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IBUS 302: International Finance
Topic 3-FX Quotations
Lawrence Schrenk, Instructor
.
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Learning Objectives
1. Explain the structure and mechanisms of the FX market.
2. Explain the spot market.
3. Convert FX rates between American and European terms.▪
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An Additional Resources
The Basics of Foreign Trade and Exchange (NY Fed)
Yahoo! Currency Converter Abbreviations List (supplements)
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FX Rates
Foreign Exchange (FX or Forex) How much one currency is worth in terms of
another? Transfer of purchasing power FX rates are volatile and uncertain
Foreign Exchange Risk is The possibility that the value of an investment,
cash flow, return might change due to changes in exchange rates for currencies.
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Current FX Rates
NOTE: Yen quotations are to 6 places, not 4.
1.7769 dollars are worth one pound.
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Currency Abbreviations
Every currency has a three letter abbreviation Since ‘dollar’, ‘franc’ and ‘pound’ ambiguous
Abbreviations List (supplements)
AUD Australian Dollar (AU$) CAD Canadian Dollar (C$)CHF Swiss Franc (CHF) EUR Euro (€)GBP British Pound (£) HKD Hong Kong Dollar (HK$)JPY Japanese Yen (¥) USD United States Dollar ($)
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FX Notation I–Technical
S(j/k) price of one unit of k in terms of j Or the number of j needed to buy 1 k.
S($/¥) is 1 yen in terms of dollars Or the number of dollars to buy 1 yen.
NOTE: In this notation either symbols (¥) or abbreviations (JPY) can be used, e.g., S(¥/$) = S(JPY/USD)
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FX Notation II
S($/AU$) = .8363 means... You need to pay 0. 8363 USD for AU$ 1. Spot rate for Australian dollars is $0. 8363 An Australian dollar is worth $0. 8363. AU$ 1 = $0.8363.
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‘Yours’ versus ‘Theirs’
Spot Rate: The immediate rate Direct Quotation: From ‘your’ currency
If an American works for a firm in Germany, ‘your’ currency is the euro.
Indirect Quotation: From ‘their’ currency If an American works for a firm in Germany, ‘their’
currencies are the yen, American dollar, Kuwaiti dollar, etc.
What about an American working for a German firm in Japan? ▪
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American Terms
FX Quotation in American Terms Non-dollar currency priced in US dollars S($/___) = number of US dollars to buy 1 ___.
In American terms, $ is before the ‘/’. S($/C$) = number of US dollars to buy 1
Canadian dollarS($/C$) = $0.9422 (September 2008)
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European Terms
FX Quotation in European Terms US dollars priced in a non-dollar currency S(__/$) = number of ___ to buy 1 US dollar
In European terms, $ is after the ‘/’. S(C$/$) = number of Canadian dollars to buy
1 US dollarS(C$/$) = C$1.0613 (September 2008)
NOTE: The non-dollar currency need not be ‘European’.
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Reading the FX Table IEuropean Terms
American Terms Cross Rates ▪
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Reading the FX Table IIEuropean Terms
European Terms: How many non-dollar units does it take to buy one dollar?
It takes 108.3650 yen to buy one dollar. ▪
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Reading the FX Table IIIAmerican Terms
American Terms: How many dollars does it take to buy one non-dollar unit?
It takes $1.4457 to buy one euro. ▪
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Reading the FX Table IV
Cross Rates
Cross Rates: How many non-dollar units does it take to buy a different non-dollar unit?
It takes C$1.8859 to buy one pound. ▪
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Reading the FX Table V
Cross Rates: How many non-dollar units in the row does it take to buy a non-dollar unit in the column? ▪
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Appreciation/Depreciation I
When there is more demand for the pound, Pound appreciates relative to the U.S. dollar S($/£) exchange rate increases More dollars to buy one pound.
When there is less demand for the pound, Pound depreciates relative to the U.S. dollar, S($/£) exchange rate decreases Less dollars to buy one pound. ▪
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Appreciation/Depreciation II
If S($/£) = 1.80 You need to spend more than $1 for a pound. IMPORTANT: This does not mean the pound is
‘stronger’ or more in demand than the dollar. ‘Stronger’/’more in demand’ refers to change
over time If yesterday S($/£) = 1.80, and now S($/£) = 1.70, The dollar has become ‘stronger’ or more in demand
relative to the pound, Because it takes fewer dollars to buy one pound.
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Appreciation/Depreciation III
Remember supply and demand curvesDollar Demand and Supply of Pounds ▪
What Happened?▪
Demand for Pounds
Supply of Pounds
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American and European terms are inverses (or reciprocals), i.e.,
If you convert $1.74 From dollars to pounds, Then pounds to dollars You still have $1.74
Converting between American and European Terms I
1 1American = European =
European Americanor
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American Terms S($/CHF) = 0.9049 ($0.9049 buys 1 Swiss franc)
European Terms How many Swiss francs to buy 1 US dollar?
‘Reverse’ for European → American Terms ▪
Converting between American and European Terms II
1S(CHF/$) =
S($/CHF)
1S(CHF/$) = = 1.1051
0.9049
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Converting between American and European Terms: Examples
European → American
American → European
If S($/¥) = 0.009228
1 =
S($/¥)
1 = = 108.365
0
S(¥/$)
S(¥/$).009228
S(£/$)
S(£
If = 0.5628
1S($/£) =
1S($/£) = = 1.7768
0.5628
/$)
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General Rules of Thumb
Most currencies are worth less than the USD If the FX rate between the US Dollar and another
currency is less than 1, the rate is probably in... American Terms, i.e., S($/Non-Dollar)
Exceptions GBP (£) and EUR (€) A few other minor currencies
It takes a lot of yen to buy anything
