The Foreign Exchange Market
1. Value Date: The settlement of a transaction takes place by transfers of deposits between two parties. The day on which these transfers are effected is called the Settlement Date or the Value Date. 2. Spot Rate: When the exchange of currencies takes place on the second working day after the date of the deal, it is called spot rate. 3. Forward Transactions: If the exchange of currencies takes place after a certain period from the date of the deal (more than 2 working days), it is called a forward rate. A trader may quote a forward transaction for any future date. It is a binding contract between a customer and dealer for the purchase or sale of a specific quantity of a stated foreign currency at the rate of exchange fixed at the time of making the contract.
4. Swap Transaction: A swap transaction in the foreign exchange market is combination of a spot and a forward in the opposite direction. Thus a bank will buy DEM spot against USD and simultaneously enter into a forward transaction with the same counter party to sell DEM against USD against the mark coupled with a 60- day forward sale of USD against the mark. As the term ‘swap’ implies, it is a temporary exchange of one currency for another with an obligation to reverse it at a specific future date. 5. Bid Rate: The bid rate denotes the number of units of a currency a bank is willing to pay when it buys another currency. 6. Offer Rate: The offer rate denotes the number of units of a currency a bank will want to be paid when it sells a currency. 7. Bid - Offer Rate: The bid offer Rate is the rate which states both, the price which is the bank is willing to pay to buy other currencies and the price the bank expects when it sells the same currency. Bid and Ask will always be from a bank’s point of view. Thus (A/B)bid will denote the number of units of A the bank will pay when it buys one unit of B and (A/B)ask will mean the number of units of A the bank will want to be paid in order to sell one unit of B. 8. European Quote: The quotes are given as number of units of a currency per USD. Thus DEM1.5675/USD is a European quote.
It may result from 2 currencies. 10. direct quotes are those that give unit of the currency of that country per unit of a foreign currency. Arbitrage:
Arbitrage may be defined a san operation that consists in deriving a profit without risk from a differential existing between different quoted rates. also known as.Direct Quotes: In a country. 11. American Quotes: American quotes are given as number of dollars per unit of a currency. Thus USD 3. Thus USD0.
.Indirect Quote: Indirect or Reciprocal Quotes are stated as number of units of a foreign currency per unit of the home currency. triangular currencies. also known as.00/USD is a direct quote in India.9560/INR 100 is an indirect quote in India. 12. Thus INR 35. geographical arbitrage or from 3 currencies.4575/DEM is an American quote.9.
. Bankers: large commercial banks operating either at retail level for individual exporters and corporations or at wholesale level in the InterBank market. Answer: In a business setting. only one currency is used while in a foreign transaction. They are four main participants in the foreign exchange market. The foreign exchange market also known. there is a fundamental difference between making payment in the domestic market and making payment abroad.What is foreign exchange market? Explain the functions. two or more currencies maybe used. they communicate with each other through telephone telex computer terminals and other electronic menace of communication.Descriptive questions
1. Central bank. In a domestic transaction. The foreign exchange market is the market in which currencies are brought and sold against each other it is the largest market in the world. as forex market is an over-thecounter market. The traders sit in the foreign exchange dealing room of major commercial banks around the world. this means that there is no single market place or an organized exchange like a stock exchange. Broker 2. Corporations 4. Bankers 3.
.Central bank: central banks of various countries that intervene in order to maintain or to influence the exchange rate of their currencies within a certain range as also to execute the orders of government. Individual brokers or corporations: bank dealers often used brokers to stay anonymous since the identity of banks can influence short-term course.
Foreign Exchange Flow
primary price maker or professional dealer make a two way market to each other & their clients.e.
F O R E IG N E X C H A N G E M A R K E T
W H O L E SA L E M A R K E T
R E T A IL M A R K E T
WHOLESALE MARKET (primary price maker) The wholesale market is also referred to as interbank market the average transaction size in this market is very small.Elaborate the structure of the foreign exchange market and compare it with the foreign exchange of India Answer: The Foreign exchange market may be broadly classified into -: Wholesale market and Retail market . Participants: Commercial banks.This group mainly include commercial bank but some large investment dealer & a few large corporation have also assumed the role of primary dealers. Corporations and Central bank Among these participants.2.
. i. on request they will quote a two-way price & be prepared to take either the buy or sell side . Primary price makers perform an important role in taking positions off the hands of another dealer or corporate customer & then offsetting these by doing an opposite deal with another entity which has a matching requirement.
Total turnover & transaction size is very small.Among primary price maker there is a kind of tiering –
(deal in large number of currencies & in large amount without using broker )
(deal in small number of currencies & use the services of broker )
(market in a small number of major currencies against home currency ) RETAIL MARKET (Secondary price maker ) It is the market in which travelers & tourists exchange one currency for another in the form of currency notes & traveler’s cheques. The bid-ask spread is large. Foreign currency brokers Foreign currency brokers act as middlemen between two market makers. The secondary price maker make foreign exchange prices but do not make a two way market . Their main function is to provide information to market making banks about
prices at which there are firm buyers & sellers in a pair of currencies. The broker hunts around for an appropriate counterparty –another bank . The structure of foreign exchange market in India The foreign exchange market in India may broadly said to have 3 segments or layers :First layer consists of the Central bank i. these interventions are obligatory when interventions are reached. a central bank may still intervene to influence market sentiment. Central bank Central bank of various countries (such as RBI in India) intervene in the market from time to time to attempt to move exchange rates in a particular direction. Large corporations are the price taker who use the foreign exchange market for a variety of purposes related to their operations.
.& collects commission on conclusion of deal. Banks may also use brokers to acquire information about the general state of the market even when they do not have a specific deal in mind. In case of limited flexibility systems like EMS. ADs are mostly commercial banks &Financial institutions such as IDBI. ICICI & the travel agent like Thomas cook. RBI & the Authorized dealers (ADs). Price takers Price takers are those take the prices quoted by primary price makers & buy or sell currencies for their own purposes but do not make a market themselves. They do not take active positions in the market to profit from exchange rate fluctuations.e. The important thing is brokers do not sell or buy on their own account. In other cases though there is no commitment to defend any particular rate.
Communications between dealers tend to be very terse. Cochin & Bangalore Indian market also has accredited brokers who match buyers & sellers.3 billion. in interbank markets this is a matter of mutual accommodation.Write a note on Inter bank dealing Answer: Primary dealers quote two – way prices and are willing to deal either side. However. Third layer is in which ADs deal with their corporate customers .e. A dealer will be shown a two-way quote only if he / she extends the privilege to fellow dealers when they call for a quote.”
. Chennai. The most important centre is Mumbai whereas other active centres are Delhi. Full fledged money changers are allowed to buy & sell foreign currency & restricted money changers are allowed only to buy. Foreign Exchange Dealer’s Association of India has made it mandatory to route deals between two ADs through brokers . they buy and sell the base currency up to conventional amounts at those prices.e. Calcutta. A typical spot transaction would be dealt as follows: BANK A : “ Bank A calling. The daily turn over in the foreign exchange market is currently estimated to be between US $ 1. i. Your price on mark – dollar please. FEDAI i.Second layer is the inter bank segment in which ADs deal with each other.5.
3. In retail market in addition to ADs there are moneychangers who are allowed to deal in foreign currencies.
This is known as “back-to11
. If the bank A dealer wanted to sell say 5 million dollars. also called ask price.4548. When a dealer A calls another dealer B and asks for a quote between a pair of currencies. 0. he would instead said “Five dollars yours at forty”. The second 1. Between dealers it is assumed that the caller knows the big figure.” BANK A : “ Ten dollars mine at forty eight.4540/1. Bank A is dealing at 1. The difference between the two. dealer B may or may not wish to take on the resulting position on his books. is bank B’s price for buying USD against DEM or its bid for USD.4540 for every USD it buys. If he does. Bank B dealer therefore quotes the last two digits (points) in her bid offer quote viz. Bank A dealer whishes to buy dollars against marks and he conveys this in the third line which really means “ I buy ten million dollars at your offer price of DEM 1. B will immediately offset it with C. It compensates the bank for costs of performing the market making function including some profit. it will charge DEM 1. he will immediately call a dealer C. get his quote and show that quote to A.45.4548per US dollar. If A does a deal. Bank B would have been “hit” on its bid side. 1. is its selling or offer price for USD. 40 – 48.0008 or 8 points is bank B’s bid – offer or bid – ask spread.4540. 1. he will quote a price based on his information about the current market and the anticipated trends and take the deal on his books. it will pay DEM 1. The first of these.” Bank A dealer identifies and asks himself for B’s DEM/USD. viz.BANK B : “ Forty forty eight.4548. This is known as “warehousing the deal”.4548 for very USD it sells. If he does not wish to warehouse the deal.” Bank B is said to have been “hit” on its offer side.
back-to-back deals are done when the client asks for a quote on a currency.the amount bought/sold. The bank margin would then be the bid – ask spread.back” dealing. etc. Given the variability of exchange rates. That is in the pound – dollar case above. Of course pound
.7500 to $1. which a dealer does not actively trade. But suppose in the course of trading the trader finds that he is being hit on one side of hiss quote much more often than the other side.-in their respective banks’ computerized record systems and go to the next transaction. maintaining a large net short or long position in pounds of 1000000. Suppose bank A wishes to buy the British pound sterling against the USD. If he has sold / bough t more pounds than he has bought/ sold he is said to have a net short position / long position in pounds. This implies that the banks liability increases by $2000 ($0. In a normal two-way market. On a normal business day the trader expects to buy and sell roughly equal amounts of pounds / dollars.7520. This enables them to do deals very rapidly. a trader expects “to be hit” on both sides of his quote amounts. The pound suddenly appreciates from say $1. This leads to a trader building up a position. bank A will turn over a US dollar deposit to bank B and B will turn over a sterling deposit to A. Subsequently. The traders are out of the picture once the deal is agreed upon and entered in the record systems. In the pound – dollar example this means that he is buying many more pounds that he selling or vie versa. the price. If the price is acceptable they will agree to do the deal and both will enter the details. A trader in bank A might call his counterpart in bank B and asks for a price quotation.0020 per pound for 1 million pounds. the identity of the counter party. In the interbank market deals are done on the telephone. written confirmations will be sent containing all the details. Normally. On the day of the settlement.
7518 i. yen.e. When a trader realizes that he is building up an undesirable net position he will adjust his bid ask quotes in a manner designed to discourage on type of deal and encourage the opposite deal.7510 he might move it to 1. Similarly a net long position leads to a loss if it has to be covered at a lower price and a gain if at a higher price. pound sterling etc will be commonly given against the US dollar. i. Swiss Francs.7500 – 1. This is done by prescribing the maximum size of net positions a trader can build up during a trading day and how much can be carried overnight. Thus quotations for Deutschemarks. Takes place against the US dollar. If his initial quote was say DEM/USD 1. A trader net long in pounds must sell pounds to cover a net short must buy pounds. However when central banks intervene. Bulk of the trading of the convertible currencies. it is possible for banks as a group to gain or lose at the expense of the central bank.e offer more marks per USD sold to the bank and charge more marks per dollar bought from the bank. a cross rate will be worked out from the DEM/USD and JPY/USD quotation.7508 – 1. it is a zero – sum game. Since most of the trading takes place between market making banks. will want to discourage further sellers of marks and encourage buyers. If a corporate customer wants to buy or sell yen against the DEM. (By covering a position we mean undertaking transactions that will reduce the net position to zero. Building and carrying such net positions for a long duration would be equivalent to speculation and banks exercise tight control over their traders to prevent such activity. For instance a trader who has overbought say DEM against USD.depreciation would have resulted in a gain. A potential gain or loss from a position depends upon the size of the position and the variability of exchange rates. One reason for using a common currency (called the vehicle currency) for all quotations is to economize on the number of
. gains made by one trader are reflected in losses made by another.
When the delivery is made
. therefore represented by T + 0.
4. Also by this means the possibility of triangular arbitrage is minimized. which need not be the same as the settlement locations. the number is reduced to 9 or in general n – 1ss.exchange rates. Settlement location: To effect the transfers. • Cash – Cash rate or Ready rate is the rate when the exchange of currencies takes place on the date of the deal itself. Dealing locations: The location of the two banks involved in the trade is dealing locations. With 10 currencies 54 two-way quotes will be needed. the banks in the countries of the two currencies involved must be open for business. Classification of transaction based on value date
Types of transaction
Cash – T + 0
Tom – T +1
Spot – T + 2
Forward – T+3
Cash – Where T represents the current day when trading takes place and n represents number of days. By using a common currency to quote against.Define the value date and classify the transactions into spot and forward transactions based on value date Answer: Value Date: A settlement of any transaction takes place by transfers of deposits between the two parties. The relevant countries are called settlement locations. However some banks specialize in giving these so called cross rates. There is no delay in payment at all. The day on which these transactions are effected is called the settlement date or the value date.
9. If the 3rd march is holiday in any bank in dealing location or settlement location deposit will takes place on next business day. • Tom – It stands for tomorrow rate. Here rate of transaction is fixed on transaction date for transactions in future. which indicates that the exchange of currencies takes place on the next working day after the date of the deal. 3 rd march. Value date is arrived as follows: Value date for spot transaction: 3rd Jan. g. e.6. Wednesday. the London bank will turn over yen deposit in Japan to the Paris bank on Wednesday and the Paris bank will turn over $ deposit in US to the London bank on same day i. it is called as spot rate. and 12 months. 1st march. For e.on the day of the contract is booked. a London bank sells yen against dollar to a Paris bank on Monday. e. Standard forward contract maturities are 1.3.2. • Forward –The forward rate is a contractual rate between a foreign – exchange trader and the trader’s client for delivery of foreign currency sometime in the future. 1 month forward purchase of pounds against dollars on 1st Jan.
. g. it is called a Telegraphic Transfer or cash or value – day deal. and therefore represented by T+ 1. The spot rate is the rate quoted for current foreign – currency transactions. • Spot – When the exchange of currencies takes place on the second day after the date of the deal (T+2). It applies to interbank transactions that require delivery on the purchased currency within two business days in exchange for immediate cash payment for that currency.
It may result from two currencies (also known as geographical arbitrage) or from three currencies (also known as triangular arbitrage). One type of profit – seeking activity is arbitrage. • Swap: A swap transactions in the foreign exchange market is combination of spot and forward transaction. for e.
. even though the transaction is not connected to any other business purpose. Thus a bank will buy deutchemarks spot against US dollar and simultaneously enter into forward transaction with the same counterparty to sell deutchemarks against US dollar.
Answer: Sometimes companies deal in foreign exchange to make a profit. this type of foreign – exchange activities is more likely to be persuaded by foreign – exchange traders and investors. such as trade flows or investment flows. arbitrage may be defined as an operation that consists in deriving a profit without risk from a differential existing between different quoted rates. But this must not take you for next month. g.Value date for forward transaction: 3rd Jan + 1 calendar month = 3rd Feb If the 3rd Feb.
5. if value date is Feb 28 is value date and it is ineligible your cannot shift it to 1st March it must be rolled back to Feb 27. however. is holiday in any bank in dealing location or settlement location deposit will takes place on next business date. Hence.Define arbitrage and explain the different types of arbitrage. which is the purchase of foreign currency on one market for immediate resale on another market (in a different country) in order to profit from a price discrepancy. Usually.
. For example.
Inverse quotes and 2 – point arbitrage : The arbitrage transaction that involve buying a currency in one market and selling it at a higher price in another market is called Two – point Arbitrage.Interest arbitrage involves investing in foreign – bearing instruments in foreign exchange in an effort to earn a profit due to interest – rates differentials. The rates will be close to each other but it may be possible for a corporate customer to save some money by shopping around. invest the money in the United Kingdom for ninety days and then convert the pounds back into dollars. where the activity contains both the element of risk and the chances of a greater profit. foreign – exchange transactions can be used to hedge against a potential loss due to an exchange – rate change. foreign currency.e. a trader may invest $ 1000 in the United States for ninety days or convert $1000 into British pounds. As a protection against risk. Thus they can be a valuable source of both supply and demand for a currency. Speculators are important in the foreign – exchange market because they spot trends and try to take advantage of them. The investor would try to pick the alternative that would be the highest yielding at the end of ninety days. it is not true that all banks will have identical quotes for a given pair of currencies at a given point of time.
Spot Quotations: Arbitraging between Banks: Though one hears the term “market rate”. But Speculation is the buying or the selling of the commodity i.
Then he sells these US $ to trader B and receives FFr 55.012). in the process he gains FFr 24 (=55.012. which is FFr 5.markets quickly eliminate two – point arbitrage opportunities if and when they arise. We find out the reciprocal rate of the quote given by the trader B. in practice buying and selling rates are likely to be different.5036 / US $ (= 1/0. sell B for C and finally sell C back for A ending up with more A than one began with. • Cross rates and 3 – point arbitrage : The term three – point arbitrage refers to the kind of transaction where one starts with currency A.5012/US$ US $ 0. say.
Numerical Examples 1. An Arbitrage between two Currencies.036 .1817/FFr We assume that the buying and selling rates for these traders are the same.1817) . US $ 10. Since.000 from the trader A by paying FFr 55.55. sell it for B. so the quotation is likely to be as follows: Trader A Trader B
.A combiste buys.036.less arbitrage profit of this kind. Suppose two traders A and B are quoting the following rates: Trader A (Paris) Trader B (New York) FFr 5. Efficient foreign exchange markets do not permit risk .
60/SFr $ 0.An Arbitrage between three currencies Suppose two traders.60) at the trader A and SFr 0.US $ 0.51/DM $ 0.60/SFr $ 0. both located at New York are quoting as follows: Trader A Trader B $ 0.60/SFr $ 0.51 DM $ 0.FFr 5.60) at the trader B.4500/US $ . But this process would tend to increase the selling rate at the trader A because of the increase in demand of US dollars and the reverse would happen at the trader B because of increased supply of US dollars.60/SF $ 0.867/DM (= 0. the situation looks like as follows: Trader A Trader B $ 0. These are: SFr 0.1817/ FFr These rates mean that trader A would be willing to buy one unit of US dollar by paying FFr 5.501. we find the cross rates between SFr and DM as well.51/0. 2. The same holds true for the corresponding figures of trader B.85/DM (= 0.52/0.45 while he would sell one US dollar for FFr 5.5012 US $ US $ 0. This would lead to an equilibrium after some time.FFr 5.52/DM
.1785/FFr . Thus.52 DM Since three currencies are involved here.
As mentioned earlier.85/DM SFr 0. But enterprises may obtain form banks quotations for different periods. Examine clearly the different types of forward transactions and describe discount and premium evaluation in forward quotations. some transactions maybe entered into on one day but not completed until after two business days. Swiss franc. the spot market is for foreign – exchange transactions within two business days. Pound sterling.SFr 0. three. The following two arbitrages are.867/ DM Hence what are the arbitrage possibilities? There is no arbitrage gain possible between the US $ and the Swiss franc. So buy DM’s from the trader A and sell them to trader B. they are generally quoted in terms of US dollars. b. Outright forward quotation: Some of the major currencies quoted in the forward market are Deutschmarks. However. Deutschmarks against the US $ is being quoted at the trader B. For example. The US importer is obligated
. Canadian dollar etc. however possible. Japanese yen. a. Currencies may be quoted in terms of one.
6. Buy DM’s against SFr’s from the trader A and sell them to the trader B. a French exporter of perfume might sell perfume to an US importer with immediate delivery but payment not required for thirty days. six months and one year forward.
it implies premium. The difference between the spot and the forward rates is known as either the forward discount or the forward premium on the contract. When Fwd rate > Spot rate. In the case of forward market. Thus the forward rate is the rate quoted by foreign – exchange traders for the purchase or sale of foreign exchange in the future. Spot 1-month 3-months 6-months (FFr/US$) 5. It is calculated as follows: Forward discount/ premium = Forward mid – Spot mid * 12/n * 100 Spot mid Where n indicates the number of months forward.2340 per US $ 0. Fwd rate < Spot rate. the arbitrage operates in the differential of interest rates and the premium or discount on exchange rates. If the domestic currency is quoted on a direct basis and the forward rate is greater than the spot rate.2321/2340 25/20 40/32 20/26 In outright terms these quotes would be expressed as below: Maturity Bid/Buy Sell/Offer/Ask Spread Spot FFr 5. it implies discount.to pay in francs in thirty days and may enter into a contract with a trader to deliver francs in thirty days at a forward rate. the foreign currency is selling at a premium. a rate today for future delivery. Numerical problems 1.0019
.2321 per US $ FFr 5.
Spot 1-month 3-months 6-months Rs 32. The reverse is the case for 6 months forward.0024 3-months FFr 5.1375 per US$ 0.0090 0.2341 per US $ FFr 5.
.1235 per US $ Rs 32.1100 225/275 300/350 375/455 Spread 0.0140 3-months Rs 32.0140 6-months Rs 32.0025 It may be noted that in the forward deals of one month and 3 months. 2.0050 0.2296 per US $ FFr 5. The first figure is greater than the second both in one month and three months forward quotes. US $ is at discount against the French franc while 6 months forward is at a premium.0090 1-month Rs 32.1-month FFr 5.1385 per US $ Rs 32.1100 per US $ 0.1450 per US $ 0.2320 per US $ 0. these quotes are at a discount and accordingly these points have been subtracted from the spot rates to arrive at outright rates.1010 per US $ Rs 32. Therefore.2281 per US $ FFr 5.0050 0. We take an example of a quotation for the US $ against Rupees.2366 per US $ 0.0170 Here we notice that the US $ is at a premium for all three forward periods.0080 The outright rates from these quotations will be as follows: Maturity Bid/Buy Sell/Offer/Ask Spread Spot Rs 32. given by a trader in New Delhi.1555 per US $ 0.0027 6-months FFr 5.1310 per US $ Rs 32.2308 per US $ 0.1010-Rs32.
the bank will pay 1. in question. 1.6235 = 0. On a particular date the following DEM/$ spot quote is obtained from a bank: -1.6159 $ from Bank A and would have
. it should be noted that the spreads in forward rates are always equal to the sum of the spread of the spot rate and that of the corresponding forward points.6159/63.6225 DEM for each US dollar it buys and will want to be paid 1. When DEM/$ is 1.6163)
Ans.e.6225 = 0.6225/35. the implied inverse quote is:
Another bank quoted $/DEM 0.6154/59 and Bank B quotes $/DEM 0. $/DEM becomes 0. Also it shows the number of DEM used to buy or sell one US dollar i. the initial figure i.6159/63 (1/1.6225/35 a) Explain this quotation.6225 being the bid rate and the latter being the ask rate. The above quotation shows the bid rate and the ask rate of the currencies
Compute implied inverse quote. Is there an arbitrage? If so how would it work?
Ans. There is no arbitrage opportunity since the main purpose of doing an arbitrage is making a profit without any risk or commitment of capital. Suppose Bank A quotes $/DEM 0.Also.6154/59.6159 and 1/ 1.e. Numerical problems and solutions 1.6235 DEM for each US dollar it sells. Ans. This doesn’t exist in the given case as a potential buyer would end up buying a DEM at 0.
The buyer will go into a loss if he buys from bank A at 4.9580 FFr since he would have to sell it to bank B for 4. 4. There is no arbitrage opportunity in this case. This will result into a one – way market.9570/80 Bank B 4. The following quotes are obtained from the banks: Bank A FFr/$ spot i.to sell it to Bank B at the same price since that would be the only way of not making any losses.9578 FFr undergoing a loss of 0.9578/90
Is there an arbitrage opportunities be
Ans. b) What kind of market will it result into? Ans. This can represented diagrammatically as: FFr/$ 4.9570 78 80 90
Bank A Bank B
The quotes are overlapping each other hence preventing an arbitrage.
.6154 Bank A 59 Bank B 63
2.0002 FFr. It is clear form the diagram shows that shows no arbitrage is possible: $/DEM 0.
5255] = 180.0080/181.
3.0080/181.5250/55 JPY/ GPB spot 180.0030 Therefore.180.0080 A1 – 181.0030 3.0080 3. JPY/ DEM = B1 A1 A2 B2 [where B1 .5250
. In London a dealer quotes: DEM/ GPB spot 3.5250 A2 – 3.0030 a) What do you expect the JPY/ DEM rate to be in Frankfurt? Ans. A one – way market may be created when a bank wants to either encourage the seller of dollars and discourage buyers or vice – versa. In London: DEM/ GPB spot 3. In this case. Bank A wants to encourage buyers of dollars and discourage sellers of the same thus creating a net long positioning dollars.c) What might be the reason for this? Ans.5250/55 JPY/ GPB spot 180.0030 B2 . it would mean that regular clients of Bank B wanting to buy dollars can save some money by going to Bank A and vice – versa.5255 181.3. At the same time Bank B wants to encourage the sellers of dollars and discourage buyers thus creating a net short position in dollars. Eventually. Hence the outcome would be that Bank A will be confronted largely with buyers of US dollars and few sellers while for Bank B the reverse case will hold true.
5880/ 90 1.0588 / 51.2250 JPY and sells it in London for 51.month forward 10/ 5
.0588 Frankfurt London
b) Suppose that in Frankfurt you get a quote: JPY/ DEM spot 51.1530
.2250.= 51.0588 / 51. Diagrammatically it can be represented as:
JPY/ DEM 51.1530/ 51.0588 / 51.0588 JPY. The following quotes are obtained in New York: DEM/$ spot 1.3483 JPY/ DEM It is assumed that the JPY/ DEM rate in Frankfurt will also approximately be the same as in London. the JPY/ DEM rate in Frankfurt is 51. If he buys in Frankfurt where 1 DEM is 51.3483.2250 There is no arbitrage opportunity as the quotes overlap each other and the buyer will stand to make a loss.2250
.1530/ 51.3483 and In Frankfurt: JPY/ DEM 51. Is there an arbitrage opportunity? Ans.3483
4. Therefore. When in London: JPY/ DEM 51. he makes a loss of 0.1662JPY.
Thus.month forward 30/ 15 Calculate the outright forward rates.1.5850/ 75
.1.1. the outright rates are: DEM/$ spot .5880/ 90 1 – month forward . Therefore. the forward points will be subtracted form the spot rate figure.2. Ans.1.5860/ 80 3 – month forward .month forward 20/ 10 3. While observing the forward quotations. it is clear that the US dollar is at discount in the forward market since the points corresponding to the bid price are higher than those corresponding to the ask price.5870/ 85 2 – month forward .