国际金融ch16

1、CHAPTERForeign ExchangeDerivativeMarket 2003 South-Western/Thomson LearningnExplain how various factors affect exchange ratesnDescribe how foreign exchange risk can be hedged with foreign exchange derivativesnDescribe how to use foreign exchange derivatives to capitalize (speculate) on expected exch

2、ange rate movementsnExchanging currencies is needed when:lTrade (real) prompts need for forexlCapital flows (financial) prompts need for forexnForeign exchange tradinglVia global telecommunications network between mostly large bankslBid/ask spreadnQuoted two ways:lForeign currency per U.S. dollarlDo

3、llar cost of unit of foreign exchangenAppreciation/depreciation of currencylAppreciation = more forex to buy $lPurchase more forex with $lDepreciation = foreign goods cost more $lTotal return to foreign investor decreasesnExchange rate quotations are available in the financial press and on the Inter

4、net with spot exchange rate quotes for immediate deliverynForward exchange rate is for delivery at some specified future point in timenForward premium is the percent annualized appreciation of a currencynForward discount is the percent annualized depreciation of a currencynExchange rates involve dif

5、ferent kinds of quotes for comparing the value of the U.S. dollar to various foreign currenciesl1 unit of foreign currency worth some amount of U.S. dollarse.g. $.70 U.S. per Canadian Dollarl1 U.S. dollars value in terms of some amount of foreign currency e.g. CD$1.43 per U.S. dollarlNote reciprocal

6、 relationshipnCross-exchange rates express relative values of two different foreign currencies per $1 U.S.nCross-exchange rates are foreign exchange rates of two currencies relative to a currency.nValue of one unit of currency A in units of currency B = value of currency A in $ divided by value of c

7、urrency B in $nBritish Pound = $1.4555; Euro = $.8983nValue of Pound in Euros = $1.4555/$.8983 orl1.62 Pounds per Euro using the forex rates per U.S. dollarnCurrency terminologylAppreciation means a currencys value increases relative to another currencylDepreciation means a currencys value decreases

8、 relative to another currencynSupply and demand influences the values of currencies nMany factors can simultaneously affect supply and demandn19441971 known as the Bretton Woods EralGovernment maintained exchange rates within a 1% rangelRequired government intervention and controlnBy 1971 the U.S. d

9、ollar was clearly overvaluedBackground on Foreign Exchange MarketsnSmithsonian Agreement (1971) among major countries allowed dollar devaluation and widened boundaries around set values for each currencynNo formal agreements since 1973 to fix exchange rates for major currencieslFreely floating excha

10、nge rates involve values set by the market without government interventionlDirty float involves some government interventionnThere is a wide variation in how countries approach managing or influencing their currencys valuelFloat with periodic interventionlPegged to the dollar or some kind of composi

11、telSome countries have both controlled and floating rateslSome arrangements are temporary and others more permanentnDifferential country inflation rates affect the exchange rate for euros and dollars if inflation is suddenly higher in EuropenTheory of Purchasing Power Parity suggests the exchange ra

12、te will change to reflect the inflation differentialinfluence from real sector of economynCurrency of the higher inflation country (euro) depreciates compared to the lower inflation country ($)nDifferential interest rates affect exchange rates by influencing capital flows between countriesnFor examp

13、le, the interest rates are suddenly higher in the United States than in EuropenInvestors want to buy dollar-denominated securities and sell European securitiesnEuros are sold, dollars bought to buy U.S. securitiesnDownward pressure on the euro, appreciation of the dollarnDirect intervention occurs w

14、hen a countrys central bank buys/sells currency reservesnFor example, the U.S. central bank, the Federal Reserve sells one currency and buys anotherlSale by central bank creates excess supply and that currencys value drops relative to the one purchasedlMarket forces of supply and demand can overwhel

15、m the interventionnIndirect intervention involves influencing the factors that affect exchange rates rather than central bank purchases or sales of currenciesnInterest rates, money supply and inflationary expectations affect exchange ratesnHistorical perspective on indirect interventionlPeso crisis

16、in 1994lAsian crisis in 1997lRussian crisis in 1998nSome countries use foreign exchange controls as a form of indirect intervention to maintain their exchange ratesnPlace restrictions on the exchange of currencynMay change based on market pressures on the currencynVenezuela in mid-1990s illustrates

17、the issues involved in controlling rates via intervention and the affect of market forcesnForeign exchange rate changes can have an important effect on the performance of multinational firms and economic conditionsnMany market participants forecast rateslMarket participants take positions in derivat

18、ives based on their expectations of future rateslSpeculators attempt to anticipate the direction of exchange ratesnThere are several forecasting techniquesTechnical ForecastingFundamental Forecasting Market-based ForecastingMixed ForecastingnTechnical forecasting is a technique that uses historical

19、exchange rate data to predict the futurenUses statistics and develops rules about the price patternsdepends on orderly cyclesnIf price movements are random, this method wont worknModels may work well some of the time and not work other timesnFundamental forecasting is based on fundamental relationsh

20、ips between economic variables and exchange ratesnMay be statistical and based on quantitative models or be based on subjective judgementnRegression used to forecast if values of influential factors have a lagged impactnNot all factors are known and some have an instant impact so sensitivity analysi

21、s is used to deal with uncertaintynLimitation of fundamental forecasting methods:lSome factors that are important to determining exchange rates are not easily quantifiablelRandom events can and do affect exchange rateslPredictor models may not account for these unexpected eventsnMarket-based forecas

22、ting uses market indicators like the spot and forward rates to develop a forecastnSpot rate: recognizes the current value of the spot rate as based on expectations of currencys value in the near futurenForward rate: used as the best estimate of the future spot rate based on the expectations of marke

23、t participantsnMixed forecasting is used because no one method has been found superior to anothernMultinational corporations use a combination of methodsnAssign a weight to each technique and the forecast is a weighted averagenPerhaps a weighted combination of technical, fundamental, and market-base

24、d forecastingnMarket participants forecast not only exchange rates but also volatilitynVolatility forecast lRecognizes how difficult it is to forecast the actual ratelProvides a range around the forecastnVolatility of historical datanUse a times series of volatility patterns in previous periodsnDeri

25、ve the exchange rates implied standard deviation from the currency option pricing modelMethods Used To Forecast VolatilitynFor example, a dealer takes a short position in a foreign currency to profit from expected depreciationnDealer forecasts currency 1 to depreciate relative to foreign currency 2

26、so the first step is to borrow currency 1 and then exchange currency 1 for currency 2lInvest in currency 2 and receive the investment returns at maturitylConvert back to foreign currency 1 and pay back loan denominated in currency 1Hedge or SpeculateForward ContractsCurrency SwapsCurrency OptionsnFo

27、rward contractslNegotiated with a counterpartylSpecify a maturity date, amount and which currency to buy or selllNegotiated in over-the-counter marketlUsed to lock in the price paid or price received for a future currency transactionlClassic hedging contractnForward contracts can be used to hedge if

28、 a corporation must pay a foreign currency invoice in the futurelPurchase foreign currency for amount/date of invoicelLocks in cost of invoicelHedges foreign exchange risk of transactionnForward contracts are also used by hedgers who have a foreign currency inflow on some future datenForward rate pr

29、emium or discountP = % annualized premium or discount FR = Forward exchange rate S = Spot exchange rate n = number of days forwardWhere:xFR - S S360 np=nCurrency futures contracts trade on exchanges, are standardized in terms of the maturity and amountnCurrency swaps allow one currency to be periodi

30、cally swapped for another at a specified exchange ratenCurrency options contracts offer one-way insurance to buy (call) or sell (put) a currencynBuying a call option on a foreign currency is the right to purchase a specified amount of currency at the strike price within the specified time periodlExe

31、rcise the option if the spot rate rises above the strike pricelDo not exercise if the spot rate does not reach or exceed the strike pricelU.S. business that owes Canadian in 60 days buys currency call options to hedge spot forex risknBuying a put option on a foreign currency is the right to sell a s

32、pecified amount of currency at the strike price within the specified time periodlExercise the option if the spot rate falls below the strike pricelDo not exercise if the spot rate does not decline below the strike pricelU.S. business hedges Canadian dollar payment it will receive in 30 days by buyin

33、g CD currency put optionsif CD depreciates against U.S., gain will offset spot lossnBusiness or person has no spot interest in underlying assettakes position based on forecast of currency movementsnForward contractslBuy/sell foreign currency forwardlWhen received, sell in the spot marketnPurchase/se

34、ll futures contractsnPurchase call/put optionsnFor example, what position in derivates would a speculator take if he/she anticipates a depreciation in a currency?nForward contractslSell foreign currency forwardlAt maturity, buy in the spot marketnSell futures contractsnPurchase put optionsnArbitrage

35、 takes advantage of a temporary price difference in two locations to make profits buying at a lower price than you can receive via the simultaneous sale of an asset, financial instrument or currencynRisk free because the purchase and sale price are locked in simultaneouslynAs arbitrage occurs, price

36、s in both locations change until equilibrium (one price) returns nCovered interest arbitrage activity creates a relationships between spot rates, interest rates and forward rates nBorrow in country 1nConvert the funds to currency for country 2 using the spot rate; buy forward contract for return nIn

37、vest in country 2 and earn an investment rate of returnnConvert back to country 1 currency using forward contract, repay loannCovered interest arbitrage activity makes forward premium approximately equal to the differential in interest rates between two countriesnIf forward premium does not equal th

38、e interest rate differential, covered interest arbitrage is possiblenIf the forward premium or discount equals the interest rate differential, there are no opportunities for arbitragenEquation for covered interest arbitrageP = Forward premium or discountih = Home country interest rateif = Foreign in

39、terest rateWhere:( 1 + ih) (1 + if ) 1P =nIndicators of foreign exchange derivatives are closely monitored by market participantsnHedgers and speculators continuously forecast direction and degree of movement and monitorlInflation rates between countrieslInterest rates lEconomic indicatorsnExchangin

40、g Currencies Is Needed When:lTrade (real) prompts need For forexlCapital flows (financial) prompts need for forexnForeign Exchange TradinglVia global telecommunications network between mostly large bankslBid/ask spreadnQuoted Two Ways:lForeign currency per U.S. DollarlDollar cost Of unit Of foreign

41、exchangenAppreciation/Depreciation of CurrencylAppreciation = more forex To buy $lPurchase more forex with $lDepreciation = foreign goods cost more $lReturn To foreign investor decreasesnBretton Woods Era (1944-1971)lFixed Or pegged forex rateslCentral bank maintained rateslCould not adjust To major

42、 economic changenSmithsonian Agreement (1971)lDevalued dollarlWidened trading range Of forexlFirst Step Toward Market-Determined ForexnMarket-Determined Rates (1973)lDirty FloatlExchange Rate Mechanisms:uCurrencies pegged to anotheruEuropean currency unit (ECU)uCentral Bank involvementuERM problemsnDifferential inflation rates between countrieslGoods and services impact demand/supply for foreign exchangelInflating currency declines to provide.lPurchasing power paritynDifferential