Currency Markets

Foreign Exchange Market- Currencies are bought and sold against each other.

Major Currencies: USD,GBP,EUR,CHF,JPY,AUD

Participants

Banks and its Customers

Interbank market- Between banks

Banks and RBI (Central bank)

Currency Markets

Primary price makers or professional dealers make a two-way market to each other and to their clients.

Foreign currency brokers act as middlemen between two market makers.

Corporations are usually price takers.

Geographical Spread

New Zealand to West coast of U.S.

Gap between NY closing and Tokyo opening is about 2 ½ hours.

Trading volume- London, Tokyo and NY accounting for about 50% volume.

International Trade on Finance

At what point of time will the trade be settled? In what currency?

Terms of the transaction namely quantity, quality, price, time etc would be negotiated and settled between buyer and seller.

Regulations- Both parties conform to the trade regulations of both the countries.

Conversion- Financial side by the authorised banks/agencies.

Facilitating Forex Dealings..

Nostro Account – Our account with you.

Bank of India maintains an account with Nat west bank in London, maintained in GBP. While corresponding BOI will refer to its account as NOSTRO account.

Forex Dealings..

Vostro Account – Your account with us.

The account opened by a foreign bank in Indian rupee with a Indian bank.

Bank of Middle East, Sharjah, maintains a rupee account with Syndicate Bank, Mumbai. Syndicate Bank would refer to this as VOSTRO account.

Forex Dealings

Loro Account – Their account with you.

BOI has an account in USD with Citi Bank in NY. When BOB wishes to refer the account of BOI with CB, it would refer to it as LORO account.

Quotation Conventions

Spot rate Quotations Base currency/Quoted Currency USD/CHF: USD base, CHF quoted Quotation given as no: of units of quoted currency

per unit of base currency, bid rate/offer rate. Bid rate- Market maker buying base currency Offer rate- Market maker selling base currency

Spot Quotes

USD/CHF SPOT: 1.4575/1.4580

Bank will buy 1 USD and give CHF 1.4575

Bank will sell 1 USD and want to be paid CHF 1.4580

Shortened to 1.4575/80 or 75/80

Spot Quotes

GBP/USD:1.5665/75

GBP/EUR:1.2545/50

USD/INR:45.7585/45.7685

USD/JPY:110.25/35

Quotations

European Terms: Units of a currency per US dollar. USD/INR:46.7560/7675

American Terms: US dollars per unit of a currency: GBP/USD: 1.5060/65

Direct Quotations: Units of “home” currency per unit of “foreign currency”. USD/INR, a direct quote in India.

Reciprocal or Indirect Quotes: Units of “foreign” currency per unit of “home” currency.

Quotes

Identify whether the following is a direct quote in USA. If not, find it.

A. Rs.46 = $1 B. $1 = S$1.60 C. GBP 1 = $0.639

Exchange Rates

Interbank Rate – Base Rate

Customer Rate – Add a margin to the base rate. Margin as per regulations.

Forex Rates

TT Buying Rate:– Interbank spot buying rate for the currency

– Less: Exchange Margin

– TT Buying Rate

E.g On September 15, 2001 you (a bank) receive a TT from your Los Angeles branch for US$ payable to your customer. Your account with your branch has been credited with the amount of TT. Assuming that US$/INR are quoted in the local interbank market as the following:

Spot: US$ 1 = Rs. 47.50/60

You require an exchange margin of 0.08% to be loaded on the rate.

USD/INR spot buying rate = Rs.47.500 Less: Ex.margin @ 0.08% = Rs. 0.038

TT Buying Rate(R’ded off) = Rs. 47.46 Amount payable to the = Rs.474,600

customer for $10,000

TT Selling Rate:– Interbank spot selling rate for the currency

– Add: Exchange Margin

– TT Buying Rate

E.g. Your customer has requested you to issue a demand draft on NY for USD20,000. Assuming the E/R quoted in the interbank market as the following:

Spot USD/INR = Rs.47.50/60 The exchange margin to be loaded is 0.15%.

USD/INR spot buying rate = Rs.47.60 Less: Ex.margin @ 0.15% = Rs. 0.07

TT Buying Rate(R’ded off) = Rs. 47.67 Amount payable by the = Rs.953,400

customer for $20,000

Arbitrage

Suppose banks A & B are quoting:

A B

GBP/USD:1.4560/1.4570 1.4548/1.4558

Is there arbitrage?

Inverse Quotes

USD/CHF:1.4965/1.4972 a bank in Zurich

CHF/USD: 0.6696/0.6699 a bank in NY

Is there any arbitrage profit by buying 1 ml CHF in Zurich?

Implied Quotes

Implied (CHF/USD) bid = 1/(USD/CHF)ask

Implied (CHF/USD) ask = 1/(USD/CHF)bid

What would have been the quotes in NY to have no arbitrage?

Cross Rates

In London, a dealer quotes: GBP/CHF Spot: 3.5250/55 GBP/JPY Spot: 180.80/181.30 What do you expect the CHF/JPY rate to be

in Geneva? Assume that the Geneva quote is CHF/JPY

51.1530/51.2550. Is there any opportunity for arbitrage?

Cross Rates

CHF/JPY rate implied by the quotes: (CHF/JPY) bid = (CHF/GBP) bid X (GBP/JPY) bid (1/(GBP/CHF)ask)) X (GBP/JPY) bid (1/3.5255) X 180.80 = 51.2835 (CHF/JPY) ask = (CHF/GBP) ask X (GBP/JPY) ask (1/3.5250) X 181.30 = 51.4326

Cross Rates

Buy 1 CHF from Geneva – Pay 51.2550

Sell 1 CHF in London – Rcv GBP 1/3.5255

(0.2836)

Sell GBP in London – Rcv JPY 51.2748

Forward and Swap Quotes

Forward quotes can be given like spot quotes.

USD/CHF 3-months 1.5655/65

Forward and Swap Quotes

It can be given as spot quotes plus a pair of swap points. Each swap point is 0.0001/0.01.

USD/CHF Spot: 1.6530/40 1 month:15/10 3 months:35/25 GBP/USD Spot: 1.4925/35 1 month:12/15 3 months:28/35

Outright Rates

Spot quote(+/-) swap points Rule: If swap points are High/Low, subtract,

base currency at forward discount, quoted currency at premium.

If swap points are Low/high, add. Quoted currency at discount, base currency at premium.

Outright Rates

USD/CHF Spot: 1.6530/40 1 month:15/10 3 months:35/25 Conversion: 1.6530-0.0015=1.6515 1.6540-0.0010 = 1.6530 Outright rate = 1.6515/1.6530

Forex Rates…

Bill buying Rate: Rate applied for foreign bills purchased. (Export bills)

In the forward market the forward margins could be at premium or discount.

While making calculations, the bank will see that the period for which forward margin is loaded is beneficial to the bank. If f.margin is at premium round off to lower month. If f,margin is at discount transit period is rounded off to the higher month.

On Sep 25,2006 your customer has presented to you as their bankers documents for USD100,000 drawn on NY and request you to purchase the same.

Spot rate USD/INR 47.50/60 October 0.22/0.26 Transit period is 20 days and the exchange margin

to be loaded is 0.15%. USD is at premium. Transit period would be rounded

off to the lower month. No premium would be conceded to the customer.

Spot Rate Rs.47.50/60 Add: Forward premium Nil 1-month buying rate Rs.47.50 Less Ex.Margin @ 0.15% Rs.0.07 Bill buying rate Rs.47.43 Amount payable to the customer for

USD.100,000 is 4,743,000.

On Sep 25,2006 your customer has presented to you as their bankers documents for USD100,000 drawn on a party in NY and request you to purchase the same.

Spot rate USD/INR 47.50/60 October 0.60/0.57 Transit period is 20 days and the exchange margin

to be loaded is 0.15%. USD is at discount. Transit period would be rounded

off to the higher month.

Spot Rate Rs.47.50/60 Less: Forward discount Re. 0.60 1-month buying rate Rs.46.90 Less Ex.Margin @ 0.15% Rs.0.07 Bill buying rate Rs.46.83 Amount payable to the customer for USD

100,000 @ Rs. 46.83 is Rs. 4,683,000.

Bill Selling Rate: E.g Import bills The bill selling rate is arrived at by adding exchange

margin to the TT selling rate. On Sep 12,2006 your customer has received an

import bill for USD.20,000.He asks you to retire the bill.

Spot rate USD/INR 47.50/60 October 0.60/0.67 Exchange margin to be loaded is 0.15% on TT sales

and 0.20% on bills selling rate.

Spot Rate Rs.47.60 Add Ex.Margin @ 0.15% Rs.0.07 for TT selling rate TT Selling rate Rs.47.67 Add: E.margin@ 20% Re.0.10 Bills Selling Rate Rs.47.77

for bills selling rate Amount payable by the customer for USD 20,000 @

Rs. 47.77 is Rs.955,400.

Broken Dates

Standard forwards are whole month. Bank will do any number of days forward.

These are “broken dates”. USD/INR spot 46.95/96 1 month 10/12 2 months 20/27 Customer wants to buy 43 days forward.

Broken Dates

15 paise premium from 1 month to 2 months. Assume 30 days in the 2nd month. 0.5 paise per day, 6 paise for 12 days. Rate will be 46.96+0.12+0.06

Broken Dates

Today is April 22. You see the following quotes: USD/INR Spot: 48.85/48.86 Spot-April 2/3 Spot- May 5/7 Spot – June 11/15 Spot – July 19/25 Find the rate for buying USD delivery on July 17.

Broken Dates

Outright rate for June 30 are: (48.85+0.11)/(48.86+0.15) 48.96/49.01

July end spread over june is 8/10 10 paise offer spread for 31 days. For July 17, spread over june is (10/31)17 = 5.48

paise July 17th rate = 49.01+0.05=49.06

Premia/Discounts

(Forward-Spot)/(Spot) X (12/No: of months)

(Forward-Spot)/(Spot) X (365/No: of days)

Premia/Discount

A bank is giving the following quotes: USD/AUD spot: 1.3045/50 91-day forward:1.3425/35 Which currency is at premium? How much is the annualised percentage

premium?

Premia/Discount

Use mid rates: (1.3430-1.30475)/(1.30475) (365/91) 11.76%

Investment Return

A UK investor purchased a 91-day instrument (Face value $1000) for $987.65. At that time, the exchange rate was $1.75 per GBP. At maturity, the exchange rate was $1.83 per GBP. What was the investor’s holding period return in Pounds?

Investment Return

Instrument Cost = 987.65/1.75 GBP 564.37 Maturity value = $1,000 Value in GBP = 1000/1.83 = GBP 546.45 HP return = (546.45-564.37)/564.37 -0.0317 or -3.18%

Investment Option

Suppose the following rates are available to an investor whose functional currency is DEM.

Euro GBP 6-M LIBOR:6.64% p.a Euro CHF 8-M LIBOR: 2.06%p.a Spot E/R CHF/DEM : 1.1000 6-M forward :1.1107 Spot rate: GBP/DEM : 2.8000 6-M forward: 2.7475 Which investment is better if he has DEM 100 as

surplus funds for next six months?

Investment Option

DEM 100 invest in CHF – (100/1.1)(1.0103)(1.1107) = DEM 102.0128

DEM 100 invest in GBP– (100/2.8)(1.0332)(2.7475) = DEM 101.3827