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Euro ( €) versus the U. S. $ [Interbank Rate – 1/1/99 to 2/1/13]. “Rescue ...for the Euro Falls Short…” [ New York Times , 9-24-00].
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Euro (€) versus the U. S. $[Interbank Rate – 1/1/99 to 2/1/13]
“Rescue ...for the Euro Falls Short…”[New York Times, 9-24-00] • “To the disappointment of many European bankers, American officials refrained from speaking out strongly in support of a stronger euro and raised doubts about their willingness to intervene forcefully in currency markets by selling dollars or buying euros.”
“Rescue ...for the Euro Falls Short…”[New York Times, 9-24-00] • “The market badly needs a statement from the Americans that the euro is substantially under-valued and the dollar is substantially overvalued,” Mr. Friedrich said.”
“Rescue ...for the Euro Falls Short…”[New York Times, 9-24-00] • “… the amount of money used to intervene … was very modest. The ECB gave no clue about the magnitude of its campaign to buy euros or sell other currencies, but currency experts and traders have estimated that the amount was about $6 billion or $7 billion.”
“Rescue ...for the Euro Falls Short…”[New York Times, 9-24-00] • “… Dow Jones Newswires, quoting an anonymous official at the ECB, said the actual amount of the intervention was in the ‘low single digits,’ perhaps $2 billion or $3 billion’.”
“Rescue ...for the Euro Falls Short…”[New York Times, 9-24-00] • “Psychology and timing may ultimately be more important to the future of the euro than the amounts of money used by the world’s central banks on its behalf.”
Problems: Chapter 6 • 6.1 • 6.2 • 6.4
The Foreign Exchange Market Function: “...to trade one currency for another currency.”
The Foreign Exchange Market • interbank market (95% of transactions) • wholesale market • major banks (20) as traders • spot market: two day delivery (35%) • forward market: future delivery (12%) • swaps: spot + forward (53%)
The Foreign Exchange Market • electronically linked network • Society for Worldwide Interbank Financial Telecommunications (SWIFT) • trade volume – 5% • capital transactions – 95%
The Foreign Exchange Market • Participants • large commercial banks • foreign exchange brokers • multinational corporations • central banks
ORGANIZATION OF THE FOREIGN EXCHANGE MARKET SIZE OF THE CURRENCY MARKET A. Largest financial market in the world 2005: traded $1.9 trillion daily 2011: traded $4.0 trillion daily B. Largest Global Market Centers(2004): 1. London = $753 billion daily 2. New York= $461 billion daily 3. Tokyo = $199 billion daily
The Spot Market[Foreign Exchange] • Foreign exchange quotes: • trades among dealers in the interbank market • transactions: $1 million or more • “Use your credit cards!”(?)
The Spot Market[Foreign Exchange] • American Terms: • number of U. S. $ per unit of foreign currency • Example: SFr 1 = $0.8672 • Example: €1 = $1.3449
The Spot Market[Foreign Exchange] • European Terms: • number of foreign currency units per U. S. $ • Example: $1 = ¥93.5853 • Example: $1 = SFr 1.1531 • Verify: $1 / 1.1531 = $0.8672
American Terms: Number of U. S. $ per unit of foreign currency Example: SFr1 = $0.8672 European Terms: Number of foreign currency units per U. S. $ Example: $1 = SFr 1.1531 The Spot Market[Foreign Exchange]
The Spot Market[Foreign Exchange] • Direct Quotation: • home currency price of foreign currency • Example: • (France) FF 3.3862 = 1 DM • (Germany) DM 0.29531 = 1 FF
The Spot Market[Foreign Exchange] • Indirect Quotation: • value of one unit of home currency in the foreign currency • Example: • (England) £1 = $ 1.6698
Currency Exchange Rates and Cross Rates Newspaper Listing
Currency Cross-Rates • “The exchange rate between two currencies, neither of which is the U. S. dollar, calculated by using the dollar rates for both currencies.”
Currency Cross-Rates • www.bloomberg.com/markets/currencies/fxc.html
Calculating Cross Rates • Yen: ¥120.18 / U. S. $1 • Won: W1,186.94 / U. S. $1 • ¥/$ ÷ W/$ = ¥/W • ¥120.18 ÷ W1,186.94 = ¥0.10125 / W1
The Spot Market[Foreign Exchange] • Transaction costs: • Bid (buy) - Ask (sell) spread • Percent spread = ([Ask Price - Bid Price] / Ask Price) X 100 • Typical Spread: 0.1 - 0.5%
The Spot Market[Foreign Exchange] • Transaction costs (Spread): • £1 = $1.6124 - 43 • (%) = ((Ask-Bid) ÷ Ask) x 100 • (%) = [(1.6143-1.6124)/1.6143] X 100 • (%) = 0.00118, or .12%
Currency Arbitrage • 40% of currency transactions don’t involve the dollar • Looking for exchange rate inconsis- tencies; different prices in different markets • Buy in one market; sell in another • Arbitrage maintains equivalent rates everywhere (in theory)
Currency Arbitrage[Example] Exhibit 6.7 Triangular Currency Arbitrage
The Forward Market[Foreign Exchange] • Delivery at a fixed future date • Specified amount of currency • Exchange rate fixed at contract date • Performance required - not an option
The Forward Market[Example] • U. S. Co. buys textiles from UK • £1 million due in 90 days • £1 = $1.71 ($1,710,000) • Forward rate: £1 = $ 1.72 • Importer owes pounds (short) • 90-day forward contract (long)
The Forward Market[Example] Hedging a Future Payment with a Forward Contract
Shapiro: Problem 6.1 • $:€ exchange rate: €1 = $1.35 • €:SFr exchange rate: SFr1 = €0.61 • SFr:$ exchange rate? • SFr1 = €0.61 X $1.35 = $0.8235
Shapiro: Problem 6.2.a • New York: £1 = $1.9880-5 • £500,000 = $??? • £500,000 x $1.9885 = $994,250
Shapiro: Problem 6.2.b • What is the direct quote for dollars in London? • London: 1/1.9885 - 1/1.9880 = 0.50289 - 0.50302
Shapiro: Problem 6-4 • Buy Euros (€) spot at $1.3480 • Sell Euros (€) forward (180 days) at $1.3526 • A. What is the swap rate on euros? • B. What is the forward premium or discount on 180-day Euros?
Shapiro: Problem 6-4.a • Buy Euros (€) spot at $1.3480 • Sell Euros (€) forward (180 days) at $1.3526 • A. What is the swap rate on euros? • $1.3526 - $1.3480 = $0.0046, or a premium of 46 points (“pips”)
Shapiro: Problem 6-4.b • Buy Euros (€) spot at $1.3480 • Sell Euros (€) forward (180 days) at $1.3526 • b. What is the forward premium or discount on 180-day Euros?
