FOREIGN EXCHANGE

MARKETS AND EXCHANGE

RATES
 What we will learn?

• Foreign Exchange Markets

• Definition and characterisitics of foreign exchange markets
• Functions of foreign exchange markets
• Actors in foreign exchange markets
• Exchange Rates
• Definition of foreign exchange rates
• Exchange rates determinants
• Foreign exchange transactions
• Foreign exchange risk
 Takeaways

• Understand the meaning and functions of the foreign exchange

market
• Know what the spot, forward, cross, and effective exchange rates are
• Understand the meaning of foreign exchange risks, hedging,
speculation, and interest arbitrage
FOREIGN EXCHANGE
MARKETS
 DEFINITION and characterisitics of foreign exchange markets

• The foreign exchange market is the market in which individuals, firms, and
banks buy and sell foreign currencies or foreign exchange.
• The foreign exchange market is the market in which individuals, firms, and
banks buy and sell foreign currencies, means of payments or valuable
papers quoted in foreign currencies.
• The foreign exchange is a market for converting the currency of one country
into that of another.
 Definition and CHARACTERISITICS of foreign exchange markets

• The largest market in the world, the average daily trading volume is about 5
trillion USD.
• Takes place anywhere.
• The market does not sleep, operates 24 hours a day and 365 days a year.
• Focus on strong currencies, the most is USD.
• The center of FX is the interbank market.
• Very sensitive to economic, political, social, psychological events... happening
in the world.
 Definition and characterisitics of foreign exchange markets

• Which currencies are traded most frequently in foreign exchange

market?
• Which trading centers are the most important for the foreign
exchange market? 
• When was the Euro born? Why did the euro become an important
international currency ? Will the euro displace the U.S. dollar as the
leading international or vehicle currency?
 Definition and characterisitics of foreign exchange markets

• Which currencies are traded most frequently in foreign exchange

market?
% of daily trades (bought or sold)
Rank Currency ISO 4217 code (symbol)
(April 2019)

1  United States dollar USD (US$) 88.30%

2  Euro EUR (€) 32.30%
3  Japanese yen JPY (¥) 16.80%
4  Pound sterling GBP (£) 12.80%
5  Australian dollar AUD (A$) 6.80%
6  Canadian dollar CAD (C$) 5.00%
7  Swiss franc CHF (CHF) 5.00%
8  Renminbi CNY ( 元 / ¥) 4.30%
9  Hong Kong dollar HKD (HK$) 3.50%
10  New Zealand dollar NZD (NZ$) 2.10%
Definition and characterisitics of foreign exchange markets

The U.S. Dollar as the Dominant International Currency

 Definition and characterisitics of foreign exchange markets

The Birth of a New Currency: The Euro

Austria,
Belgium, Britain, Sweden, and Denmark ?
Germany,
Finland, Why did the euro become an important international
France,
currency ?
Ireland,
Italy,
Luxembourg, Will the euro displace the U.S. dollar as the
Spain, leading international or vehicle currency?
Portugal,
Cyprus,
the Nether Greece Slovenia Slovakia Estonia Latvia Lithuania
Malta
lands

1999 2001 2007 2008 2009 2011 2014 2015

 Definition and characterisitics of foreign exchange markets

• Which trading centers are the most important for the foreign exchange
market? 

In April 2019:
• United Kingdom - 43.1%
• United States - 16.5%
• Singapore + Hong Kong - 7.6%
• Japan accounted - 4.5%.
 Definition and characterisitics of foreign exchange markets

AUD GBP JPY MYR THB

CAD HKD KRW PHP TWD

CNY IDR LAK SEK USD

EUR INR MXN SGD VND

 Functions of foreign exchange markets

• Transferring funds or purchasing power from one nation and currency to

another
• Being clearinghouses for the foreign exchange demanded and supplied in the
course of foreign transactions by the nation’s residents
• Determining the value of a currency on the basis of supply and demand
• The Central Bank intervenes to change the exchange rate in favor of the
economy
• The credit function
• Providing the facilities for hedging and speculation
 Actors in foreign exchange markets

The nation’s central bank

Foreign exchange brokers

Commercial banks

Traditional users as tourists, importers, exporters, investors, etc.

FOREIGN EXCHANGE RATES
 Definition of foreign exchange rates

• The exchange rate is the price of one country’s currency in terms of another
country’s currency
• The exchange rate is the rate at which the market converts one currency into
another.
• The exchange rate is the price of one country's money in units of another
country's money.
• The foreign exchange rate is the price at which the currency of one country
exchanges for the currency of another country.
 Equilibrium Foreign Exchange Rates

The price of euro in dollar is equal to the number of dollars needed to purchase one
euro. That is,
 Methods of quoting exchange rates

• Commodity Currency (C): A currency that expresses its value in terms of another
currency, usually with a fixed number of units and equal to 1.
• Term Currency (T): A currency used to determine the value of another currency,
often with a variable number of units.
1 commodity currency = X term currency
X = commodity currency/term currency
Direct Quoting Method/Indirect Quoting Method
 Rules of quoting exchange rates

Direct Quoting Method/Indirect Quoting Method

1 commodity currency = X term currency
Direct quotation Indirect quotation
1 foreign currency= X 1 domestic currency= X term
domestic currency currency
USD/VND = 23.860 EUR/USD = 1.3615
USD: commodity currency EUR: commodity currency
VND: term currency USD: term currency
 The exchange rate quotation

Exchange rate A/B =

USD/JPY = 113,50 so
1/[Exchange rate B/A]
JPY/USD = 1/113,51 =
Exchange rate B/A =
0,008811
1/[Exchange rate A/B]
HOW TO READ EXCHANGE RATE QUOTATION?
 Cross-rate

An exchange rate between two currencies determined based on

their relationship to a third currency.

A/B x B/C = A/C

Why calculate cross rate?
Why is USD often used as the common parity currency?
 Cross-rate

Ex.1
We have: 1) JPY/VND
2) AUD/USD
USD/JPY = 122,01 3) GBP/EUR
USD/VND = 22.380 (4) GBP/JPY
AUD/VND = 16.335 (5) EUR/AUD
GBP/USD = 1,5695
EUR/USD = 1,1392
 Cross-rate

Case 1: Cross-rate of 2 currencies in the term position

USD/VND = 21860 – 22150 VND

USD/JPY = 119,25 – 119,80

JPY/VND = 182,47 – 185,74

 Cross-rate

Case 2: Cross rate of 2 currencies in the commodity position

USD/VND = 21860 – 22150 VND

EUR/VND = 23250 – 23830

EUR/USD = 1.0497 – 1.0901

 Cross-rate

Case 3: Cross rate of 2 currencies in 2 pricing positions

USD/VND = 21,860 – 22,150 VND

GBP/USD = 1.3850 – 1.3870

GBP/VND = 30276 – 307221

 Cross-rate

Ex.2
VCB quotes the exchange rate: USD/VND = 21860 – 22150
USD/JPY = 119,25 – 119,80
Firm A exports seafood to Tokyo, earning JPY 1 million.
Japanese importing firm wants to sell JPY for VND to pay
expenses for firm A. At what exchange rate it buy or sell
currencies?
 Cross-rate

Ex.3
A Vietnamese company needs to buy 250000 EUR and pay in
VND. So, at what rate will the bank sell EUR? How much VND
does the company pay to the bank?
The market rate is as follows:
EUR/USD = 1.2860 – 80
USD/VND = 21860 – 21880
 Cross-rate

Ex.4
A British company after exporting goods to France earned 100,000
EUR. The company needs to exchange EUR for GBP. At what rate
will the bank sell GBP? So how much GBP will the bank pay the
company?
Indicate the exchange rate on the market as follows: USD/JPY =
119.25 – 119.80
EUR/JPY = 121.15 – 121.30
GBP/USD = 1.3230 – 1.3250
 Cross-rate

Ex.5
Company A exports to France and earns EUR 2,000,000 and needs
to pay for an import shipment worth GBP 900,000. Is EUR enough
to buy 900000 GBP? How much more VND does the company need
or how much VND will be left after paying for the import shipment?
GBP/USD = 1,5810 – 1,5820 EUR/USD = 1,2350 – 1,2370
GBP/JPY = 170,70 – 170,90 EUR/VND = 26880 – 27000
 TYPES OF EXCHANGE RATES

Buying rate - selling rate

Spot rate - derivative rate
Transfer rate - cash rate
Opening rate - Closing rate
Official exchange rate - Black market rate
Export rate - import rate
Nominal exchange rate - real exchange rate
Bilateral exchange rate - multilateral rate
THE INCREASE AND DECREASE IN VALUE OF A CURRENCY
 THE INCREASE AND DECREASE IN VALUE OF A CURRENCY
Table 1. CURRENCIES VS U.S. DOLLAR
Table 2. CHANGE SO FAR IN 2021
Currency Latest bid Previous day Pct Move
Currency Latest bid End 2020 Pct Move
Japan yen 115.140 115.12 -0.02
Japan yen 115.140 103.24 -10.34
Sing dlr 1.367 1.365 -0.12
Sing dlr 1.367 1.3209 -3.35
Taiwan dlr 27.794 27.809 +0.05
Taiwan dlr 27.794 28.483 +2.48
Korean won 1189.600 1189.7 +0.01
Baht 33.220 33.08 -0.42 Korean won 1189.600 1086.20 -8.69

Peso 50.560 50.57 +0.02 Baht 33.220 29.96 -9.81

Rupiah 14265.000 14255 -0.07 Peso 50.560 48.01 -5.04
Rupee 74.423 74.4225 +0.00 Rupiah 14265.000 14040 -1.58
Ringgit 4.207 4.197 -0.24 Rupee 74.423 73.07 -1.82
Yuan 6.392 6.3923 +0.01 Ringgit 4.207 4.0200 -4.44
Yuan 6.392 6.5283 +2.14

November 24, 20219:10 AM +07

 THE INCREASE AND DECREASE IN VALUE OF A
CURRENCY

When the exchange rate increases:

- The commodity currency will be exchanged for more term currencies
- The term currency becomes less exchangeable for the commodity currency
When the exchange rate decreases:
- The commodity currency will be exchanged for less of the term currency
- The term currency will be exchanged for more commodity currency
 THE INCREASE AND DECREASE IN VALUE OF A
CURRENCY

Price in the U.S. Exchange rates Price in Vietnam

$999/Iphone X 64GB
21.000VND/$ 20.979.000 VND
$999/Iphone X 64GB
21.500VND/$ 21.478.500 VND
(home country)

15.000.000 VND/ton
$714,3 21000VND/$
15.000.000VND/ton
$697,7 21500VND/$
(home country)

USD appreciates against VND: The U.S. goods become more expensive in VN
VND depreciates against USD: VN goods become cheaper in US
When a country's currency depreciates, its goods abroad become cheaper and foreign goods in that
country become more expensive.
 THE INCREASE AND DECREASE IN VALUE OF A
CURRENCY

Price in the U.S. Exchange rates Price in Vietnam

$999/Iphone X 64GB
21.000VND/$ 20.979.000 VND
$999/Iphone X 64GB
21.500VND/$ 21.478.500 VND
(home country)

15.000.000 VND/ton
$714,3 21000VND/$
15.000.000VND/ton
$697,7 21500VND/$
(home country)

USD appreciates against VND: The U.S. goods become more expensive in VN
VND depreciates against USD: VN goods become cheaper in US
When a country's currency depreciates, its goods abroad become cheaper and foreign goods in that
country become more expensive.
 THE INCREASE AND DECREASE IN VALUE OF A
CURRENCY

Price in the U.S. Exchange rates Price in Vietnam

$999/Iphone X 64GB
21.000VND/$ 20.979.000 VND
$999/Iphone X 64GB
21.500VND/$ 21.478.500 VND
(home country)

15.000.000 VND/ton
$714,3 21000VND/$
15.000.000VND/ton
$697,7 21500VND/$
(home country)

USD appreciates against VND: The U.S. goods become more expensive in VN
VND depreciates against USD: VN goods become cheaper in US
When a country's currency depreciates, its goods abroad become cheaper and foreign goods in that
country become more expensive.
 Three points
ARBITRAGE Arbitrage

An exchange operation to use the difference in exchange rates

between markets at the same time to make a profit.
That is, buying at the lowest price and selling at the highest price.
Local Arbitrage - International Arbitrage

Features Of International Arbitrage

• Occurs when there is an inconsistency in exchange rates
between markets
• Enjoy no exchange rate risk and capital is not tied up
• at any time. Two points
• Exists only for a fleeting moment. Arbitrage
• Tends to equalize exchange rates between markets
 TWO-POINT ARBITRAGE

Ex.1: At one time, the market had the following parameters for the spot rate of some currencies:

GBP/USD Market A Market B

Buying price 1,60 1,61

Selling price 1,61 1,62

CHF/USD Market C Market D

Buying price 0,495 0,505

Selling price 0,500 0,510

Is there an arbitrage opportunity?

 THREE-POINT ARBITRAGE

Ex.2: At one point in time, the spot rates of several currencies in the market were as follows:
- Market A: GBP/USD = 1.9809 – 39
- Market B: USD/AUD = 1.6097 – 17
- Market C: GBP/AUD = 3.1650 – 70
Do arbitrage opportunities exist?
If yes, how would you do business if you had 1,000,000 USD (assuming no transaction costs). How
much profit?
 THREE-POINT ARBITRAGE

• Calculate the appropriate cross-rate

• Compare relevant cross-rate and quoted cross-rates
• If the appropriate cross rate differs from the quoted cross rate, then 3-party arbitrage is possible
• Take a long position on the overvalued currency
 THREE-POINT ARBITRAGE

1. Calculate the GBP/AUD rate betwen the two market

GBP/AUD = 1.9809 *1.6097 - 1.9839 * 1.6117 = 3.1887-3.1975
2. Compare the calculated cross rate with the quoteed exchange rate
Calculated cross-rate # the quoted exchange rate
Buying calculated exchange rate > Selling quoted exchange rate
(3.1887 > 3.1670)
Existence of arbitrade opportunity
3. Buy the overvalued curency
Buying calculated exchange rate < Buying quoted exchange rate
(3.1650 < 3.1887)
AUD is overvalued. We can buy AUD
Cycle: USD -> AUD -> GBP -> USD
 THREE-POINT ARBITRAGE
167 168
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Á B t đ u v i 1.000.000 USD
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GIAO
Participants D CH
use TÁC ĐBank
USD to buy AUD: NG raises AUD
Th trư ng A Th trư ng B
USD asking price
USDagainst
AUD USD
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AUD/GBP
n Nh n 1.006.837,61 USD Nh n 1.609.700 AUD d ng USD đ mua AUD so v i USD
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asks toAUD GBP in GBP,
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