FOREIGN EXCHANGE. TRAVEL OVERSEAS IMPORT GOODS & SERVICES INVEST OVERSEAS Why foreign money?
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Transcript of FOREIGN EXCHANGE. TRAVEL OVERSEAS IMPORT GOODS & SERVICES INVEST OVERSEAS Why foreign money?
FOREIGN EXCHANGE
• TRAVEL OVERSEAS
• IMPORT GOODS & SERVICES
• INVEST OVERSEAS
Why foreign money?
WHERE ARE CURRENCIES SOLD?
• COMMERCIAL BANKS
• CURRENCY DEALERS
• BROKERS
WHERE ARE THE MARKETS LOCATED?
CHARACTERISTICS
• UNWRITTEN CODE OF CONDUCT
• TRADING IN A FEW CURRENCIES--MOSTLY DOMINATED BY US DOLLAR
• CURRENCIES WITH LIMITED CONVERTIBILITY PLAY NO ROLE
• BLACK MARKETS DEVELOP IF EXCHANGE IS CONTROLLED
SIZE OF THE MARKETFX/DAY NYSE WORLD RESERVES
10 BIGGEST DAILY TRADE OF THE 10
MARKETS VOLUME MARKETS
1973 $ 10b < 1.0b $ 600b $ 80b
1983 $ 100b $ 3.0b
1989 $ 590b $ 6.2b $ 6764b
1992 $ 820b $ 7.0b
1995 $1190b $12.5b
1998 $1490b $30.0b $737b
2001 $1210b $45.0b $12000b $964b
Nyse.comBis.org Worldbank.org
2001 FX MARKET SIZEDaily Average Turnover
SHARE VALUE• LONDON 31.1% $504b• NEW YORK 15.7% $254b• JAPAN 9.1% $147b• SINGAPORE 6.2% $101b• FRANKFURT 5.4% $ 88b• ZURICH 4.4% $ 71b• HONG KONG 4.1% $ 67b • SYDNEY 3.2% $ 52b• PARIS 3.0% $ 48b• CANADA 2.6% $ 42b
Bis.org
2001 FX MARKET SIZECurrency Distribution of Turnover
1989 1992 1995 1998 2001• US Dollar 90 82 83.3 87.3 90.4• Euro 37.6• Deutsche Mark 27 39.6 36.1 30.1• French Franc 2 3.8 7.9 5.1• ECU 4 11.8 15.7 17.3• Yen 27 23.4 24.1 20.2 22.7• Pound 15 13.6 9.4 11.0 13.2• Swiss Franc 10 8.4 7.3 7.1 6.1• Canadian D 1 3.3 3.4 3.6 4.5
Total percentage should add to 200%
Bis.org
LANGUAGE OF FX
A FOREIGN CURRENCY IS FOREIGN EXCHANGE.
EXCHANGE RATE
PRICE OF A FOREIGN CURRENCY IN OUR
CURRENCY
TWO WAYS
• DIRECT PRICE– Example: 1.6 U.S.$ per 1.0 British
Pound
• INDIRECT PRICE– Example: 0.625 British Pound per
U.S.$
• Spot Rate
– Price for OTC delivery.
• Forward Rate– Price for future delivery.
Expect:
• Bid rate to be lower than Ask rate.
• Retail rate to be higher than wholesale rate.
• Rates may vary for each client.
WSJ WHOLESALE QUOTES February 28, 2003
U.S.$/Unit Units/U.S.$
Argentina 0.3135 3.1898
Britain 1.5803 .6328
Euro 1.0760 .9294
Indonesia 0.0001124 8,897
Kuwait 3.3340 .2999
Turkey 0.00000063 1587,302
Japan 0.008506 117.56
CAUTION:
DON’T JUDGE THE STRENGTH OF A CURRENCY BASED ON HOW MUCH OF IT CAN BE PURCHASED FOR ONE U.S.
DOLLAR
WHAT’S THE RIGHT FX RATE?
• PURCHASING POWER PARITY
• RELATIVE VERSION OF PPP
• MONETARY VERSION OF PPP
• ASSET MARKET APPROACH
PPP
$1 SHOULD BUY AS MUCH IN THE U.S. AS $1 WORTH OF FOREIGN CURRENCY
BUYS IN ITS HOME COUNTRY
BIG MAC INDEX Dec 14, 2001
Price PPP FXResult
in $ Rate Rate2/1/02 2/1/02 2/1/02
Malaysia 4.58R .57$/R .26$/R - 54%
U.K. 1.99£ 1.30$/£ 1.45$/£ +12%
Euro 2.72€ .95$/€ .89$/€ - 6%
U.S.A. 2.59$
Economist.com
BIG MAC INDEX
Price PPP FX Result
Local Rate Rate
4/1/99 4/1/99 12/22/00
Malaysia 4.96R .49$/R .26$/R - 47%
Swiss 3.97F .61$/F .61$/F at par
Euro 2.71E .90$/E .92$/E +2%
U.S.A. 2.43$
QUESTION:WHICH PRODUCT TO
SELECT FOR PPP?
• BIG MAC
• HAIR CUT
• TELEVISION
• AIRLINE TICKET
• …..
ANSWER
• BASKET OF SIMILAR GOODS• PREFERABLY
INTERNATIONALLY TRADED GOODS IN BOTH COUNTRIES.
RELATIVE VERSION OF PPP
EXCHANGE RATES SHOULD CHANGE IN LINE WITH
RELATIVE INFLATION RATES.
MONETARY VERSION OF PPP
EXCHANGE RATES SHOULD CHANGE IN LINE WITH THE
CHANGE IN MONEY SUPPLY.
ASSET-MARKET APPROACH
EXCHANGE RATES SHOULD STABILIZE AT A LEVEL
WHERE TOTAL EXPECTED RETURN FROM EACH COUNTRY IS EQUAL.
SUMMARY
CURRENCY PRICES ARE THE RESULT OF THE DEMAND
AND SUPPLY OF CURRENCIES IN THE MARKET DUE TO:
“REAL” TRADE
CAPITAL FLOWS
ACTIONS OF THE GOVERNMENTS
SPECULATION
EXCHANGE RATE SYSTEM• GOLD STANDARD each currency
declared what it was worth in terms of weight of gold.– U.S. Dollar = 23.22 grains of gold
– British Pound=113 grains of gold
– Exchange Rate= 113/23.22= 4.8665 $/£
• Worked for 40 years before WW1.
• GOLD EXCHANGE SYSTEM– AFTER WW2, INTEREST SHIFTED
TOWARD MONETARY DISCIPLINE– 44 NATIONS AGREED IN 1944 AT
BRETTON-WOODS TO FIX THE VALUE IN TERMS OF GOLD.
– THERE WAS NO OBLIGATION TO EXCHANGE THEIR CURRENCY FOR GOLD.
– EXCEPT U.S. DOLLAR WHICH WAS PRICED AT 35$/OZ OF GOLD.
SYSTEM WORKED!
• THERE WAS CONFIDENCE IN THE U.S. DOLLAR’S UNCHANGING VALUE.
• AS LONG AS U.S. REMAINED COMMITTED TO CONVERTIBILITY OF DOLLAR INTO GOLD.
• AS THE WORLD ECONOMY RECOVERED:– U.S. SUPPLIED LIQUIDITY THROUGH
OUTFLOW OF $.– TOWARDS THE END OF 60S, HOWEVER, U.S.
FACED GOVERNMENT DEFICITS, HIGH INFLATION, RECESSION, AND LOSS OF COMPETITIVENESS.
– AT THE SAME TIME, ITS INTERNATIONAL POLICIES WERE BECOMING UNPOPULAR.
– AND, THE WAR-RAVAGED ECONOMIES HAD BOUNCED BACK.
GOLD WANTED
• U.S. STOCK VALUED AT $24b IN 1948 DROPPED TO $15b IN 1964 AND TO $11b IN 1971.
• UNDER THE GOLD-EXCHANGE STANDARD, THE U.S. WAS COMMITTED TO CONVERT DOLLARS INTO GOLD.
• TO SAVE THE GOLD, THE ONLY WAY OUT WAS TO CHANGE THE RULES.
U.S. CHANGED THE RULES
• BY MARCH 1973, THE GOLD-EXCHANGE STANDARD (ALSO KNOWN AS FIXED-EXCHANGE SYSTEM) WAS ABANDONED.
• VIRTUALLY EVERY CURRENCY LOST ITS VALUE.
• VIRTUALLY EVERY CURRENCY WAS FLOATING.
• SOME DECIDED TO STAY PEGGED.
FLOATING EXCHANGE RATES
IMF RECOGNIZED IN 1976 THAT EXCHANGE RATE STABILITY OF ANY
LASTING DURATION CANNOT BE IMPOSED EXTERNALLY BY
ADOPTATION OF THE PEGGED EXCHANGE RATES AND HEAVY GOVERNMENT INTERVENTION.
CHANGE IN FX PRICE
LET US ASSUME THE FOLLOWING
PRICE OF £ ON FEB 17, 2000 = 1.6080 $
PRICE OF £ ON FEB 17, 1999 = 1.6420 $
CHANGE IN $ PRICE OF £ FOR THE PERIOD
= (1.6080-1.6420)/1.6420
= -0.0207 OR -2.07%
BRITISH POUND DEPRECIATED BY 2.07%
AT 259.20 ¥/$ IN 1985, A COMPUTER COSTING $2500 COST 648,000¥.
WHEN YEN APPRECIATED TO 199.20 ¥/$ IN 1986, THE SAME COMPUTER COST 498,000 ¥ (A DECLINE OF 23.15%)
CHANGE IN THE PRICE OF ¥ LET US ASSUME THE FOLLOWING:
FX RATE OF ¥ ON FEB 17, 1985 = 259.20 ¥/$
FX RATE OF ¥ ON FEB 17, 1986 = 199.20 ¥/$
CHANGE IN ¥ PRICE OF $ FOR THE PERIOD
= (199.2-259.2)/259.2
= -0.2315 OR -23.15%
THE DOLLAR DEPRECIATED BY 23.15%
THE YEN APPRECIATED BY 30.12%
DESTABILIZING PERIOD• OIL CARTEL RAISED PRICES 3 FOLD
IN 1973.
• AND, RAISED IT AGAIN IN 1979.
• MANY DEVELOPING COUNTRIES BORROWED IN $s.
• MANY DEFAULTED ON THEIR LOANS IN EARLY 80s.
• CURRENCIES WERE DEVALUATED
INFLATION WAS RAMPANTEXPERIENCE OF ARGENTINIAN “PESO”
2003 $1 0.000000000016
1995 $3.19 0.000000000051990 $6.54 0.0000000001
1985 $39,850 0.0000006
1980 $160,060,210 0.0025
1975 $5,239,386,800 0.08
1973 $63,800,000,000 1.00
IT HASN’T BEEN EASY FOR MANY IN THE 90s EITHER
GIVE US REAL MONEY
DOLLARIZATION IS IN FASHION
PEGGING TO $.
PEGGING STRICTLY TO $.
ADOPTING $.
BUT EU WANTS TO COMPETE WITH THE
DOLLAR!
FX RISK EXPOSURE
BUSINESSES WHO HAVE PAYABLES OR RECEIVABLES
IN FOREIGN CURRENCIES ARE EXPOSED TO FX RISK
WATERFORD CRYSTAL
IS AN IRISH COMPANY THAT MANUFACTURES IN IRELAND AND SELLS PART OF OUTPUT
IN THE U.S.
LOOK DEEPER
• PRICE OF WINE DECANTER = $150 IN THE U.S. IN 1985
• $150 = 148 POUNDS IN 1985
• $150 = 106 POUNDS IN JULY 86.
TWO CHOICES FOR WATERFORD:
RAISE THE PRICE IN U.S.$
OR
FACE PROFIT SQUEEZE.
HEDGE--THE THIRD OPTION!
FORWARD CONTRACT
FUTURES CONTRACT
OPTIONS
FORWARD CONTRACT
• A CONTRACT WITH A BANK TO PURCHASE OR SELL A FOREIGN CURRENCY AT A PRE-DETERMINED PRICE AT A PRE-DETERMINED FUTURE DATE.
FORWARD MARKET QUOTES: FEB 17, 2000
U.S.$/LC LC/U.S.$Britain 1.6080 .6219 1-Month Forward 1.6077 .6220 3-Month Forward 1.6076 .6220 6-Month Forward 1.6078 .6220Japan 0.009141 109.40 1-Month Forward 0.009187 108.85 3-Month Forward 0.009276 107.80 6-Month Forward 0.009426 106.09
WATERFORD LOCKED IN FORWARD CONTRACT FOR
2 YEARS.• WATERFORD WAS ABLE TO
TRANSLATE $50m IN U.S. SALES INTO 48m IRISH POUNDS.
• IF IT HAD NOT ENGAGED IN THE FORWARD MARKET, IT WOULD HAVE RECEIVED ONLY 37m IRISH POUNDS.
FUTURES & OPTIONS
• A CONTRACT TO PURCHASE OR SELL A FOREIGN CURRENCY IN THE FUTURES MARKET, LIKE
New York Cotton Exchange.
Chicago Mercantile Exchange.
Philadelphia Stock Exchange.
Mid-America Commodity Exchange.
COST OF OPTIONS
• AVERAGE PREMIUM RUNS 1.5 TO 4% BUT COULD BE HIGHER.
• LONGER-TERM OPTIONS ARE PROGRESSIVELY MORE EXPENSIVE.
• VOLATILE CURRENCIES OR LOW-TRADE-VOLUME CURRENCIES ARE MORE EXPENSIVE.