if 1 -forex market
TRANSCRIPT
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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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FOREIGN EXCHANGE MARKETS
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/$) = 59.30
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FOREIGN EXCHANGE MARKETS
Two basic contracts in FX markets
FX Spotcontract is an agreement made today to
buy or sell FX at the current market price
FX forwardcontract is an agreement made today
that represents an obligation to buy/sell FX at pre
specified price (forward rate) at some future date
(maturity or settlement date). Most common maturities are 1,2,3,6,12 months.
However, they can be negotiated.
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FOREIGN EXCHANGE MARKETS
Forward premium / discount
If a currency is more (less) expensive in the forward
market when compared to the spot market, we say it
is at forward premium (discount).
Forward premium (+) / discount (-) on currency j
vis--vis currency i (premium on fixed currency, j) :
100(i/j)nS
S(i/j)-(i/j)Fn
Example:
Spot DLR|INR 59.00
1 month Forward rate 59.50
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FOREIGN EXCHANGE MARKETS
Forward premium (+) / discount (-) on currency i vis--
vis currency j (premium on variable currency, i)=
100(i/j)nF
(i/j)F-S(i/j)
n
n
Example:What is the premium/ discount on INR
Spot DLR|INR 59.00
1 month Forward rate 59.50
Premium is always
expressed as % p.a.
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FOREIGN EXCHANGE MARKETS
)/(
1)/( jaskiSibidjS
)/(
1)/(
jbidiSiaskjS
Example. Suppose US$|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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FOREIGN EXCHANGE MARKETS
)/($$)/()/( GBPbidSbidINRSGBPbidINRS
Cross rate calculationExample. Suppose you have the following information
US$|INR: 59.00/20
GBP|US$ 1.565/70
Question: Calculate GBP|INR
)/($$)/()/( GBPaskSaskINRSGBPaskINRS
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FOREIGN EXCHANGE MARKETS
)/()/$()/$( 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
Outright forward exchange and swaps
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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.
Outright forward exchange and swaps
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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.
Outright forward exchange and swaps