If 1 -Forex Market

8/22/2019 If 1 -Forex Market

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INTERNATIONAL FINANCE

Ganesh Kumar N.


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IF - Modules

1. FOREIGN EXCHANGE MARKETS AND

INTERNATIONAL PARITY CONDITIONS

5 sessions

2. BALANCE OF PAYMENTS, CAPITAL

FLOWS AND CAPITL ACCOUNT

CONVERTIBILITY4 sessions

3. EXCHANGE RATE SYSTEMS AND THEIR

IMPACT6 sessions


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Evaluation

Component Wt.

Quizzes 30%

CP+ Case Analysis 30%

End Term 40%


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Exchange Rate Risk

Fluctuations in exchange rate will have

impact on companies whether they are

directly exposed to exchange rate changessuch as importers/ exporters, or indirectly

exposed.

Changes in exchange rate are some timestemporary, some times permanent. These

changes calls for different responses from

firms.


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Rupee to appreciate on a long term:

Morgan Stanley, Nov 20, 2007

"Indian rupee will be appreciating further.

We expect rupee to reach to the level of Rs

36-37 per dollar by the end of next year,"Managing Director, Morgan Stanley


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The rupee has risen 13.7% over a year.

He said the Indian currency would continue to

appreciate further in future.

If I were in company management, I would

allow at least Rs 2 per year or Re 1 a year

strengthening,

K V Kamath sees Re 1 gain against dollar

every year

DNA, Tuesday, November 20, 2007


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What happened after 2008?


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Rising Yen in 1980s

Long term trends in exchange rate.

Much more difficult for companies to

manage

calls for strategies such as relocation of

production.


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APPRECIATION OF JAPANESE YEN IN 1980s


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Interbank market/ Whole sale market:

Players: Banks, Big firms with active

treasury, central banks

Retail market: Banks

Retail clients:

Exporters, importers, travelers etc.

THE FOREX MARKET


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Spot FX Market Spot FX rates are determined in the interbank

market based on demand and supply

Bid-Ask spread

Bid-Ask(offer) spread. Bid rates


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Retail vs. Interbank spot rate

Retail rates are based on interbank rates, but

spread will be higher

Retail quotes are adjusted less frequently

than inter bank rates.


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FOREIGN EXCHANGE MARKETS

Fixed (base) currency and variable currency

Fixed currency is the currency against which all

other (variable) currencies are quoted Cross rate is the rate between two currencies

when none of them is US$


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Quotation:

Market convention:

DLR |INR: 59.20/30.

Fixed|VariableBid rate is 59.20, ask rate 59.30.

Text book:

S(INR/US$): 59.20/30

variable/fixedS(INR /bid$) =59.20 or Sb(INR/$) =59.20

S(INR/ask$): 59.30 or Sa(INR/$) = 59.30


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Two basic contracts in FX markets

FX Spotcontract is an agreement made today to

buy or sell FX at the current market price

FX forwardcontract is an agreement made today

that represents an obligation to buy/sell FX at pre

specified price (forward rate) at some future date

(maturity or settlement date). Most common maturities are 1,2,3,6,12 months.

However, they can be negotiated.


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Forward premium / discount

If a currency is more (less) expensive in the forward

market when compared to the spot market, we say it

is at forward premium (discount).

Forward premium (+) / discount (-) on currency j

vis--vis currency i (premium on fixed currency, j) :

100(i/j)nS

S(i/j)-(i/j)Fn

Example:

Spot DLR|INR 59.00

1 month Forward rate 59.50


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Forward premium (+) / discount (-) on currency i vis--

vis currency j (premium on variable currency, i)=

100(i/j)nF

(i/j)F-S(i/j)

n

n

Example:What is the premium/ discount on INR

Spot DLR|INR 59.00

1 month Forward rate 59.50

Premium is always

expressed as % p.a.


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)/(

1)/( jaskiSibidjS

)/(

1)/(

jbidiSiaskjS

Example. Suppose US$|INR: 59.00 / 59.50

INR|US$ or S(US$/INR)?

Market makers selling (ask) rate of INR should be thereciprocal of the bid (buying) rate for DLR (Why?). Bid

rate for INR should be the reciprocal of ask rate for DLR.


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)/($$)/()/( GBPbidSbidINRSGBPbidINRS

Cross rate calculationExample. Suppose you have the following information

US$|INR: 59.00/20

GBP|US$ 1.565/70

Question: Calculate GBP|INR

)/($$)/()/( GBPaskSaskINRSGBPaskINRS


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)/()/$()/$( PoundaskEuroSEuroaskUSSPoundaskUSS

)/()/$()/$( PoundbidEuroSEurobidUSSPoundbidUSS

Cross rate calculationS(Pound/Euro): 0.9035/40

S(US$/Euro):1.5000/10

S(US$/Pound)?

)/(

1)/$(

EuroaskPoundS

EurobidUSS

)/(

1)/$(

bidEuroPoundS

EuroaskUSS


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Triangularor Round trip arbitrage What if cross rate is mispriced? There will be

arbitrage opportunity.

Triangular arbitrage involves taking positions in

three currencies so as to exploit mispricing

S(INR/US$) = 59.20

S(US$/Euro) = 1.25

A dealer quotes: S(INR/Euro) = 74.50How will you do triangular arbitrage?

What is the arbitrage profit on INR 100?


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Triangularor Round trip arbitrage

with transaction cost

Is triangular arbitrage possible?

What is the arbitrage profit on INR 100?

Dealers quote S(INR/Euro): 69.50/69.60

BID ASK

S(INR/USD) 55.8 56.0

S(USD/EUR) 1.255 1.257


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Outright forward exchange and swaps

Outright forward transaction involves only one

transaction (buy or sell)

Swap involves two componentsspot & forwardor two forward transactions in the opposite

directions.

Swap is an agreement to buy and sell foreign

exchange at pre-specified rates where buying andselling are separated in time, or borrowing in one

currency and lending in another.


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Buy-sell and Sell-Buy swaps

Swap in USD- buying USD in spot andselling it forward (Buy-sell or swap in)

Swap out USD: Selling USD in spot and

buying it forward (sell-buy or swap out) What kind of swap you need if you are

investing overseas?

What kind of swap you need if you areborrowing from overseas?


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Swap quotations

Conventionally forward rate is quoted in

terms of spot rate and swap points (forward

points)


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Spot

DLR|INR

30 day 60 day

46.19/62 25/37 55/70 Swap quote

43 55 58Spread

46.19/62 46.44/99 46.74/47.32 Outrightquote



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SpotGBP|DLR

30 DAY 90 DAY 180 DAY

1.5980/85 19/17 55/50 95/85

Spread: 5 3 0 -5

1.5980/85 1.5999/1.6002 1.6035/1.6035 1.6075/1.6070

If the fixed currency is at forward discount you deduct swappoints.



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Spot GBP|DLR 30 DAY 90 DAY 180 DAY

1.5980/85 19/17 55/50 95/85

1.5980/85 1.5961/1.5968 1.5925/1.5935 1.5985/1.5900

Spread: 5 7 10 15

Spot +/- forward points = forward rate.

Forward points are added (subtracted)if they are in

ascending (descending) order.


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If 1 -Forex Market