Foreign Exchange QuizForeign Exchange Quiz

What is foreign exchange? What is foreign exchange?

(Trading nations’ moneys.)(Trading nations’ moneys.)

What is the exchange rate?What is the exchange rate?

(The price of one nation’s money (The price of one nation’s money in terms of another nation’s money.)in terms of another nation’s money.)

Foreign Exchange QuizForeign Exchange Quiz

What is the spot exchange rate?What is the spot exchange rate?

(The price for “immediate” (The price for “immediate” exchange)exchange)

What is the forward exchange What is the forward exchange rate?rate?

(The price that will take place (The price that will take place sometime in sometime in the future.)the future.)

Currency Trading, Wall Street Currency Trading, Wall Street JournalJournal• Wednesday, November 7, 2001Wednesday, November 7, 2001

• EXCHANGE RATESEXCHANGE RATES• The New York foreign exchange mid-range rates below apply to trading The New York foreign exchange mid-range rates below apply to trading

among banks in amounts of $1 million and more, as quoted at 4 p.m. Eastern among banks in amounts of $1 million and more, as quoted at 4 p.m. Eastern time by Reuters and other sources. Retail transactions provide fewer units of time by Reuters and other sources. Retail transactions provide fewer units of foreign currency per dollar. Rates for the 12 Euro currency countries are foreign currency per dollar. Rates for the 12 Euro currency countries are derived from the latest dollar-euro rate using the ex change ratios set 1/1/99.derived from the latest dollar-euro rate using the ex change ratios set 1/1/99.

• U.S. S EQUIV. U.S. S EQUIV. CURRENCY PER CURRENCY PER U,S, $U,S, $• CountryCountry WedWed TueTue WedWed

TeaTeaArgentina (Peso) Argentina (Peso) i.0005i.0005 1.00171.0017 .9995.9995

.9983.9983Aestmlia (Dollar) Aestmlia (Dollar) 51535153 .5136.5136 1.94081.9408

1.94721.9472China (Renminhi) China (Renminhi) 12081208 .1208.1208 8.27668.2766

8,27678,2767• Colombia (Peso) Colombia (Peso) '.0004334'.0004334 .0004331.0004331 2307.502307.50

2309.002309.00Czech. Rep. (Koruna) Czech. Rep. (Koruna) ........Commercial rate Commercial rate 0268702687 .02575.02575 37.22337.223

37.38437.384Denmark (Krone) Denmark (Krone) 12051205 .1203.1203 8,29738,2973

8.31568.3156• Ecuador (US Dollar)-e... 1.0000Ecuador (US Dollar)-e... 1.0000 1.00001.0000

1.00001.0000 1.00001.0000• Finland (Markka) Finland (Markka) 15111511 .1505.1505 6.62036.6203

6.64666.6466France (Franc) France (Franc) 13691369 .1364.1364 7.30387.3038

7.33287.33281-month forward 1-month forward 13671367 .1362.1362 7312773127

7.34257.34253-months for~*ard 3-months for~*ard 13641364 .1359.1359 7.32967.3296

7.35837.35836-months forward 6-months forward 13511351 .1355.1355 7.34937.3493

7.37777.3777Germany (Mark) Germany (Mark) 45924592 .4574.4574 2.17772.1777

2.18642.18641-month forward 1-month forward 45864586 ,4568,4568 2.18042.1804

2.18932.18933-months forward 3-months forward 45764576 .4558.4558 2.18542.1854

2.19402.19406-months fcnvard 6-months fcnvard 45644564 .4546.4546 2.19132.1913

2.19972.1997Greece (Drachma) Greece (Drachma) 002536002536 .002625.002625 379.37379.37

380.92380.92Hang Kong (Dollar) Hang Kong (Dollar) 12821282 .1282.1282 7.79997.7999

7.79987.7998.8769.8769 .8804.8804

Israel (Shekel) Israel (Shekel) 23472347 .2348.2348 4.26104.26104.26904.2690

Italy (Lim) Italy (Lim) 00046380004638 .0004620.0004620 2155.962155.962164.522164.52

Japan (Yen) Japan (Yen) 008270008270 .008246.008246 120.92120.92121.27121.27

1-month forward 1-month forward 008285008285 .008261.008261 120.70120.70121.05121.05

3-months forward 3-months forward 008312008312 .008287.008287 120.31120.31120.68120.68

• U.S. $ EQUIV. CURRENCY PER U.S. $U.S. $ EQUIV. CURRENCY PER U.S. $• CountryCountry WedWed TueTue WedWed ,Tun,Tun

Kuwait (Dinar) Kuwait (Dinar) 3.27443.2744 3.27233.2723 .3054.3054 .3056.3056Lebanon (Pound) Lebanon (Pound) 00066060006606 .0006607.0006607 1513.751513.75 f5i~.50f5i~.50

• Malaysia (Ringgit)-b Malaysia (Ringgit)-b 26322632 .2632.2632 3,80003,8000 3.~9e03.~9e0Malta (Lira) Malta (Lira) 2,23862,2386 2,23262,2326 .4467.4467 , .¢479, .¢479Mexico Mexico (Peso) ................(Peso) ................

• Floating rate Floating rate 10851085 ,1086,1086 9.21559.2155 9.21059.2105Netherlands Netherlands (Guilder) (Guilder) 40754075 .4059.4059 2.45372.4537

2.46352.4635New New Zealand (Dollar) Zealand (Dollar) 41964196 .4205.4205 2.38322.3832

2.37812.3781Norway (Krone) Norway (Krone) 11331133 ,1126,1126 8.82708.8270 8.87858.8785Pakistan (Rupee) Pakistan (Rupee) 0164201642 .01635.01635 60.90060.900 61J~061J~0Peru (new Sol) Peru (new Sol) 29012901 29012901 3.44683.4468"3.4475"3.4475Philippines (Peso) Philippines (Peso) 0192801928 .01925.01925 51.87551.875 51.96051.960Poland (Zlety)-d Poland (Zlety)-d 24532453 24442444 4,07604,0760 4.09104.0910Podugal (Escudo) Podugal (Escudo) 004480004480 .004462.004462 223.23223.23 224.11224.11Russia (Ruble)-a Russia (Ruble)-a 0336203362 .03364.03364 29.74729.747 29.7~729.7~7

:1=8461:1=84611-month forward 1-month forward 61146114 .6075.6075 1.63561.6356 1.64§11.64§13-months forward 3-months forward 61156115 .6076.6076 1.63541.6354 : .6459: .64596-months forward 6-months forward 61176117 .6078.6078 1.63481.6348 1,64~1,64~Taiwaa (Dailar) Taiwaa (Dailar) 0289902899 .02899.02899 34.50034.500 34.50034.500Thailand (Baht) Thailand (Baht) 0223902239 .02238.02238 44.65544.655i114.6~5i114.6~5Turkey (Lira)-f Turkey (Lira)-f 0000006400000064 .00000065.00000065 1565000156500015400901540090United United Arab (Dirham) Arab (Dirham) 27232723 .2723.2723 3.67303.6730

3.67303.6730Uruguay (New Peso) Uruguay (New Peso) ..........Financial Financial 0712307123 .07123.07123 14.04014.040 t4.040t4.040Venezuela (Bolivar) Venezuela (Bolivar) 001345001345 .001345.001345 743.50743.50 743 50743 50SDR SDR 1.27941.2794 1.27601.2760 .7816.7816 :'.2837:'.2837Eurn Eurn 89818981 ,8946,8946 1.11351.113511.117811.1178

•Special Drawing Rights (SDR) are based on exchange rates for the U.S., German, British, Special Drawing Rights (SDR) are based on exchange rates for the U.S., German, British, French , and Japanese c~rrerf-cies. Source= International Monetary Fund. a-Russian Central French , and Japanese c~rrerf-cies. Source= International Monetary Fund. a-Russian Central Bank rate. b-Government rate. d-Floating rate; trading band suspended on 4/1 1/OO. e-Adopted Bank rate. b-Government rate. d-Floating rate; trading band suspended on 4/1 1/OO. e-Adopted U,.9. dollar as of 9/1 i/OO. f-Floating rate, eft. Feb. 22. • , 1U,.9. dollar as of 9/1 i/OO. f-Floating rate, eft. Feb. 22. • , 1

Foreign Exchange, Banks and Foreign Exchange, Banks and DemandDemand

• Where does most foreign exchange Where does most foreign exchange occur?occur?

(In banks located in London, New (In banks located in London, New York and Tokyo.)York and Tokyo.)

• Who trades most of the money on Who trades most of the money on international exchanges?international exchanges?

(Banks again.)(Banks again.)

Foreign Exchange, Banks and Foreign Exchange, Banks and DemandDemand

• Whence comes the demand for Whence comes the demand for foreign exchange?foreign exchange?

(From people, institutions and (From people, institutions and firms who want to make purchases firms who want to make purchases abroad.)abroad.)

Foreign Exchange, Banks and Foreign Exchange, Banks and DemandDemand

• What do the following flows What do the following flows produce a demand for?produce a demand for?

U.S. exports of goods and services U.S. exports of goods and services (demand for dollars)(demand for dollars)U.S. capital outflows U.S. capital outflows (demand for foreign currencies)(demand for foreign currencies)U.S. capital inflows U.S. capital inflows (a supply of foreign currency and a (a supply of foreign currency and a demand for dollars.)demand for dollars.)

Foreign Exchange: The RateForeign Exchange: The Rate

• What determines the exchange rate then?What determines the exchange rate then?

(Supply and demand for foreign exchange.)(Supply and demand for foreign exchange.)

• What kind of market type do we have here?What kind of market type do we have here?

(Competitive, because of the immediate (Competitive, because of the immediate market response to price. No product market response to price. No product

differentiation in foreign exchange markets.)differentiation in foreign exchange markets.)

Foreign Exchange: The RateForeign Exchange: The Rate

• What is a floating exchange rate What is a floating exchange rate system?system?

(One where markets, rather (One where markets, rather than bank interventions,than bank interventions, determine determine prices of foreign exchange.)prices of foreign exchange.)

Traders and ArbitrageTraders and Arbitrage

• How do foreign exchange traders How do foreign exchange traders function?function?

(See the case study on p. 404) (See the case study on p. 404)

• What is arbitrage?What is arbitrage?

(Making two markets, by buying and (Making two markets, by buying and selling between them, a single selling between them, a single market.)market.)

ArbitrageArbitrage

An arbitrager, usually a large bank, may An arbitrager, usually a large bank, may notice that in N.Y. 1 £ = $2.42 and in notice that in N.Y. 1 £ = $2.42 and in London, 1 £ = $2.40. London, 1 £ = $2.40.

An agent will buy pounds in London (for An agent will buy pounds in London (for $2.4 billion) and sell them in N.Y. (for $2.4 billion) and sell them in N.Y. (for $2.42 billion), earning a quick $20 $2.42 billion), earning a quick $20 million.million.

The increased demand in London pulls The increased demand in London pulls the price up, and the increased supply the price up, and the increased supply in New York pushes the price down, in New York pushes the price down, equalizing the pound/dollar price.equalizing the pound/dollar price.

Interbank Foreign Exchange Interbank Foreign Exchange TradingTrading

About 90% of foreign About 90% of foreign exchange trading is exchange trading is in the Interbank part in the Interbank part of the marketof the market..

Interbank Foreign Exchange Interbank Foreign Exchange TradingTrading

Provides continuous Provides continuous information on the information on the foreign exchange foreign exchange market—market—

• Talking with traders at Talking with traders at other banks.other banks.

• Observing prices Observing prices (exchange rates) being (exchange rates) being quotedquoted..

Exchange Rate and RiskExchange Rate and Risk• What is exchange rate risk exposure?What is exchange rate risk exposure?

(Earning a lot less than you expected, or paying a lot more than you expected when payment is made in the future at different exchange rates than originally prevailed.)

• What is hedging?(Reducing or eliminating a net asset or net liability position in foreign currency.)

Exchange Rate and RiskExchange Rate and Risk• What is speculation?What is speculation?

Taking a net asset or “long” Taking a net asset or “long” position (holding net assets in a foreign position (holding net assets in a foreign currency in excess of one’s anticipated currency in excess of one’s anticipated transactions needs), ortransactions needs), ortaking a net liability or “short” position taking a net liability or “short” position in a currency (owing more in a currency in a currency (owing more in a currency than one owns or holds).than one owns or holds).

Exchange Rate and RiskExchange Rate and Risk

If the forward rate of a currency, (the French franc) is lower than the spot rate (4;1, say, rather than 5:1), the market expects the value of the franc to rise against the dollar. There is a premium on forward (usually 90 days) francs and a discount on 90-day forward dollars.

Foreign Exchange and Forward Foreign Exchange and Forward ContractsContracts

• What is a forward What is a forward foreign exchange foreign exchange contract?contract?

(An agreement to (An agreement to exchange one exchange one currency for another currency for another on some date in the on some date in the future at a price set future at a price set now [the forward now [the forward exchange rate]).exchange rate]).

Foreign Exchange and Forward Foreign Exchange and Forward ContractsContracts

• How can the bank How can the bank afford to do that?afford to do that?

(This is a question of (This is a question of balance and balance and offsetting contracts.)offsetting contracts.)

Exchange Contracts under Exchange Contracts under RiskRiskCurrency FuturesCurrency Futures: : -- -- Traded on organized exchanges-- The contract locks in the price.-- The buyer must put up a margin, which grows if rates keep changing adversely for the seller.-- Profits and Losses Accrue Daily (marking to market)

Exchange Contracts under Exchange Contracts under RiskRisk

Currency OptionsCurrency Options:-- Buyer has right, seller has

obligation to a future price set today, the “exercise” or “strike” price.

-- The buyer pays a fee (“premium“) to exercise the option.

-- Size of any loss is limited to premium

Exchange Contracts under Exchange Contracts under RiskRisk

Currency SwapCurrency Swap

---- A contract to exchange flows during a time period. -- Foreign currency earnings traded for domestic currency. -- A set of spot and forward exchange rates in one contract.