bob LeClair's Finance and Markets Newsletter
For the Week Ending:
Change
1/1/09
3/7/09
3/14/09
(Week)
Dow Jones Ind. Avg.
8,776
6,627
7,224
597
(% Change)
9.01%
S & P 500 Index
903
683
757
73
(% Change)
10.71%
NASDAQ Composite
1,577
1,294
1,432
138
(% Change)
10.64%
Change
(Yr-to-Date)
(1,552)
-17.68%
(146)
-16.22%
(146)
-9.23%
S & P 500 P/E Ratio
S & P 500 Div. Yield
T-bill - S&P 500 Yield
20.0
3.20%
-3.13%
13.6
4.16%
-3.96%
15.4
3.68%
-3.49%
1.8
-0.48%
0.47%
-4.6
0.48%
-0.36%
30-Year T-Bond Yield
10-Year T-Bond Yield
90-Day T-Bill Yield
Yield Spread
2.68%
2.21%
0.07%
2.61%
3.55%
2.87%
0.20%
3.35%
3.67%
2.89%
0.19%
3.48%
0.12%
0.02%
-0.01%
0.13%
0.99%
0.68%
0.12%
0.87%
30-Year Mortgage
15-Year Mortgage
1-Year Adjustable Rate
30-Yr. - 1-Yr. ARM Rate
5.10%
4.83%
4.85%
0.25%
5.15%
4.72%
4.86%
0.29%
5.03%
4.64%
4.80%
0.23%
-0.12%
-0.08%
-0.06%
-0.06%
-0.07%
-0.19%
-0.05%
-0.02%
$ Value of Euro (€)
Japanese Yen (¥) / $
Crude Oil, Spot Price
Gasoline, Reg. ($/Gal.)
$1.3947
90.84
$38.95
$1.61
$1.2652
98.27
$45.28
$1.93
$1.2928
98.02
$46.91
$1.94
$0.0276
-0.25
$1.63
$0.01
-$0.1019
7.18
$7.96
$0.33
“Rescue ...for the Euro Falls Short…”
[New York Times, 9-24-00]
“To
the disappointment of many
European bankers, American officials
refrained from speaking out strongly in
support of a stronger euro and raised
doubts about their willingness to
intervene forcefully in currency
markets by selling dollars or buying
euros.”
“Rescue ...for the Euro Falls Short…”
[New York Times, 9-24-00]
“The
market badly needs a
statement from the Americans that
the euro is substantially undervalued and the dollar is
substantially overvalued,” Mr.
Friedrich said.”
“Rescue ...for the Euro Falls Short…”
[New York Times, 9-24-00]
“…
the amount of money used to
intervene … was very modest. The
ECB gave no clue about the magnitude
of its campaign to buy euros or sell
other currencies, but currency experts
and traders have estimated that the
amount was about $6 billion or $7
billion.”
“Rescue ...for the Euro Falls Short…”
[New York Times, 9-24-00]
“…
Dow Jones Newswires,
quoting an anonymous official at
the ECB, said the actual amount of
the intervention was in the ‘low
single digits,’ perhaps $2 billion or
$3 billion’.”
“Rescue ...for the Euro Falls Short…”
[New York Times, 9-24-00]
“Psychology
and timing may
ultimately be more important to the
future of the euro than the amounts
of money used by the world’s
central banks on its behalf.”
Chapter 6:
The Foreign Exchange Market
Problems: Chapter 6
6.1
6.2
6.4
The Foreign Exchange Market
Function: “...to trade one
currency for another
currency.”
The Foreign Exchange Market
interbank
market (95% of transactions)
wholesale market
major banks (20) as traders
spot market: two day delivery (35%)
forward market: future delivery (12%)
swaps: spot + forward (53%)
The Foreign Exchange Market
electronically
linked network
Society for Worldwide Interbank
Financial Telecommunications
(SWIFT)
trade volume – 5%
capital transactions – 95%
The Foreign Exchange Market
Participants
– large
commercial banks
– foreign exchange brokers
– multinational corporations
– central banks
ORGANIZATION OF THE FOREIGN
EXCHANGE MARKET
SIZE OF THE CURRENCY MARKET
A. Largest financial market in the world
2005: traded $1.9 trillion daily
B. Largest Global Market Centers(2004):
1. London =$753 billion daily
2. New York= $461 billion daily
3. Tokyo = $199 billion daily
The Spot Market
[Foreign Exchange]
Foreign
exchange quotes:
trades among dealers in the
interbank market
transactions: $1 million or more
“Use your credit cards!”(?)
Countries with Highest Remittance
Outflows, $Billions, 2005
Sa
U
ud SA
iA
Sw rab
itz ia
er
la
nd
G
er
m
an
y
Sp
ai
n
R
Lu us
xe sia
m
bo
ur
g
N
et Ital
he
y
rla
nd
M
al s
ay
si
a
$45
$40
$35
$30
$25
$20
$15
$10
$5
$0
Countries with Highest Remittance
Inflows, $Billions, 2005
$25
$20
$15
$10
$5
In
di
a
C
hi
na
M
ex
Ph
ic
ilip o
pi
ne
s
Fr
an
ce
Sp
ai
Be n
lg
iu
m
U
.K
G
er .
m
an
y
Le
ba
no
n
$0
The Spot Market
[Foreign Exchange]
American
Terms:
number of U. S. $ per unit of
foreign currency
Example: SFr 1 = $0.8672
The Spot Market
[Foreign Exchange]
European
Terms:
number of foreign currency units
per U. S. $
Example: $1 = SFr 1.1531
Verify: $1 / 1.1531 = $0.8672
The Spot Market
[Foreign Exchange]

American Terms:


Number of U. S.
$ per unit of
foreign currency
Example:
 SFr1 = $0.8672



European Terms:
Number of
foreign currency
units per U. S. $
Ex: $1 =
SFr 1.1531
The Spot Market
[Foreign Exchange]
Direct
Quotation:
home currency price of foreign
currency
Example:
(France) FF 3.3862 = 1 DM
(Germany) DM 0.29531 = 1 FF
The Spot Market
[Foreign Exchange]
Indirect
Quotation:
value of one unit of home currency
in the foreign currency
Example:
(England)
£1 = $ 1.6698
Currency Exchange Rates
and Cross Rates
Newspaper Listing
Currency Cross-Rates
“The
exchange rate between two
currencies, neither of which is the
U. S. dollar, calculated by using
the dollar rates for both
currencies.”
Calculating Cross Rates
Yen:
¥120.18 / U. S. $1
Won: W1,186.94 / U. S. $1
¥/$ ÷ W/$ = ¥/W
¥120.18 ÷ W1,186.94 = ¥0.10125 /
W1
The Spot Market
[Foreign Exchange]
Transaction
costs:
Bid (buy) - Ask (sell) spread
Percent spread = ([Ask Price - Bid
Price] / Ask Price) X 100
Typical Spread: 0.1 - 0.5%
The Spot Market
[Foreign Exchange]
Transaction
costs (Spread):
 £1 = $1.6124 - 43
(%) = ((Ask-Bid) ÷ Ask) x 100
(%) = [(1.6143-1.6124)/1.6143] X
100
(%) = 0.00118, or .12%
Currency Arbitrage
40%
of currency transactions don’t
involve the dollar
Looking for exchange rate inconsistencies; different prices in different
markets
Buy in one market; sell in another
Arbitrage maintains equivalent
rates everywhere (in theory)
Currency Arbitrage
[Example]
Exhibit 6.7
Triangular Currency Arbitrage
Bob LeClair's Finance and Markets Newsletter
For the Week Ending:
Change
1/1/09
3/14/09
3/21/09
(Week)
Dow Jones Ind. Avg.
8,776
7,224
7,278
54
(% Change)
0.75%
S & P 500 Index
903
757
769
12
(% Change)
1.58%
NASDAQ Composite
1,577
1,432
1,457
26
(% Change)
1.80%
Change
(Yr-to-Date)
(1,498)
-17.06%
(134)
-14.89%
(120)
-7.59%
S & P 500 P/E Ratio
S & P 500 Div. Yield
T-bill - S&P 500 Yield
20.0
3.20%
-3.13%
15.4
3.68%
-3.49%
15.8
3.55%
-3.35%
0.4
-0.13%
0.14%
-4.2
0.35%
-0.22%
30-Year T-Bond Yield
10-Year T-Bond Yield
90-Day T-Bill Yield
Yield Spread
2.68%
2.21%
0.07%
2.61%
3.67%
2.89%
0.19%
3.48%
3.66%
2.63%
0.20%
3.46%
-0.01%
-0.26%
0.01%
-0.02%
0.98%
0.42%
0.13%
0.85%
30-Year Mortgage
15-Year Mortgage
1-Year Adjustable Rate
30-Yr. - 1-Yr. ARM Rate
5.10%
4.83%
4.85%
0.25%
5.03%
4.64%
4.80%
0.23%
4.98%
4.61%
4.91%
0.07%
-0.05%
-0.03%
0.11%
-0.16%
-0.12%
-0.22%
0.06%
-0.18%
$ Value of Euro (€)
Japanese Yen (¥) / $
Crude Oil, Spot Price
Gasoline, Reg. ($/Gal.)
$1.3947
90.84
$38.95
$1.61
$1.2928
98.02
$46.91
$1.94
$1.3582
95.96
$51.46
$1.91
$0.0654
-2.06
$4.55
-$0.03
-$0.0365
5.12
$12.51
$0.30
The Forward Market
[Foreign Exchange]
Delivery
at a fixed future date
Specified amount of currency
Exchange rate fixed at contract
date
Performance required - not an
option
The Forward Market
[Example]
U.
S. Co. buys textiles from UK
£1 million due in 90 days
£1 = $1.71 ($1,710,000)
Forward rate: £1 = $ 1.72
Importer is short pounds (spot)
90-day forward contract (long)
The Forward Market
[Example]
Hedging a Future Payment
with a Forward Contract
Shapiro: Problem 6.1
exchange rate: €1 = $1.35
€:SFr exchange rate: SFr1 = €0.61
SFr:$ exchange rate?
SFr1 = €0.61 X $1.35 = $0.8235
$:€
Shapiro: Problem 6.2.a
New York:
£1 = $1.9880-5
£500,000 = $???
£500,000 x $1.9885 = $994,250
Shapiro: Problem 6.2.b
What
is the direct quote for
dollars in London?
London: 1/1.9885 - 1/1.9880 =
0.50289 - 0.50302
Shapiro: Problem 6-4
Buy
Euros (€) spot at $1.3480
Sell Euros (€) forward (180 days)
at $1.3526
– A. What is the swap rate on euros?
– B. What is the forward premium or
discount on 180-day Euros?
Shapiro: Problem 6-4.a
Buy
Euros (€) spot at $1.3480
Sell Euros (€) forward (180 days)
at $1.3526
– A. What is the swap rate on euros?
– $1.3526 - $1.3480 = $0.0046, or a
premium of 46 points (“pips”)
Shapiro: Problem 6-4.b
Buy
Euros (€) spot at $1.3480
Sell Euros (€) forward (180 days)
at $1.3526
– b. What is the forward premium or
discount on 180-day Euros?
Shapiro: Problem 6.4.b
(f1  e0 )
360
X

e0
n
Shapiro: Problem 6.4.b
(f1  e0 ) 360
X

e0
n
1.3526  1.3480
X 2  0.68 %
1.3480