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Chapter 1 The ForeignExchange Market 宁波工程学院国商教研室蒋力编 Topics to be Covered • Foreign Exchange Market • Spot Rates • Arbitrage • Short/Long term FX movement 1-2 宁波工程学院国商教研室蒋力编 Foreign Exchange Market • The Foreign Exchange Market (FEM) is a place where one country’s money is traded for that of another country. 1-3 宁波工程学院国商教研室蒋力编 • The FEM consists primarily of large commercial banks in world financial centers such as New York or London. The top three banks accounted for 36.98% of the total market in 2011, The market share for the top 10 FX roviders was at about 77%. • 1. Deutsche Bank (德意志银行)2. Barclays(巴 克莱银行)3. UBS (瑞士联合银行)4. Citi (花旗) 5. JPMorgan (摩根大通)6. HSBC (汇丰银行) 7. Royal Bank of Scotland (皇家苏格兰银行)8. Credit Suisse (瑞士信贷集团) • 9. Goldman Sachs (高盛)10. Morgan Stanley (摩根士丹利) 1-4 宁波工程学院国商教研室蒋力编 Foreign Exchange Market Trading Volume (by country 2013) (Reported by The Bank for International Settlements (BIS) ) • Foreign exchange market activity has become ever more concentrated in a handful of global financial centres. The vast majority of global FX trading in 2013 has occurred in five jurisdictions: the United Kingdom (41%), the United States (19%), Singapore (5.7%), Japan (5.6%) and Hong Kong SAR (4.1%). The share of the top five global FX trading centres moved up by 4 percentage points to 75% in 2013. • Singapore overtook Japan as the world’s third major FX trading centre in 2013. And Hongkong overtook Switerland as the world’s fifth top FX trading centre 1-5 宁波工程学院国商教研室蒋力编 FIGURE 1.1 The World of Foreign-Exchange Dealing(p5) 1-6 宁波工程学院国商教研室蒋力编 Figure 1.2 Average daily trading value Yen V.S. Dollar (p7) 1-7 宁波工程学院国商教研室蒋力编 TABLE 1.1 Estimation of Average Daily Volume of Foreign-Exchange Market Activity 1-8 宁波工程学院国商教研室蒋力编 TABLE 1.3 Foreign exchange market turnover by currency 2013 1-9 宁波工程学院国商教研室蒋力编 TABLE 1.4 Foreign exchange market turnover by currency pair 2013 1-10 宁波工程学院国商教研室蒋力编 TABLE 1.5 Foreign exchange market turnover by instruments 2013 1-11 宁波工程学院国商教研室蒋力编 Exchange Rate What is the Exchange Rate? • Exchange Rate (XR)—the price of one money in terms of another. • The XR helps determine the value of a product priced in a different currency. 1-12 宁波工程学院国商教研室蒋力编 Exchange Rate • Basic Types of Exchange Rates: Spot XR • The Spot XR are quoted at a specific day and time. 1-13 宁波工程学院国商教研室蒋力编 Qutotation Method • $ is local currency: U.S. $ per foreign currency £1 = $1.6472 (Direct); Foreign currency per U.S. $ £.0.6071 = $1 (Indirect Quotation) 1-14 宁波工程学院国商教研室蒋力编 ¥6.20 1-15 宁波工程学院国商教研室蒋力编 How many things can ¥1 buy? 0.15 Can 0.053 Bottle 0.014 Bottle 0.026 Bag $0.16 1-16 宁波工程学院国商教研室蒋力编 Exchange Rate • Spread—the difference between the buying and selling price of a currency. • The spread will tend to be higher for thinly or lowvolume traded currencies (quick returns and small margins) or for high-risk currencies. • International currency symbols p10 1-17 宁波工程学院国商教研室蒋力编 Pricing currency/Unit currency Here USD is unit currency, JPY is pricing currency, so 77.55 means the price of one USD is 77.55 JPY. The following currency pairs are similar. 1-18 宁波工程学院国商教研室蒋力编 Arbitrage • Arbitrage—the activity of simultaneously buying a currency in one market while selling in another to take advantage of profit opportunities. • For example: in our textbook the XR quotation is pricing currency/unit currency • Citibank quoting SF/$=0.8745-55 Dresdner Bank quoting SF/$=0.8725-35 1-19 宁波工程学院国商教研室蒋力编 In the real world case • Jan 7th 2016 • CNY/USD is 6.5314 at mainland market, however at the offshore market of CNY the XR is 6.7585. • The arbitrage is so obvious. 1-20 宁波工程学院国商教研室蒋力编 Cross Rate • Arbitrage could involve more than two currencies arbitrage • Cross Rate—the third exchange rate implied by any two exchange rates involving three currencies. • JPY/USD=124.84, USD/GBP=1.5720; • JPY/GBP=196.2485 • Since the dollar is actively traded with many currencies, any two exchange rates involving dollars can be used to determine cross rates. 1-21 宁波工程学院国商教研室蒋力编 Triangular Arbitrage The implied S(¥/£) cross rate is 180 Bank 3 has posted a quote of S (¥/£) =160, so there is an arbitrage opportunity. $ Bank 1 S($/£)=1.50 S(¥/$)=120 So, how can we make money with $100 initially? Bank 2 ¥ £ Bank 3 S (¥/£) =160 1-22 宁波工程学院国商教研室蒋力编 Triangular Arbitrage As easy as 1 – 3 – 2: 1. Sell our $ for ¥, $ Bank 1 Bank 2 ¥12000 at bank 1 S(¥/$)=120 S($/£)=1.50 2. Sell our ¥ for £, £75 at bank 3 3. Sell those £ for $. $ 112.5 at bank 2 ¥ £ Bank 3 S (¥/£) =160 What if I have no $ at all? Perhaps I can do… 1-23 宁波工程学院国商教研室蒋力编 Triangular Arbitrage As easy as 1 – 3 – 2: 1. Sell our $ for ¥, ¥12000 $ Bank 1 Bank 2 S(¥/$)=120 S($/£)=1.50 2. Sell our ¥ for £, £75 3. Sell those £ for $. $ 112.5 ¥ £ Bank 3 S (¥/£) =160 If everyone takes the arbitrage, what will happen? 1-24 宁波工程学院国商教研室蒋力编 Short -term movements • Depreciation—when the value of one currency falls relative to another. For example, if the U.S. dollar depreciates against the Swiss franc, then it takes more dollars to buy one franc. • Appreciation—when the value of one currency rises relative to another. 1-25 宁波工程学院国商教研室蒋力编 Depreciation & Appreciation 1-26 宁波工程学院国商教研室蒋力编 Short -term movements Why exchangge rates changes throughtout the day? • Inventory control effects p14-15 • Asymmetric information effects p16 1-27 宁波工程学院国商教研室蒋力编 Long term movements • Trade flow model P17 • Refer to Figure 1.3 Dollar/YEN Market • Demand for DOLLAR curve—comes from the Japanese demand for U.S goods, services, and financial assets. • Supply of DOLLAR curve—comes from the USA demand for Japanese goods, services, and financial assets. • Equilibrium exchange rate—found at the intersection of the demand and supply curves. 1-28 宁波工程学院国商教研室蒋力编 FIGURE 1.5 Centra bank intervention Suppose the U.S. demand for British goods ↑, which causes the demand for pounds to shift to the right. As a result, the dollar ↓ and pound ↑. The Bank of England may intervene to stop the pound appreciation by supply more pounds in the foreign exchange market. 1-29 宁波工程学院国商教研室蒋力编 Exchange Rate Index 1-30 宁波工程学院国商教研室蒋力编 Exchange Rate Index • Exchange Rate Index – a weighted average of a currency’s value relative to other currencies, where the weights are based on the relative trade importance of each currency. • Page 21 1-31 宁波工程学院国商教研室蒋力编 1-32 宁波工程学院国商教研室蒋力编 1-33 宁波工程学院国商教研室蒋力编 1-34 宁波工程学院国商教研室蒋力编