EECS 1710 Lecture Notes - Lecture 26: Foreign Exchange Market, Eurozone
24 Jun 2018
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EECS 1710 Lecture 26 Notes
Introduction
Repay loans
Amount of pounds Hampton needs to repay loan in euros: 603,000 euros= (1.456 euros
per pound) ¼ 414,148 pounds
Amount of pounds Hampton has after repaying loan: 460,110 pounds 414,148 pounds
¼ 45,962 pounds
Hampton converts pounds held into U.S. dollars: 45,962 pounds $1.80 per pound ¼
$82,731
Hampton’s profit: $82,731 $100,000 ¼ $17,268
In this case, Hampton experiences a loss that amounts to nearly 17 percent of its
original $100,000 investment.
Hampton’s loss is due to the euro’s appreciation against the pound, which increased the
number of pounds that Hampton needed to repay the euro loan.
Consequently, Hampton had fewer pounds to convert into dollars at the end of the
month.
Because of its high financial leverage (its high level of borrowed funds relative to its
total investment), Hampton’s losses are magnified.
In periods when changing conditions impel carry traders to question their trade
positions, many such traders will attempt to unwind (reverse) their positions.
This activity can have a major impact on the exchange rate.
EXAMPLE
Over the last several months, many carry traders have borrowed euros and purchased
British pounds.
Today, governments in the eurozone announced a new policy that will likely attract
much more investment to the eurozone, which in turn will cause the euro’s value to
appreciate.
Document Summary
Amount of pounds hampton needs to repay loan in euros: 603,000 euros= (1. 456 euros per pound) 414,148 pounds. Amount of pounds hampton has after repaying loan: 460,110 pounds 414,148 pounds. Today, governments in the eurozone announced a new policy that will likely attract much more investment to the eurozone, which in turn will cause the euro"s value to appreciate. Because the euro"s appreciation against the pound will adversely affect carry trade positions, many traders decide to unwind their positions. They liquidate their investments in british pounds, selling pounds in exchange for euros in the foreign exchange market so that they can repay their loans in euros now (before the euro appreciates even more). Pounds hampton has after repaying loan: 460,110 pounds 414,148 pounds 45,962 pounds. Hampton converts pounds held into u. s. dollars: 45,962 pounds . 80 per pound . In this case, hampton experiences a loss that amounts to nearly 17 percent of its original ,000 investment.
