Presntation 3

7/30/2019 Presntation 3

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P A K I S T A N S P R E M I E R I N V E S T M E N T F I R M

Mohammad Ali Jinnah University

Fall 2012Mr. Eraj Hashmi

Treasury & Fund Management

Eraj Hashm i


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Banks generally do not charge commissions on foreign currency transactions. Instead, they make their profit

from the bid-ask spread. The spread is the difference between the bid and the ask. The bid price is the price a

dealer is willing to pay to buy a currency. If you are selling the currency, you will receive this price. The ask

price is the price a dealer is willing to take to sell a currency. If you are buying the currency, you will pay the ask

price.

Example: Assume the following quotes:

A bid of 1.6625 USD/GBP

An ask of 1.6635 USD/GBP

Calculate the direct (U.S. quote) percentage spread.

(1.6635 1.6625) / 1.6635 = 0.0006 = 0.06%

bid-ask spread

Eraj Hashm i


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Explain how spreads on foreign currency q uotat ions can

dif fer as a resul t of market condit ion s, bank /dealer pos i t ions ,

and t rad ing volume

Market conditions

Market conditions affect currency spreads because the bid-ask spread on foreign

currency quotations increases as exchange rate volatility (uncertainty) increases

Greater trading volume Greater trading volume leads to narrower spreads (and vice versa).

Bank and currency dealer

positions

Bank and currency dealer positions do not directly affect the size of foreign currency

spreads. If a dealer wants to reduce her holdings, she will usually adjust the mid-

point of the spread rather than the spread itself.

Eraj Hashm i


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Money Ma

direct and indirect methods of foreign exchange quotations

To convert a direct quote to an indirect quote, or vice versa, you simply take the reciprocalof the one that you are given. For example, in Japan, a direct quote of 125/$ is equivalentto an indirect quote of 1 / (125/$) = 0.0080$/. Just use the 1/x key on your calculator to

turn the indirect quote 1.25 /$ into the direct quote of 0.0080/$.

To convert a direct quote to an indirect quote, or vice versa, you simply take the reciprocalof the one that you are given.

Eraj Hashm i

Direct

Direct foreign exchange quotations are in domestic currency per unit of foreign currency. They arefrom the perspective of the counter currency. For example, in the quotation AUD:USD = 0.60, thebase currency is AUD and the counter currency is the USD. The quote is a direct quote to a U.S.investor. It tells him the cost of one AUD in his domestic currency. This quote may also appear asUSD/AUD = 0.60.

Indirect

Indirect quotations are in the foreign currency per unit of the domestic currency. They are from theperspective of the base currency. The quote AUD:USD = 0.60 is an indirect quote to an Australianinvestor.


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Example:The spot exchange rate between the Swiss franc (CHF) and the USD is 1.7799 CHF/USD, and the spot

exchange rate between the New Zealand dollar (NZD) and the U.S. dollar is 2.2529 NZD/USD. Calculate the

CHF/NZD spot rate.

Answer:

In Switzerland, the direct exchange rate is:

1.7799 CHF/USD / 2.2529 NZD/USD = 0.79005 CHF/NZD

Example:

Given the following bid-ask spreads, calculate the SF/DKK bid ask spread:

SF/$ bid-ask 1.3096 1.4528

DKK/$ bid-ask 2.4365 2.5843Answer:

Set up a bid-ask matrix using: SF/$ bid-ask 1.3096 1.4528

DKK/$ bid-ask 2.4365 2.5843 (1.3096 SF/$) / (2.5843 DKK/$) = 0.50675 SF/DKK

(1.4528 SF/$) / (2.4365 DKK/$) = 0.59627 SF/DKK

Calculate and interpret currency cross rates, given two spot

exchange quotations involving three currencies.

Eraj Hashm i




A Pakistani dealer gives a quote of 8.00 bid / 8.10 ask (PKR/AED) and a Dubai dealer quotes the AED at 2.00

bid / 2.1 ask (THB/AED). What is the PKR/THB bid and ask from the perspective of a Pakistani dealer?

This result is determined as follows:

Step 1: Invert THB quote.

First, we need to invert the THB quotes to make the currency units AED/THB. Then, when we multiply by the

PKR/AED quote we will have the correct PKR/THB units. (Remember that when you take the reciprocal of a

quote, the bid becomes the ask and vice versa. So, for the bid we take the given ask)

Bid: 1.00000 / 2.10000THB/AED = 0.47619AED/THB Ask: 1.00000 / 2.00000THB/AED = 0.50000AED/THB

Step 2: Calculate PKR/THB bid-ask Prices.

Bid: 8.00000PKR/AED 0.47619AED/THB = 3.80952PKR/THB, or3.81PKR/THB.

Ask: 8.10000PKR/AED 0.50000AED/THB = 4.05000PKR/THB, or4.05PKR/THB.

Thus, the PKR/THB bid-ask is: 3.81PKR/THB - 4.05PKR/THB

Calculate and interpret currency cross rates, given two spot

exchange quotations involving three currencies. (2nd Slide)

Eraj Hashm i




Assume that the USD/GBP six-month forward rate is quoted at a bid of 1.63843 and an ask of 1.64073. From a

U.S. dealers perspective, calculate the bid-ask spread.

Answer:

In this case the spread is simply 0.0023 USD/GBP = 1.64073 1.63843.

Just as with spot market foreign currency spreads, spreads in the forward foreign currency market increase with

greater exchange rate volatility and decrease when trading volume is higher. Spreads tend to increase with the

term of the forward contract, and forward currency spreads are typically greater than spot currency spreads

Calculate and interpret the spread on a forward foreign

currency quotation and explain how spreads on forward

foreign currency quotations can differ as a result of marketconditions, bank/dealer positions, trading volume, and

maturity/length of contract

Eraj Hashm i




Money Ma

forward discount or premium

The forward discount or premium on a foreign currency can be calculated as an

annualized percentage differential between the spot rate and the forward rate:

Forward discount = forward rate spot rate = negative number

Forward premium = forward rate spot rate = positive number

Eraj Hashm i

Forward Discount

What Does Forward Discoun tMean?In a foreign exchange situation where the domestic current spot exchange rate is tradingat a higher level then the current domestic futures spot rate for a maturity period. Aforward discount is an indication by the market that the current domestic exchange rate isgoing to depreciate in value against another currency.

Read more: http://www.investopedia.com/terms/f/forwarddiscount.asp#ixzz06SipMPhcForward Premium

What Does Forward Prem iumMean?When dealing with foreign exchange (FX), a situation where the spot futures exchangerate, with respect to the domestic currency, is trading at a higher spot exchange rate thenit is currently
http://www.investopedia.com/terms/f/forwarddiscount.asphttp://www.investopedia.com/terms/f/forwarddiscount.asphttp://www.investopedia.com/terms/f/forwarddiscount.asphttp://www.investopedia.com/terms/f/forwarddiscount.asp

Presntation 3

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