International Trade

Chapter (14)-The market of exchange

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(1)Foreign exchange markets and their functions:
a Definition markets where individuals, firms, and banks buy and sell foreign
currencies or foreign exchange

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b Functions:
UTransfer the purchasing power from one nation and currency to l s)
another I S lt)) asjoLissrlal)Glsls Aii 1)
Demand for foreign exchange arise from (impors or goo4
r 1 ) G l » ) i ss
services, buy investments abroad w a
Supply for foreign exchange arise from (exports of goods and /qyoup
services, sell investments abroad

4p a o a S 2 Undertaken by foreign currency traders and speculators

y Ll) Commercial banks operate as clearing houses for foreign exchangeS li)
olap a l s demanded and suppliedthroughthe intermediation of foreign
i r ) exchange brokers
4The nation's central bank acts as a borrower or lender oflast resort
L a).b
s Financing international trade (exports, imports, capital inflows, capitalos
ybolple)gaa TG) outflows
n 3 i 3 6 ) Today about 90% of foreign trading reflects purely financial Cblxa)/
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transactions through 24 hours per day

Dealers and users in foreign exchange market: M paptslswrsmlls NTL)

ius Traditionalusers: tourists, importers, exporters, and investors aloypda
L b Commercial banks: act as a clearing houses between users and eaners of a x l p s |
foreign exchange
slawCForeign exchange brokers: through whom commercial banks inflows and
outflows among themselves (inter-banks, wholesale market)
 L International Trade
U)sdCentral banks: act as aseller or buyer of last resort, draws down its foreign
exchange reserves or add to it
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)Foreign exchange rate "R":ilaaJ
qYolph 1n (@ Definition? domestic currency price offoreign currency
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h e /hext
Pdge
las (le BI iis Tauy) iais is
Graphically it is determined by the intersection of the demand and supply
curves on a particular currency
1 A t equilibrium rate: R = 3, Qd = 600, Qs= 600
A t higher rate: R =4, Qd 500, Qs = 700
There's a surplus-x (700 -500) (4-3) =$100
x

A t lower rate: R=1, Qd- 1000, Qs 300

There's a shortage-x (1000 300)*(3-1)=$700
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(4) Arbitrage:
a Definition: purchasing à currency in the monetary center where it is cheaper,
for immediate resale in the monetary center where it is expensive in order to
make profit d zsli
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2)a/awia
(5) Effective exchange rate:
a. Definition: weighted average of the exchange rates between the domestic
currency and that of nation's most important trade partners, with weights
given by the relative importance of the nation's trade with each of these trade
partners

(6Spot and forward exchange rates? Loes ilsgal

a Spotrate "SR" exchange rate that is determined by the intersection of
demand and supply, Reflects spot economic transaction within
two days.

b Forward rate "FR"2 an agreement today to buy or sell a specific amount of

foreign currency at a specific future date at a rate agreed upon today,

P Forward discount "FD"; if the forward rate is below the present spot
rate( RSR).
B9 2 Forward premium "FP"; if the forward rate is above the present spot
Frate FRSR) éye)wp )_in)úe
2
 3foreian eicha.nge tate (R):

$/LE
S

(T0-50o) X(-3)

7(l000-300) X(3-)
1
D
o 300 500
d
TO0 000
Q
200 suxp us

To0 shortage

Arbityoge
$1 -LE 18 $1-L.E20
CASE ) Yew lork

$1 -LE19 $1-L.E19
5 china TO% X lyuan = 25LE 1.75
.S 20 X1s$ 18 LE 3.6
L.K 10 X 1£ 2LE 2.2 i
eHetive VOTe 7.55
 Spot 6 vnonhsS tOYword
$1-LE18 $1-LE 20
>FR -SR
FRSR TOUWaxd premium P
R<SRforuaad discount TFD

O FP/FD FR-SR X100 PJ

SR F D

S-P(1-Yt)
*ToYund Volue =S pot Volue (+ interest rote time)
FRSR FP
FR<SR FD
Spot Vobue ot toreign Cuency $5000 $5/L.E
SR LE I000
Spot Voue ot domestic cCurencu

R Toruadvolue ot TOYeiqn Curency

tOYuad Volue of domestic Cuwyencu

FR-SR 1+oreign Curency intexest vate XContvaa time

+ domestic aunenu intenest Yae XContva time
 International Trade
RUT
(7) Hedging:
a Definition: the avoidance of foreign exchange riskoDcovering an open
position.

(8)Speculation:
Definition: the opposite of hedging, where a hedger seeks to cover a foreign
exchange risk, a speculator accepts and even seeks out a foreign exchange
risk or an open position in a hope of making more profits.

Formulas
O FP/FD= FR-SR X100
SR

2 Forward value=spotvalue (1 +interestrate xtime)S= P(I+Yt)

(3 SR= Spotvalueof foreign currency
Spot value of domestic currency

) FR=Forward value of foreign currency

Forward value of domestic currency

FR= SR 1+/oreign currency interest ratexcontract time 1

1+domestic currency interest ratexcontract time-

T0.25
FR-SP-EFD Problems
(1)If you know that SR: $1 = £1 and FR after three months: $0.99 = £1. Caleulate
forward premium/discount
1 FD PR-SR x 100 = x 100 x 0.25 -0.25
SR

(2)If you know that SR: $1 =£1 and FR after three months: $1.03 = £1. Calculate
forward premium/discount
1 FP =R-SR x 100 = x 100 x 0.25 =

0.75
SR 1

FR-SR- FP
3
 International Trade
JI (3) Suppose that foreign exchange market can purchase $6000 LE4000 and the
interest rate in 6 months for the US dollar =6%, while theinterest rate in 6
L months for the Egyptian pound =8%. Caleulate spot rate and forward rate for
LET
1- SRfor LEl =
Spot value of foreign currency»
Spot value of domestic currency $6000$1.5
LE4000

2- FR for LE1:

FR
Forward value of foreign cuTTEncy 6000 (1+60XU.5) =
$1486
Forward value of domestic currency 4000 (1+8%x0.5)

FR =
SR|TOrelgni currTency interestratexcontract time"
1+domestic currency interest ratexcontract time

FR 1.5 1+8%x0.5J =$1.486

S1.486

(4)If the exchange rate ¬l $0.96 in New York exchange market (monetary
center) and ¬l =S1.04 in Fraukfurt exchange market (monetary center).
Calculate profits if an Arbitrager purchase ¬30000in New York and sell the
same quantity in Frankfuri exchange market New Yovk Tankrut
1-Profits=¬30000 (1.04-0.96) =$2400
El $0.9b E-$1.04

5)Ifyou know that: S1 =LE6, S1=Riyal 4.5,$1=£0.7, S1=DM1.8,S1=¥ 180,

S1 LIR500, $1=Franc 0.9. Calculate:
1- LE/S 8- £/DM1
2- Riyal/S 9- LIRA¥
3- E/S 10-4/DM1
4- DM/S 11-Franc/LIR
5- /S 12-£/LIR
6- LIR/S
13-DM/Riyal
7- Franc/S
 probkem 3 :
sIajlasl
6000= L.E 4000
ot domestic
Spor value Spot value
ot foreiqn Cufency Cuer

intexest Yoe - 6 vmontns= 6%

itexest Yote LE- 6 months -8

Requned:SRGFR
Answer
SR-Spot volue of TOYeign Omenoy $bo00 - $1.5
Spot value ot domestic Curvencu L.E 40O0

FR-SR Cl+ intexes vate XEime)

6000 +6 * e ) - 1.486
FR
4000 ( 3 *
OY
inteNest yate X time
FR-SR
Curren cy
toveign
L+domestic Curency inteyest yote Xtime

-1.5 +6* T $1.486

L+8t *

FR SR torwaxd discouit
.486 1.5
 Answer

LE/S= LE s 8 £/DM=D=18
£/$ 0.7
DM
s 180
2 Riyal/S= Riyal 4.5 9- LIR=/LIR/S 500

10-4/DM=DM=18 DM
¥/$
180

4DM/SDM18 DM 1.8
(11-Franc/LIR = LIR/S500IR
Franc/$ 0.9

/S--S 12-£/LIR = R/S,= 500 LIR

£/$ 0.7

6- LIR/S =:LIR 1500

=.

(13 DM/Riyal *iyals-45

=
Riyval
DM/$ 1.8

Franc/S =

Franc 0 9