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Currency Exchange Rates: Presenter's Name Presenter's Title DD Month Yyyy
Currency Exchange Rates: Presenter's Name Presenter's Title DD Month Yyyy
1. INTRODUCTION
The foreign exchange (FX) market is the market for trading currencies against
each other.
- The FX market is the worlds largest market.
- The FX market facilitates world trade.
- The FX participants buy and sell currencies needed for trade, but also
transact to hedge and speculate on currency exchange rates.
An exchange rate is the price of a countrys currency in terms of another
countrys currency.
Example:
USD/INR = 61.965
THE FX MARKET
PARTICIPANTS AND PURPOSES
Companies and individuals
transact for the purpose of the
international trade of goods and
services.
Capital market participants transact
for the purpose of moving funds into
or out of foreign assets.
Hedgers, who have an exposure to
exchange rate risk, enter into
positions to reduce this risk.
Speculators participate to profit
from future movements in foreign
exchange.
TYPES OF FX PRODUCTS
Currencies for immediate delivery
(spot market).
Forward contracts, which are
agreements for a future exchange
at a specified exchange rate.
FX swaps, which are a
combination of a spot contract and
a forward contract, used to roll
forward a position in a forward
contract.
FX options, which are options to
enter into an FX contract some
time in the future at a specified
exchange rate.
FX PARTICIPANTS
BUY SIDE
Corporations
Real money accounts
Leverage accounts
Retail accounts
Governments
Central banks
Sovereign wealth funds
SELL SIDE
Large dealing banks
Exchange-traded derivatives; 4%
3. CURRENCY EXCHANGE
RATE CALCULATIONS
A direct currency quote uses
the domestic currency as the
price currency and the foreign
currency as the base currency.
An indirect currency quote
uses the domestic currency as
the base currency and the
foreign currency as the price
currency.
Example
Consider the quote USD/BRL = 2.3638.
- The base currency is the Brazilian real
(BRL).
- The price currency is the US dollar
(USD).
- USD/BRL is a direct currency quote
from the US perspective.
- USD/BRL is an indirect currency quote
from the Brazilian perspective.
From the Brazilian perspective, we can
convert the USD/BRL into the direct quote
of BRL/USD by inverting:
BRL/USD = 0.4230
IN PRACTICE
There are a number of conventions, which simply refer to a particular exchange
rate [see Exhibit 9-6 for a more comprehensive list].
FX Rate Quote
Convention
Name
Convention
EUR
JPY
GBP
euro
dollaryen
sterling
Actual Ratio
(Price currency/Base
currency)
USD/EUR
JPY/USD
USD/GBP
Dealers will quote a bid (at which the dealer will buy) and an offer price (at
which the dealer will sell). [Note: bid < offer]
APPRECIATING OR DEPRECIATING
Appreciation or depreciation is
with respect to the base
currency relative to the price
currency.
Appreciation is a gain in
value of one currency relative
to another currency.
Depreciation is the loss in
value of one currency relative
to another currency.
The percentage change is the
ratio of the exchange rates
minus one:
% change =
Example:
Suppose USD/CZK is 20.2000 and increases
to 20.3258.
The percentage change is
This means that the Czech koruna (CZK)
appreciated 0.6228% against the US dollar.
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CURRENCY CROSS-RATES
Given three currencies, a currency cross-rate is the implied exchange rate
of a third country pair given the exchange rates of two pairs of three
currencies that have a common currency.
If arbitrage is possible, cross-rates will be consistent.
Example 1: Suppose you have the following quotes:
AUD/USD = 0.8812 USD/DKK = 5.5027
What is the AUD/DKK exchange rate?
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Example
Suppose that the AUD/USD spot rate
is 0.8808 and that the one-month
forward rate is 0.8789.
= Spot rate
Therefore,
= 0.8789,
= 0.8808, and
= 30/360.
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Example:
Suppose we have the spot exchange rate of the CAD/USD of 1.0969. If the
one-year T-bill interest rate in the United States is 0.109% and the Canadian
one-year Treasury rate is 0.95%, what is the one-year forward rate?
The estimated forward rate is 1.1061, which means that the forward rate
should be trading at a premium of 1.1061 1.0969 = 92 pips.
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Fixed
Exchange
Rate Regime
Pegged
System
Independently
Floating Rate
Regime
15
Type
No separate legal
tender
Shared currency
Currency board
system
Target zone
Description
16
Type
Description
Peg
Peg
Managed float
Float
Independently
floating rates
Float
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Using the national accounts relationship, we see the relationship between trade and
expenditures/savings and taxes/government spending:
XM
(S I)
Savings less
investment
(T G)
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