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International Finance-lecture2.docx

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FIN 621
Sergiy Rakhmayil

• International Finance-lecture2 IBS 621 • Lecture 2 • Foundations of International Financial Management • Globalization and the Multinational Firm • International Monetary System • Balance of Payments • The Market for Foreign Exchange • International Parity Relationships • The FOREX Market • Structure – Place of trading • OTC – Volume • Wholesale (interbank) and retail – Timing • Spot: deal now, deliver now (up to 2 business days) • Forward (deal now, deliver in the future) • Spot Rate Quotations • Direct quotation – the Canadian dollar equivalent – e.g. “a Japanese Yen is worth about a penny” • Indirect Quotation – the price of a Canadian dollar in the foreign currency – e.g. “you get 100 yen to the dollar” • View daily foreign exchange rate updates from the US Federal Reserve System or the Bank of Canada • Recent notation: EUR:USD or EURUSD means USD/EUR • Exchange rates and trade • If AUD 1 = 6 HKD, then what is the likely flow of goods? Ignore transaction costs. • Currency rate changes Year 1: €1 = $0.8163, Year 2: €1 = $0.9107 The euro appreciated against the dollar by (0.9107 0.8163)/0.8163 = • Currency rate changes • Atrader took a short position of _______________when the USD/GBP rate was _______. After that the exchange rate changed to ________. (a) Is this movement beneficial for the FX trader in question? (b) How did the US bank’s liability change as a result of this FX rate move? • Spot FX trading • Bid-ask spread – The bid price is the price a dealer is willing to pay to buy the currency. – The ask price is the amount the dealer wants to sell you the currency. – The bid-ask spread is the difference between the bid and ask prices. • Trading – In the interbank market, the standard size trade is about U.S. $10 million. – Abank trading room is a noisy, active place. – The stakes are high. – The “long term” is about 10 minutes. • Cross- rates: view major cross-rates @ Bloomberg • Bid-ask spread Direct ask (DC/FC) = 1 / Indirect bid (FC/DC) Direct bid (DC/FC) = 1 / Indirect ask (FC/DC) – Notation: DC=domestic currency, FC=foreign currency • Example • If the direct quotation for the exchange rate is USD/EUR=0.9825-0.9829, then what is the indirect EUR/USD quote? • Bilateral arbitrage • Assume no transaction costs for now. (=ignore bid-ask spread) • Domestic currency is DC, foreign currency is FC, exchange rate is DC/FC • You observe two rates at different banks: DC/FC bank1nd DC/FC bank2 • No-arbitrage: DC/FC bank1 FC/DC bank2ust = 1 • Reason: Law of One Price – the price of the same item should be the same regardless of where it is sold, otherwise there will be arbitrage opportunities – Mathematically, DC/FC* FC/DC = 1 • Bilateral arbitrage • Solution. First check if DC/FC* FC/DC = • 1.4959 * 0.6695 =1.001505 ___1 Arbitrage ______ • Cross Rates • Suppose that S($/SFr) = .50 – i.e. $1 = 2 SFr • and that S(¥/SFr) = 50 – i.e. SFr1 = ¥50 • What must the $/¥ cross rate be? • Cross Rates • You find the following rates: USD/EUR=0.9119, CHF/USD=1.5971, JPY/USD=128.17 • Compute all cross-rates. • Cross Rates and Bid-Ask Spread • Notation: DC=domestic currency, FC1=foreign currency #1, FC2=foreign currency #2 • Cross-rates FC1/FC2 – (FC1/FC2)ask=(FC1/DC)ask * (DC/FC2)ask – (FC1/FC2)bid=(FC1/DC)bid * (DC/FC2)bid • Cross-rates FC2/FC1 – (FC2/FC1)ask=(DC/FC1)ask * (FC2/DC)ask – (FC2/FC1)bid=(DC/FC1)bid * (FC2/DC)bid • Cross Rates and Bid-ask Spread • Abank is quoting the following exchange rates: USD/EUR=1.1610-1
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