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8/3/2019 Forex Market _2
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FOREIGN EXCHANGE RATES
Basic calculation-cont….
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FOREIGN CURRENCY
Basis Point
1 cent = 100 basis points
For example $/£ 1.8525. This means that there is one dollar, 85 cents and 25 basis
points to the pound or there is one dollar and 851/4 cents to the pound
Illustration $/£ 1.8645
Narrate the exchange rate in terms of basis points
Illustration $/£ 1.0550
Narrate the exchange in terms of basis points
As cent represents one hundredth of a dollar
So basis point represents one-hundredth of a cent
1 dollar = 100 cents
There is one Dollar, 86 cents and 45 basis points to the pound
There is one Dollar, 5 cents and 50 basis point to the pound
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INVERTING EXCHANGE RATES:
If you are given a middle rate: $/£ 1.5385, this indicates that
$1.5385=pound 1. Notice that the exchange rate can be found from the
inversion of the $/£ exchange rate.
Illustration
If exchange rate: $/£ 1.5240; andY/£ 235.20
Determine
Exchange rate Y/$
SolutionY/$ = 235.20 = 154.33
1.5240
Thus £/$ = 1/1.5385 = 0.6500 In other words £ 0.6500 (or 65 p) = $1
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Illustration 2
If exchange rate: DM/£ 2.5150; and
PTE/£ 205.80
DetermineExchange rate PTE/DM
Illustration 3If exchange rate: Y/$ 154.33; and
Y/£ 235.20
Determine
Exchange rate £/$
Solution 2 PTE/DM = 205.80 = 81.83
2.5150
Solution 3 £/$ = 154.33 = 0.6562
235.20
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Illustration 4
If exchange rate: SFF/£ 4.3510; and
$/SFF 0.4450
DetermineExchange rate $/£
However, be careful if you wish to turn exchange rate around in this way and you
are given a buying and selling rate. Not only should you take the inverse of each,but also switch each around s follows:
Solution 4 $/£ =0.4450 * 43510 = 1.9362
£/$ 0.6734 0.6748
$/ £ 1.482 1.485
£/$ 1 11.485 1.482
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Illustration 6
If exchange rate: Rs./$ 55 – 58 ; and
Rs./Y 0.4852 – 0.4910
DetermineExchange rate $/Y
$/Y 0.008365 0.008926
$/Rs. 0.1724 0.01818
Rs./Y 0.4852 0.491
Rs./$ 55 58
Rs./$ 1 1
58 55
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Illustration 6
SOLUTION
Y/$ 153.8663 154.6649
Y/£ 234.8 235.4
If exchange rate: $/£ 1.522 – 1.526 ; and
Y./£ 234.8 – 235.4
DetermineExchange rate Y/$
Illustration 6
$/£ 1.522 1.526
1 1
£/$ 1.526 1.522
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Spot Market
Is where you can buy and sell currencies for immediate (i.e. on the
spot) exchange or delivery.
Forward MarketIs where you can arrange a deal now to buy or sell a specific amount of
currency at a specific rate of exchange (the forward rate) for exchange/delivery
on a specific future date (the forward date).
Although spot markets exist for most of the world’s currencies, for many of the more minor currencies there is no forward market, because there is
insufficient demand.
The four major trading currencies in the world are the US$, £, Y and DM and
the forward market amongst these currencies can stretch up to 10 years
forward.
Standard periods of time forward are one month, three months and these rates
and together with the spot rate are instantly available. Other forward rates such
as the 84 days forward rate have to be specially quoted by the bankers.
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Spot and forward rates may be given as follows:
$/pound spot 1.5840 – 1.5860
However it is more likely that instead of being given the forward rates like
this you are given them as a rate of discount on the spot rate:
Three months forward 6.85c – 7.00 c discount
$/pound spot 1.5840 – 1.5860
$/pound one month forward 1.6290 – 1.6335
$/pound three months forward 1.6525 – 1.6560
One month forward 4.50 c – 4.75 c discount
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Therefore:
Spot 1.5840 – 1.5860
1 month forward 1.6290 – 1.6335
3 months forward 1.6525 - 1.6560
To obtain the actual forward rate, you add the discount to spot rate
Add discount 0.0450 – 0.0475
And
Spot 1.5840 – 1.5860
Add discount 0.0685 - 0.0700
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Putting this more technically, the $ is weakening or depreciating against thePound. It is becoming less valuable. (And Pound therefore is appreciating )
More generally, If forward rates are at a discount, the first currently is
depreciating against the second currency is your pair of currencies.
If you want to buy $/Pound spot, for every 1 Pound you would receive$1.5840, but if you bought $ for 3 months/ forward delivery you get $ 1.6525
for every 1 Pound.
Thus in the forward markets, the $ is becoming cheaper to buy.
NOTE
When
Forward rates are at discount to the spot ratesForward rates > Spot rates
To illustrate further
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this signifies that the first currency is appreciating against the second of the pair of
currencies.
When
Forward rates < Spot rates
Forward rates are at Premium to the spot rates
When forward rates are quoted at a premium, we subtract the premium
from the spot rate to find the forward rate.
Therefore Whenever forward rates are smaller numbers than spot rates,
the forward rates are at a premium
And
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Illustration 7$/pound spot 1.8420 1.8260
1 month forward 0.85 c 0.75 c Premium
Determine one month forward rate
Solution
1 month forward 1.8335 1.8185
The $ is becoming more valuable, it is appreciating against Pound. Every 1 Pound
buys you $ 1.8420 at spot, but only buys you $1.18335 in one month’s time.
Spot 1.8420 - 1.8260
- premium 85 - 75
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Illustration 8$/pound spot 1.5210
12 months forward 8.65 c Discount
Determine Twelve months forward rate
Solution
+ discount 0.0865
Spot rate $/£ 1.5210
12 months forward rate 1.6075
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So far we have learnt
Two Things
If forward rate at a discount
1st Currency is depreciating
against the 2nd currency
If forward rate at a premium
1st Currency is appreciating
against the 2nd Currency
We can also express rate of
depreciation/Appreciation as %ageof spot rate
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For Example$/pound spot 1.5210
12 months forward 8.65 c Discount
Determine Twelve months forward rate
Rate of Depreciation = Discount x 100%= 0.0865 x 100%=5.69%
Spot rate 1.5210
Which indicate (as it is a discount) that a forward rate represents a 5.69%
depreciation of the $ on the spot rate. As a result, the forward rate can be
calculated as:
Forward rate = spot rate x (1+ rate of depreciation)
12 month forward = 1.5210 x (1 + 0.0569) = 1.6075
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Illustration 9$/pound spot 1.6580
12 months forward 5c PremiumDetermine Twelve months forward rate
Solution 9
Therefore the forward rate represents a 3% appreciation in the $ giving
12 Months forward rate $/£ = 1.6580* (1 – 0.03) = $ 1.6083
Similarly
Rate of Appreciation = Premium x 100% = x %
Spot rateForward rate = Spot rate x (1 – rate of appreciation)
Rate of Appreciation= 0.05 = 0.03 or 3%
1.6580
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Illustration 10Suppose you are told that $/pound Spot is 1.5345 and the $ is expected to
depreciate by 5% per year over the next two years and thereafter appreciate
by 7% per year.
Required
Calculate the forward rates for the next 5 years.
SolutionOne year forward $1.5345 * (1+ 0.05) = $1.6112
Two years forward $1.6112 * (1 + 0.05) = $ 1.6918
Three year forward $1.6918 * (1- 0.07) = $ 1.5734
Four year forward $ 1.5734 * (1 - 0.07) = $ 1.4632
Five year forward $ 1.4632 * (1 – 0.07) = $ 1.3608