Computer Architecture Lecture 3: Logical circuits, computer arithmetics Piotr Bilski.
SESSION 1-8 FX Arithmetics
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Transcript of SESSION 1-8 FX Arithmetics
Prof. (Dr.) Paresh Shah, FCMA., Ph.D.(Finance), F.D.P. (IIMA)
Foreign Exchange Airthmetic
Domestic Currency And Foreign Currency
Domestic Currency denotes the currency in which the Annual Reports prepared. Known as Home Currency
Foreign currency denotes any currency other than the domestic currency
Foreign currency is a medium of exchange, and also store of value – an asset
Foreign currency is commodity in terms of commercial life
Exchange rate
Rate at which one currency is exchanged i.e., bought or sold for another currency
For any currency, there is an exchange rate for every other traded currency on the foreign exchange market
In an exchange rate , two currencies are involved Exchange rate quoted in four decimal places Rs./US$ means Rs. ……. Per unit US Dollar Rs. / € means Rs. ………….. Per unit Euro currency
Direct Quote
Direct quote - the exchange rate in terms of home currency per unit of foreign currency - used in India 1 € = Rs. 35 The price comes first, the commodity next FC is the commodity which is being sold and bought
Indirect Quote
Indirect quote – exchange rate in terms of foreign currency per unit of home currency Re. 1 = € 0.0286 The currency for which unit is fixed as “1” is the
commodity and the currency for which units vary is the price
An indirect quote is the reciprocal of direct quote
( 1/35) = 0.0286
Spot Rate Quotations
The direct quote for British pound is:
£1 = $1.5627
CountryUSD equiv Friday
USD equiv Thursday
Currency per USD Friday
Currency per USD Thursday
Argentina (Peso) 0.3309 0.3292 3.0221 3.0377
Australia (Dollar) 0.5906 0.5934 1.6932 1.6852
Brazil (Real) 0.2939 0.2879 3.4025 3.4734
Britain (Pound) 1.5627 1.566 0.6399 0.6386
1 Month Forward 1.5596 1.5629 0.6412 0.6398
3 Months Forward 1.5535 1.5568 0.6437 0.6423
6 Months Forward 1.5445 1.5477 0.6475 0.6461
Canada (Dollar) 0.6692 0.6751 1.4943 1.4813
1 Month Forward 0.6681 0.6741 1.4968 1.4835
3 Months Forward 0.6658 0.6717 1.502 1.4888
6 Months Forward 0.662 0.6678 1.5106 1.4975
Spot Rate Quotations
The indirect quote for British pound is:
£.6399 = $1
1.49751.51060.66780.6626 Months Forward
1.48881.5020.67170.66583 Months Forward
1.48351.49680.67410.66811 Month Forward
1.48131.49430.67510.6692Canada (Dollar)
0.64610.64751.54771.54456 Months Forward
0.64230.64371.55681.55353 Months Forward
0.63980.64121.56291.55961 Month Forward
0.63860.63991.5661.5627Britain (Pound)
3.47343.40250.28790.2939Brazil (Real)
1.68521.69320.59340.5906Australia (Dollar)
3.03773.02210.32920.3309Argentina (Peso)
Currency per USD Thursday
Currency per USD Friday
USD equiv Thursday
USD equiv FridayCountry
Spot Rate Quotations
Note that the direct quote is the reciprocal of the indirect quote:
6399.
15627.1
1.49751.51060.66780.6626 Months Forward
1.48881.5020.67170.66583 Months Forward
1.48351.49680.67410.66811 Month Forward
1.48131.49430.67510.6692Canada (Dollar)
0.64610.64751.54771.54456 Months Forward
0.64230.64371.55681.55353 Months Forward
0.63980.64121.56291.55961 Month Forward
0.63860.63991.5661.5627Britain (Pound)
3.47343.40250.28790.2939Brazil (Real)
1.68521.69320.59340.5906Australia (Dollar)
3.03773.02210.32920.3309Argentina (Peso)
Currency per USD Thursday
Currency per USD Friday
USD equiv Thursday
USD equiv FridayCountry
American quote v/s European term
A quote which is a direct quote for the American is said to be in American quote
A quote which is an indirect quote for the American is said to be European quote
The direct quote for British pound is: £1 = $1.5627
The indirect quote for British pound is: £.6399 = $1
American quote v/s European term
Since American term and European term are direct and indirect respectively for American, the European term can be said to be reciprocal of the American term
International quotes except £, NZ $, AU$, SA Rand, and € are all expressed in European terms
The Spot Market
Spot Rate Quotations The Bid-Ask Spread Spot FX trading Cross Rates
The Bid-Ask Spread
The bid price is the price a dealer (Bankers) is willing to pay you for something.
The ask price is the amount the dealer (Bankers) wants you to pay for the thing.
The bid-ask “spread “is the difference between the bid and ask prices. Spread will provide a margin to bank to cover costs and make a small profit
Factors determine size of Spread
Stability of exchange rate If exchange rate stable, the spread will be narrow If exchange rate volatile, the spread will be wider
Depth of the market Depth means volume of transactions in the market
Deep market – high volume of transactions - spread will be narrow
Thin market – low volume of transactions – spread will be larger
Two way quote
Bid and Ask on Foreign Currency Bid Ask
Bank Buys FC Sells FC
Sells LC Buys LC Customer
Buys LC Sells LC
Sells FC Buys FC
Three – tier Architecture
Header: Authorised dealers i.e., Scheduled banks Full fledged foreign exchange business
Sub-header: Co-operative and commercial banks Licensed to maintain
Bottom level: Money changers Licensed to carry our FOREX transactions by RBI
Two way Quotes
In the direct quote: Bid rate < Ask rate Bank always wants to gain
In the indirect quote:Ask rate > Bid rate
Bid (Rs./$) = 1 / Ask ($/Rs.) Ask (Rs./$) = 1 / Bid ($/Rs.)
Cross rate
Denotes an exchange rate that does not involve the home currency
Cross multiplication is the mechanism used to derive the exchange for a set of currencies, when the exchange rates for two other sets of currencies are available
A/B = A/C x C/B Bid (A/B) = Bid (A/C ) x Bid (C/B) Ask (A/B) = Ask (A/C ) x Ask (C/B)
Cross Rates
Suppose that S($/€) = .50 i.e. $1 = 2 €
and that S(¥/€) = 50 i.e. €1 = ¥50
What must the $/¥ cross rate be?
,¥
€
€
$
¥
$ since
¥100 $1or .01 ¥)/($¥100
1$
¥50
1€
2€
1$ S
Cross rate
Bid (A/B) = 1 / Ask (B/A ) Ask (A/B) = 1 / Bid (B/A )
Fluctuations
Inter day fluctuation intra-day fluctuation
Transaction based rates, rate for Bills - Export / Imports TT Buying / Selling TC Buy / Sell Currency Buy/ sell
Spot v/s Forward Rate
Spot rate- rate applicable for immediate settlement Transaction will be settled on the second working day
Forward rate – rate contracted today for exchange of currencies at a specified future date Customer and banker - obliged to perform on the
specified future date
Spot Foreign Exchange Microstructure
Market Microstructure refers to the mechanics of how a marketplace operates.
Bid-Ask spreads in the spot FX market: increase with FX exchange rate volatility and decrease with dealer competition.
Private information is an important determinant of spot exchange rates.
The Forward Market
Forward Rate Quotations Long and Short Forward Positions Forward Cross Exchange Rates Swap Transactions Forward Premium
The Forward Market
A forward contract is an agreement to buy or sell an asset in the future at prices agreed upon today.
If you have ever had to order an out-of-stock textbook, then you have entered into a forward contract.
Forward contract to mean a transaction involving delivery, other than cash (delivery of the FX on the day of transaction), or TOM (delivery of FX on a working day next to the day of transaction) or Spot delivery of FX.
Forward Rate Quotations
The forward market for FOREX involves agreements to buy and sell foreign currencies in the future at prices agreed upon today.
Bank quotes for 1, 3, 6, 9, and 12 month maturities are readily available for forward contracts.
Longer-term swaps are available.
Forward Rate Quotations
Consider the example from above:
for US $, the spot rate is
$1.5627 = £1.00
While the 180-day forward rate is
$1.5445 = £1.00 What’s up with that?
Spot Rate Quotations
Clearly the market participants expect that the pound will be worth less in dollars in six months.
1.49751.51060.66780.6626 Months Forward
1.48881.5020.67170.66583 Months Forward
1.48351.49680.67410.66811 Month Forward
1.48131.49430.67510.6692Canada (Dollar)
0.64610.64751.54771.54456 Months Forward
0.64230.64371.55681.55353 Months Forward
0.63980.64121.56291.55961 Month Forward
0.63860.63991.5661.5627Britain (Pound)
3.47343.40250.28790.2939Brazil (Real)
1.68521.69320.59340.5906Australia (Dollar)
3.03773.02210.32920.3309Argentina (Peso)
Currency per USD Thursday
Currency per USD Friday
USD equiv Thursday
USD equiv FridayCountry
Forward Premium V/s. Discount
Forward premium – LC appreciating means LC become expensive and FC loose its value
Forward discount – LC depreciating means FC become expensive and local currency loose its value
RELATIONSHIP (Direct quote) FC > LC FC appreciating; LC depreciating FC < LC LC appreciating; FC depreciating
Forward Premium
It’s just the interest rate differential implied by forward premium or discount.
For example, suppose the € is appreciating from S($/€) = .5235 to F180($/€) = .5307
The forward premium is given by (Direct Quote): Indicates with respect to foreign currency %
02751.5235.
5235.5307.
180
360
€)/($
€)/($€)/($180$,€180
S
SFf v
Forward premium (Indirect Quote)Indicates with respect to Local currency %
02713.5307.
5307.5235.
180
360
€)/($
€)/($€)/($180$,€180
F
FSf v
Forward premium or Discount
If the answer is positive as per direct quote it means LC at Discount and FC at premium
If the answer is negative as per direct quote it means FC at Discount and LC at premium FC i.e., commodity Direct quote
Indirect quote Appreciating (LC Discount) Add
Deduct Depreciating (LC Premium) Deduct
Add
Determination
If swap Ask > Swap Bid, the LC is depreciating, FC is appreciating
If Swap Ask < Swap Bid, the LC is appreciating, FC is depreciating
Spot Rs./ US $ 45 / 45.20 Swap points 0.10/0.15 means INR depreciate
FR 45.10 / 45.35 Swap points 0.15/0.10 means INR appreciating
FR 44.85 / 45.10
Forward Cross Exchange Rates
It’s just an “delayed” example of the spot cross rate discussed above.
In generic terms
)/($
)/($)/(
and
)/($
)/($)/(
kF
jFjkF
jF
kFkjF
N
NN
N
NN
SWAPS
A swap is an agreement to provide a counterparty with something he wants in exchange for something that you want.
Swap transactions account for approximately 56 percent of interbank FX trading, whereas outright trades are 11 percent.
Swap points
FX can be quoted as Outright forward or Adjustment to sport rates (known as swap point)
The difference between the outright forward rate and spot rate known as swap differential or swap points.
Spread is difference between Bid and Ask rate
Swap V/s Spread
Term Bid Ask Spread Spot A B B – A Forward C D D – C
Swap C – A D – B Forward Bid : Bank’s buying rate in the forward
market Forward Ask : Bank’s selling rate in the forward
market