国际金融学课件：Chapter 3 Foreign Exchange Markets and Foreign Exchange Rates

1、Chapter objective:examines the functions, actual operation of the FOREX markets including exchange rate and international financial markets. Foreign Exchange Markets and Foreign Exchange Rates3Outline 1.Foreign Exchange Market2.Foreign Exchange Rates3.Spot and Forward Rates, Currency Swaps, Futures

2、and Options4.Foreign Exchange Risks, Hedging, and Speculation5.Interest Arbitrage 6.Offshore Financial Markets1. FOREX Market (1)concept (2)Function and Structure(1) conceptFOREX market is the market in which individuals ,firms,and banks buy and sell foreign currencies or foreign exchange. Broadly d

3、efine: FOREX market encompasses the conversion of purchasing power from the currency into another, bank deposits of foreign currency, the extension of credit denominated in a foreign currency, foreign trade financing, and trading in foreign currency options and futures contracts.the largest financia

4、l market, open 365 days a year, 24 hours a daycentral marketplace over the counter(OTC) Reuters, Telerate, Bloombergthree major market segments:Australasia, Europe, North America(2)Function and Structure of the FOREX Market 1)Function2)Structure1)Function:the transfer of funds or purchasing power fr

5、om one nation and currency to anotheroperate as clearinghouses for the foreign exchange demanded and suppliedthe credit functionthe facilities for hedging and speculation2)Structure Wholesale or interbank market Retail or client market Participants: Four levels central bank FX brokers commercial ban

6、ks customers (tourists,importers, exporters, investors)(2)Function and Structure of the FOREX Market3.Foreign Exchange Rates(1)Equilibrium exchange rates(2)Foreign exchange rate quotations(3) Exchange rates categories (4)Arbitrage(1) Equilibrium exchange rates R D S E Million /dayAppreciation and De

7、preciation(2)FX rate quotations(Direct quotations) the price of one unit of the foreign currency priced in domestic currency. See case study FX quotations:p.463 WednesdayThe dollar price of the euro:$1.0551/1(Indirect quotations) The price of one domestic currency in the foreign currency. Case study

8、 p.463:The euro price of the dollar: 0.9478/$ (3) Exchange Rates CategoriesCross exchange rate Ignore the transaction costsA cross exchange rate is an exchange rate between a currency pair where neither currency is the U.S. dollar. If S($/)=1.5683 S($/ )= 0.5235 then / S( /)= S($/)/S($/ ) = 1.5683 /

9、 0.5235=2.9958Effective exchange rateNominal exchange rateReal exchange rate(4)ArbitrageMake a profitTwo-point arbitrage:The exchange rate between any two currencies is kept the same in different monetary centers. example: in the same time in Hong Kong $100=HKD778.07 in New York $100=HKD775.07 one H

10、ong Kong bank sold 1million dollars in Hong Kong, and in New York sold 7.7507million Hong Kong dollars, gained 1 million dollars. Profit:30 thousand HKD(4)ArbitrageTriangular arbitrage: three currencies and three monetary centers are involved. example: in the same time =$2 in London， $0.4= SF1in New

11、 York。The corresponding cross rate is /SF=($/SF)/($/ )=0.4/2=0.2. If we observe the market where one of the three exchange rates is not out of line with the other two, arbitrage opportunity.(4)ArbitrageSuppose in Zurich /SF=0.2,while in New York $/SF=0.4,but in London $/ =1.9.one trade could buy 1mi

12、llion in London for $1.9million.using pounds to buy francs at /SF=0.2,so 1million=SF5million, then in New York using SF5million to buy dollars,so that SF5million=$2million.The initial $1.9million could be turned into $2million.earning $0.1million.(4)ArbitrageRemember:The different financial centers

13、operate in different time zones. Therefore, it only makes senses to compare quotations at a time when the markets overlap. Could not compare $/ quotes in New York with those in Tokyo because there is no overlap between the trading time.3.Spot and Forward Rates, Currency Swaps, Futures and Options(1)

14、spot and forward rates1)Spot transaction and spot rate2)forward transaction and forward rate(2)currency swaps(3)foreign exchange futures and options1) foreign exchange futures 2) foreign exchange options3.Spot and Forward Rates1)spot transaction and spot rateBe quoted at specific time,based on large

15、 trades Example :the U.S importer Spot transaction:FX transaction involves the payment and receipt of FX within two business days after the day the transaction is agree upon. Spot rate:The exchange rate at which the spot transaction take place . 2)forward transaction and forward rateForward transact

16、ion: contracting today for the specified future purchase or sale of foreign exchange at a rate agreed upon today.(the forward rate)The forward price :At premium : it is higher than the spot price.At discount: it is lower than the spot price.Maturities: 1,3,6,9,12 months, beyond one year,for good ban

17、k customers, extending 53.Spot and Forward Rates(2)Currency SwapAn agreement to trade currencies at one date and reverse the trade at later date.Forward trades, is the simultaneous sale or purchase of spot foreign exchange against a forward purchase or sale of a approximately an equal amount of the

18、foreign currency. outright 11% swap transactions 55% spot 34%Swap rate: is the difference between the spot and forward rates in the currency swap.(2)Currency SwapBe quoted in basis points a basis point 0.0001Not care about the actual spot and forward rate, but the difference between themMeet a banks

19、 needs ,combine two separate transactions into one dealThe names of the banks making bids and offers are not known until a deal is reached.(3)Foreign exchange futures and options1)FuturesThe futures market is a market where foreign currencies may be bought and sold for delivery at a future day.Futur

20、es contract is a forward contract for standardized currency amounts and selected calendar dates traded on an organized market. (contract size and maturity date)Standard features:Contract size, maturity date, delivery months see p.469The futures market differs from a forward market Futures ForwardOrg

21、anized exchangeStandardized amountDaily settlement done by the clearinghouse through the participants margin accountStandardized delivery dateDelivery seldom made, reversing trade is transacted to exit the marketFor small firmsOTCTailor-madeBuy or sell at maturity at the forward priceMeets the needs

22、 of investorCommonly madeFor large financial institutions, business firms and wholesale banking activities 1)Futures:Daily ResettlementSuppose you want to speculate on a rise in the $/ exchange rate (specifically you think that the dollar will appreciate). Currently $1 = 140. The 3-month forward pri

23、ce is $1=150.1)Futures: Daily ResettlementCurrently $1 = 140 and it appears that the dollar is strengthening. If you enter into a 3-month futures contract to sell at the rate of $1 = 150 you will make money if the yen depreciates. The contract size is 12,500,000To trade futures market, a trader must

24、 deposit money with a broker(margin).Your initial margin is 4% of the contract value: 1)Futures: Daily ResettlementIf tomorrow, the futures rate closes at $1 = 149, then your positions value drops.Your original agreement was to sell 12,500,000 and receive $83,333.33But now 12,500,000 is worth $83,89

25、2.62You have lost $559.28 overnight.1)Futures: Daily ResettlementThe $559.28 comes out of your $3,333.33 margin account, leaving $2,774.05This is short of the $3,355.70 required for a new position.Your broker will let you slide until you run through your maintenance margin. Then you must post additi

26、onal funds or your position will be closed out. This is usually done with a reversing trade.1)Futures: Daily ResettlementSuppose the March pound contract requires an initial margin of $2,000.if the price fell $0.0175 on one day, then the fall in the settlement price of $0.0175 represents a loss of $

27、1,093.75=0.0175 62,500, and deducting this daily loss from the margin deposit. So in a single day the margin account reduces to $906.25 1)Futures:reversing tradeIf in March the pound will sell for $1.45,and March futures contract is currently priced at $1.5 , we would sell a March contract.then at m

28、aturity ,we will receive $1.5 per pound,or $93,750. If the actual price of the pound falls below $1.5, we realize a profit. Suppose the actual price in March is $1.45, we could then buy pound for $90,625. The difference of $93,750-$90,625=$3,125,will be the profit.2)Foreign Exchange OptionsA foreign

29、 currency option is a contract that provides the right, but not the obligation, to buy (Call options )or sell (put options )a given amount of an asset at a specified price at some time in the future.American options can be exercised at any time during their life, European options can only be exercis

30、ed at maturity.Exercised price or striking price:the price at which currency can be bought or sold.2)Foreign Exchange OptionsExchange-traded options with standardized features are traded on two exchanges. Options on the spot foreign exchange are traded at the Philadelphia Stock Exchange, option on c

31、urrency futures at the Chicago Mercantile Exchange. OTC volume is much bigger than exchange volume.Trading is in seven major currencies plus the euro against the U.S. dollar.2)Foreign Exchange OptionsProfit lossLong callShort callStEE2)Foreign Exchange OptionsProfit LossLong putShort putEE2)Foreign

32、Exchange OptionsSuppose a U.S importer is buying equipment from a German manufacturer with a 1 million due in three months. The importer can hedge against a euro appreciation by buying a call option that confers the right to purchase euros over the next three months at a specified price. The current

33、 $1.2/ , if $1.25/ over the next three months. The importer exercises the option. Basic option-pricing relationships at expiration (see case study14-4 p.470-471)2)options: example1Example1: expiration value of an American call optionConsider the PHLX 75 Mar. CD American call option, the exercise pri

34、ce 75 cents per CD, current premium Ca=0.84 cents per CD. Suppose at expiration the spot rate is $0.7564/CDThe call option, exercise value: 75.64-75=0.64 cents per each of the CD50,000 of the contract, or $320. That is, the call owner can buy CD50,000, worth $37,820=CD50,000$0.7564 in the spot marke

35、t, for $37,500=CD50,000$0.7500.2)options: example1Call optionExercise price: $0.7500/CDCurrent premium: c0.84/CDSpot rate: $0.7564/CDCD50,000Exercise value: $3202)options: example1 profit 0 E=75 ST -0.84 ST=E+Ca =75+0.84 =75.84 Call option : Buyers perspectiveCall option: Writers perspective profit

36、0.84 ST ST=E+Ca2)options: example12)options: example1At ST=E+Ca both the call buyer and writer break even . The speculative possibilities of a long position in a call: Anytime the speculator believes ST will be in excess of the breakeven point, establish a long position in the call. If correct ,prof

37、it. If incorrect, the loss limited to the premium paid.If the speculator believes ST will be less than the breakeven point, a short position in the call will yield a profit, the largest amount being the call premium. If incorrect, very large losses.Example 2expiration value of an American put option

38、 Consider the 104 Sep EUR American put, a current premium pa, of 2.47 cents per EUR. If ST=$1.0307/EUR, the put contracts exercise value: 104-103.07=0.93 cents per EUR for each of the EUR62,500, worth$64,618.75=EUR62,500$1.0307 in the spot market, for $65,000=EUR62,500 $1.04. If $1.0425/EUR,the exer

39、cise value is 104-104.25=-0.25 cents per EUR.the put buyer will not exercise.2)options: example2Put optionExercise price: $1.04/EURCurrent premium: c2.47/EURSpot rate: $1.0307/EUREUR62,500Exercise 1.04-1.0307= 0.93If spot rate: $1.0425/EURNot exercise: 1.04-1.0425=-0.00252)options: example2Put optio

40、n: buyerperspectiveProfit E-Pa=104- 2.47 =101.53 E=104-2.47 104-2.47=101.53 Put option: writers perspectiveProfit2.47ST4.Foreign Exchange Risks ,Hedging, and Speculation (1)Foreign exchange risks(2)Hedging(3)Speculation(1)Foreign exchange risksExchange rate changes can systematically affect the valu

41、e of the firm by influencing the firms operating cash flows as well as the domestic currency values of its assets and liabilities. Open position. exposure classify foreign currency exposure into three classes:(1)Foreign exchange risks1)Economic ExposureExchange rate risk as applied to the firms comp

42、etitive position.2)Transaction ExposureExchange rate risk as applied to the firms home currency cash flows.3)Translation ExposureExchange rate risk as applied to the firms consolidated financial statements. Cash SAR1,000,000 Debit SAR5,000,000Accounts receivable 3,000,000 Equity 6,000,000Plant and e

43、quipment 5,000,000Inventory 2,000,000 SAR11,000,000 SAR11,000,000Dollar translation on May 31, SAR4=$1Cash $250,000 Debt $1,250,000Accounts receivable 750,000 Equity 1,500,000Plant and equipment 1,250,000Inventory 500,000 $2,750,000 $2,750,000Dollar translation on June 31, SAR5=$1Cash $200,000 Debt

44、$1,000,000Accounts receivable 600,000 Equity 1,200,000Plant and equipment 1,000,000Inventory 400,000 $2,200,000 $2,200,000Balance sheet of one-Saudi Arabia May 31(2)HedgingHedging refers to the avoidance of a foreign exchange risk,or the covering of an open position. An activity to offset risk.Money

45、 Market HedgeForward Market HedgeOptions Market HedgeFutures Market HedgeCross-Hedging Minor Currency ExposureHedging Contingent ExposureHedging Recurrent Exposure with Swap Contracts(2)HedgingHedging Through Invoice CurrencyHedging via Lead and LagExposure NettingShould the Firm Hedge?What Risk Man

46、agement Products do Firms Use?Money Market HedgeThis is the same idea as covered interest arbitrageExample: The importer of British woolens can hedge his 100 million payable with a money market hedge:Lend $112.05 million in the U.S.Translate $112.05 million into pounds at the spot rate S($/) = $1.25

47、/Invest 89.64 million in the UK at i = 11.56% for one year.In one year your investment will have grown to 100 million.Spot exchange rateS($/)=$1.25/360-day forward rateF360($/)=$1.20/U.S. discount ratei$=7.10%British discount rate i =11.56%Where do the numbers come from?We owe our supplier 100 milli

48、on in one yearso we know that we need to have an investment with a future value of 100 million. Since i = 11.56% we need to invest 89.64 million at the start of the year.How many dollars will it take to acquire 89.64 million at the start of the year if the spot rate S($/) = $1.25/?Money Market Hedge

49、Forward Market HedgeThe most direct and popular way of hedgingIf you are going to owe foreign currency in the future, agree to buy the foreign currency now by entering into long position in a forward contract.(Long position:buying currency for future delivery.)If you are going to receive foreign cur

50、rency in the future, agree to sell the foreign currency now by entering into short position in a forward contract.(Short position: selling currency for future delivery)Options Market HedgeOptions provide a flexible hedge against the downside, while preserving the upside potential.To hedge a foreign

51、currency payable buy calls on the currency.If the currency appreciates, your call option lets you buy the currency at the exercise price of the call.To hedge a foreign currency receivable buy puts on the currency.If the currency depreciates, your put option lets you sell the currency for the exercis

52、e price.ExampleSuppose that Boeing Corporation exported a Boeing 747 to British Airways and billed 10million payable in one year. the money market interest rates and foreign exchange rates are given as follows:The U.S. interest rate:6.10%The U.K. interest rate:9.00%The spot exchange rate:$1.50/ The

53、forward exchange rate:$1.46/ Give the various techniques for managing this transaction exposureExampleForward market hedgeGain=(F-ST)10 millionMoney market hedgeThe firm may borrow (lend) in foreign currency to hedge its foreign currency receivables (payables), thereby matching its assets and liabil

54、ities in the same currency.ExampleMoney market hedgeBorrow 9,174,312= 10/1.09 in the U.K.Convert 9,174,312 into $13,761,468 at the spot rate of $1.5/ Invest $13,761,468 in the U.S.Collect 10million receivable and use it to repay the pound loanReceive the maturity value of dollar investment, $14,800,

55、918= $13,761,468 1.061ExampleOption market hedge buy a put option with an exercise price of $1.46Assume premium was $0.02 per pound, $200,000Under the options hedge, the net dollar proceeds from the British sale become:$14,387,800=$14,600,000-$200,0001.061Cross-Hedging Minor Currency ExposureThe maj

56、or currencies are the: U.S. dollar, Canadian dollar, British pound, French franc, Swiss franc, Japanese yen, and now the euro. Easy to use forward ,money market, or options to hedge.In contrast, if minor currencies, such as Korean won, Czech koruna. It is difficult, expensive, or impossible to use f

57、inancial contracts to hedge exposure to minor currencies.Cross-Hedging involves hedging a position in one asset by taking a position in another asset.The effectiveness of cross-hedging depends upon how well the assets are correlated.An example would be a U.S. importer with liabilities in Czech korun

58、a hedging with long or short forward contracts on the euro. If the koruna is expensive when the euro is expensive, or even if the koruna is cheap when the euro is cheap it can be a good hedge. But they need to co-vary in a predictable way.Cross-Hedging Minor Currency ExposureHedging Contingent Expos

59、ureContingent exposure refers to a situation in which the firm may or may not be subject to exchange exposure.If only certain contingencies give rise to exposure, then options can be effective insurance.For example, if your firm is bidding on a hydroelectric dam project in Canada, you will need to h

60、edge the Canadian-U.S. dollar exchange rate only if your bid wins the contract. Your firm can hedge this contingent risk with options.Hedging Recurrent Exposure with SwapsRecurrent exposure: Recurrent cash flows in a foreign currency, hedged using a currency swap contract which can be viewed as a po