SUp0ply Chain - Markov Model

7/26/2019 SUp0ply Chain - Markov Model

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The Spot Market forThe Spot Market for

Foreign ExchangeForeign Exchange


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Spot Market Daniels and VanHoos 2

Market Characteristics:

An Interank Market! The spot "arket is a "arket for i""ediate

deli#er$ %2 to & da$s'(

! )ri"aril$ an interank "arket* +hich is the

trading of foreign,c-rrenc$,deno"inated

deposits et+een large anks(

! Approxi"atel$ ./S0(1 , 0( trillion dail$ ingloal transactions(


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Spot Market Daniels and VanHoos &

Market 3-otes: The 4S5

C-rrenc$ Trading Tale! )ro#ides spot and for+ard rates( For+ard

rates are for for+ard contracts* or the f-t-re

deli#er$ of a c-rrenc$(

! US $ equivalentis the dollar price of a

foreign c-rrenc$(

! Currency per US $is the foreign c-rrenc$price of one /S dollar(


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Market 3-otes:

Direct , Indirect 3-otes

! Direct 6-ote is the ho"e c-rrenc$ price of a

foreign c-rrenc$(

! Indirect 6-ote is the foreign c-rrenc$ price

of the ho"e c-rrenc$(


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Appreciating and

Depreciating C-rrencies! A c-rrenc$ that has lost #al-e relati#e to

another c-rrenc$ is said to ha#e depreciated(

! A c-rrenc$ that has gained #al-e relati#e toanother c-rrenc$ is said to ha#e appreciated(

! This ter"s relate to the "arket process and are

different fro" de#al-ation and re#al-ation%Chapter &'(


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Spot Market Daniels and VanHoos

Appreciating and

Depreciating C-rrencies! 4e -se the percentage change for"-la to

calc-late the a"o-nt of depreciation(

! Exa"ple* on Monda$* the peso traded at

8(0820 .9)( n T-esda$ the "arket closed

at 8(0827 .9)(

! The peso has appreciated* as it no+ takes"ore . to p-rchase each peso(


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Spot Market Daniels and VanHoos ;

Appreciating and

Depreciating C-rrencies! Exa"ple* on Monda$* the peso traded at

8(0820 .9)( n T-esda$ the "arket closed

at 8(0827 .9)(! The a"o-nt of appreciation is:


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Spot Market Daniels and VanHoos B

id , Ask Spreads:

Exa"ple fro" Financial Ti"es

! The id is the price the ank is +illing to

pa$ for the c-rrenc$* e(g(* 8(@882 .9 is theid on the e-ro in ter"s of the dollar(

! The ask is +hat the ank is +illing to sell

the c-rrenc$ for* e(g( 8(@808 .9* is the askon the e-ro in ter"s of the dollar(


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Spot Market Daniels and VanHoos @

id , Ask Spread:

Cost of Transacting

! The id , ask spread of a c-rrenc$ reflects* in

general* the cost of transacting in that c-rrenc$(! It is calc-lated as the difference et+een the ask

and the id(

! Exa"ple* 8(@828 , 8(@882 ? 8(880B(


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id , Ask Margin:

)ercent Cost of Transacting! The id , ask spread can e con#erted into a

percent to co"pare the cost of transacting a"ong a

n-"er of c-rrencies(! The "argin is calc-lated as the spread as a percent

of the ask(

! %Ask , id'9Ask > 088

! Exa"ple* %8(@828 , 8(@882'9@(828 > 088 ? 8(28(


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Cross,ates: /noser#ed ates! A cross,rate is an -noser#ed rate that is

calc-lated fro" t+o oser#ed rates(

! For exa"ple* the spot rate for the Canadian

dollar is 8(;;8 .9C.* and the spot rate on thee-ro is 8(@882 .9( 4hat is the Canadian dollar

price of the e-ro %C.9'

! Gote that %.9'9%.9C.' ? %.9'>%C.9.'?C.9(! In this exa"ple* 8(@88298(;;8 ? 0(&2@; C.9(


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Aritrage:

Consistenc$ of Cross ates! Aritrage is the simultaneous-$ing and

selling to profit %as opposed to spec-lation'(

! The ailit$ of "arket participants to aritrageg-arantees that cross rates +ill e* in general*

consistent(

! If a cross rate is not consistent* the actions ofc-rrenc$ traders %aritrage' +ill ring the

respecti#e c-rrencies in line(


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Spot Market Daniels and VanHoos 0&

Spatial Aritrage

! Spatial Aritrage refers to -$ing ac-rrenc$ in one "arket and selling it inanother(

! )rice differences arise fro" geographical%spatial' dispersed "arkets(

! D-e to the lo+,cost rapid,infor"ation

nat-re of the foreign exchange "arket*these prices differences are aritraged a+a$6-ickl$(


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Triang-lar Aritrage! Triang-lar aritrage in#ol#es a third c-rrenc$

and9or "arket(

! Aritrage opport-nities exist if an oser#ed rate

in another "arket is not consistent +ith a cross,rate %ignoring transaction costs'(

! Again* profit opport-nities are likel$ to e

aritraged a+a$ 6-ickl$* "eaning that cross,rates are* for the "ost part* consistent +ith

oser#ed rates(


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Triang-lar Aritrage: An Exa"ple

! The ritish po-nd is trading for 0(177 %.9'

and the Thai aht for 8(821 %.9' in Ge+

ork* +hile the Thai aht is trading for 8(802%9' in Jondon(

! The cross,rate in Ge+ ork is:

8(82190(177 ? 8(80 %9'! Hence* an aritrage opport-nit$ exists(


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Co"ining the T+o Effects

! A real exchange rate co"ines these t+o effects ,

the gain in p-rchasing po+er of /S residents d-e

to the no"inal depreciation of the po-nd and the

gain in relati#e p-rchasing po+er d-e to ritish

prices rising at a slo+er rate than /S prices(

! To constr-ct a real exchange rate* the spot rate* as

it is 6-oted here* is "-ltiplied $ the ratio of the/S C)I to the /P C)I(

%9.' x %/S C)I9/P C)I'


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More on )rices and the

Exchange ate! A Hitchhikers Guide to Understanding

Exchange ates$ +en H-"page* an

econo"ic ad#isor at the Federal eser#eank of Cle#eland* is a #er$ helpf-l article

on prices and real exchange #al-es(


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Effecti#e Exchange ateEffecti#e Exchange ate

A "eas-re of the general #al-e of a

c-rrenc$(


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Spot Market Daniels and VanHoos &2

Calc-lating the EE

! Co""onl$ this s-" is "-ltiplied $ 088 toexpress the EE on a 088 asis(

! Hence* an EE is an index(! As +e shall see next* the ase,$ear #al-e of

the index is 088(

! The index* therefore* is -sef-l is sho+ingchanges in the +eighted a#erage #al-e fro"

one period to another(


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Spot Market Daniels and VanHoos &&

Exa"ple

! Jet last $ear e the ase $ear(

! The effecti#e exchange rate last $ear +as:

8(&8

Q %8(09(0'>8(28=>088

? 088(

! As +ith an$ index "eas-re* the ase $ear

#al-e is 088(


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Spot Market Daniels and VanHoos &7

Effecti#e Exchange Meas-res

! There are a n-"er of effecti#e exchange

"eas-res a#ailale in the pop-lar press(

So"e co""on "eas-res are:! ank of England Index: The Economist.

! 5()( Morgan: The Wall Street Journaland

theFinancial Times(


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0

20

40

60

80

100

120

140

160

180

United States

Japan

United Kingdom


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Spot Market Daniels and VanHoos &@

The De"and C-r#e is

Do+n+ard Sloping! If* for exa"ple* the e-ro depreciates* E-ropean

goods* ser#ices* and financial assets eco"e less

expensi#e to foreign residents( Foreign residents+ill increase their 6-antit$ de"anded of the e-ro

to p-rchase "ore E-ropean goods* ser#ices* and

financial assets(

! The do+n+ard slope of the de"and c-r#e sho+sthe negati#e relationship et+een the exchange

rate and the 6-antit$ de"anded(


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The De"and C-r#e

De"and

S %.9'

3-antit$

S8

38

S0

30


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An Increase in De"and

! Consider an increase in the de"and for the e-ro(

! S-ppose* for exa"ple* that sa#ers desire e-ro,

deno"inated financial assets relati#e todollar,deno"inated financial assets eca-se of a

change in econo"ic conditions(

! The de"and for the e-ro rises as sa#ers desire

"ore e-ros to p-rchase greater a"o-nts ofE-ropean financial assets(


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Spot Market Daniels and VanHoos 1&

An Increase in De"and for the E-ro

De"and

S %.9'

3-antit$

S8

38

D

30


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The S-ppl$ of a C-rrenc$

! The s-ppl$ of a c-rrenc$ is also a deri#eddemand(

! Consider the de"and sched-le for the dollar(If the dollar depreciates relati#e to the e-ro*there is an increase in the 6-antit$ de"andedof dollars(

! As "ore dollars are p-rchased* the 6-antit$ ofe-ros s-pplied in the foreign exchange "arketincreases(


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The S-ppl$ of a C-rrenc$

S

S %.9'

S0

S8

38 30

A

3-antit$

Dollar depreciation


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Spot Market Daniels and VanHoos 1;

E6-iliri-"

S

S %.9'

S8

38

A

D

3-antit$


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Spot Market Daniels and VanHoos 1B

Increase in the De"and

for the E-ro

S

S %.9'

S8

38

D

3-antit$

D

30

S0


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Spot Market Daniels and VanHoos 1@

#er and /nder,Val-ed C-rrencies

! If a c-rrenc$s #al-e is "arket deter"ined*ho+ can it e o#er, or -nder,#al-ed

! A c-rrenc$ is said to e o#er, or -nder,#al-ed if the "arket exchange rate isdifferent fro" the rate that a "odel orindi#id-al predicts to e the KcorrectL rate(

! In other +ords* the indi#id-al elie#es the"arket Khas it +rong(L


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#er and /nder,Val-ed C-rrencies

S

S %.9'

S8

38

D

3-antit$

S>

The euro is undervalued


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/nder#al-ed

! In the pre#io-s slide* the e-ro is said to e

-nder#al-ed(

! The predicted or expected spot rate* S>* liesao#e the "arket deter"ined rate* S8(

! Hence* it sho-ld take a greater a"o-nt of

dollars to -$ each e-ro( The e-ro*therefore* is -nderpriced* or -nder#al-ed(


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SUp0ply Chain - Markov Model