Seminar 1: Foreign Exchange Markets · Seminar 1: Foreign Exchange Markets AyazZeynalov,PhD....

Seminar 1:Foreign Exchange Markets

Ayaz Zeynalov, PhD.

University of Economics, Prague

17th Februrary 2020

Course: International Finance

Office hours: Monday, 10:00-12:00, or by appointment - [email protected]

Office: NB274, Jan Masaryk Centre of International Studies, FIR

Ayaz Zeynalov, PhD. University of Economics, Prague 17th Februrary 2020 1 / 20

Overview

Foreign Exchange Market

Foreign Exchange Transactions

Foreign Exchange Quotations

Forward, Futures, and Options Markets


Global Foreign Exchange Turnover

Average daily turnover in the global foreign exchange market from 1998 to 2019

Trading in foreign exchange markets averaged $6.5 trillion per day.

BIS Derivatives Markets in 2019

Quiz - Kahoot!


https://www.bis.org/statistics/rpfx19.htm

https://create.kahoot.it


Spot transactions increased to $1.98 trillion per day in 2019 ($1.7 trillionin 2016).Outright forwards was $0.99 trillion.Foreign exchange swaps was 3.20 trillion.Currency swaps was $0.11 trillion.FX options was $0.29 trillion.



Global foreign exchange market turnover by instrument from 1998 to 2019



Global foreign exchange market turnover by country from 1998 to 2019


Foreign Exchange Market

Foreign Exchange MarketThe foreign exchange market allows for the exchange of one currency foranother.Large commercial banks serve this market by holding inventories of eachcurrency.MNCs receive/pay different currencies when selling/buying products.Individuals rely on the foreign exchange market when they travel to foreigncountries.

History of Foreign ExchangeGold StandardSuspension periodInstability periodFixed Exchange RatesFloating Exchange Rate System


Foreign Exchange Transactions

The immediate exchange called spot rate.The market for immediate exchange is known as the spot market.Delivery takes places normally on the second following business day.

Trading between banks makes up what is often referred to as the interbankmarket.

The banks often function as market makers.Individual transactions in the interbank market are usually for larger sumsthat are multiplies of a million Euros, US Dollars etc.On the client market the transactions are typically for smaller.

Attributes of Banks that Provide Foreign Exchange:

1 Competitiveness of quote.2 Special relationship with the bank.3 Speed of execution.4 Advice about current market conditions.5 Forecasting advice.



Bid/Ask Spread of Banks:Commercial banks charge fees for conducting foreign exchange transactions.A bank’s bid (buy) quote for a foreign currency will be less than its ask (sell)quote.The bid/ask spread represents the differential between the bid and askquotes

Example 1A

Assume you have 1,000 $ and plan to travel from the United States to the Czechia.Assume further that the bank’s bid rate for the Czech Koruna is 0.050 $ and itsask rate is 0.052 $.

Example 1B

Before leaving on your trip, you go to this bank to exchange dollars for CZK. Your1,000 $ will be converted as amount of U.S. dollars to be converted diveded toprice charged by bank per CZK

Amount of U.S. dollars to be convertedPrice charged by bank per CZK

=10000.052

= 19230-CZK



Example 1C

Now suppose that because of an emergency you cannot take the trip, and youreconvert the 19230 CZK back to U.S. dollars, just after purchasing the CZK.If the exchange rate has not changed, you will receive:

Amount = 19230 × 0.050 = 961.5$

Due to the bid/ask spread, you have 38,5 $ (appr. 4 percent) less than what youstarted with.

Bid/ask spread in percentage terms follows:

Bid/ask spread =Ask rate - Bid rate

Ask rate



Practice-1

You are given the following spot quote: GBP/EUR 1.5015 - 1.5040

1 The above quote is for which currency?2 What is the bid rate for GBP?3 What is the bid price for EUR in terms of GBP?

Practice-2

Bank quotes a bid rate of $.784 for the Australian dollar and an ask rate of $.80.What is the bid/ask percentage spread?


Factors That Affect the Spread

Spread = F (Order costs, Inventory costs, Competition, Volume, Currency risk)

Order costs are the costs of processing orders, including clearing costs and thecosts of recording transactions.Inventory costs are the costs of maintaining an inventory of a particularcurrency.The more intense the competition, the smaller the spread quoted byintermediaries.More liquid currencies are less likely to experience a sudden change in price.Some currencies exhibit more volatility than others because of economic orpolitical conditions that cause the demand for and supply of the currency tochange abruptly.



Quotations that represent the value of a foreign currency in domestic currency arereferred to as direct quotations:

1 e= 1.25 $

Quotations that represent the number of units of a foreign currency per domesticcurrency are referred to as indirect quotations:

1 $= 0.80 e



Practice-3

From a Canadian’s point of view,Which of each pair of quotes is the direct quotation?Which is the indirect quotation?

1 CAD/USD 2.31; USD/CAD 0.432 USD/CAD 0.84; CAD/USD1.183 CAD/EUR 1.54; EUR/CAD 0.65



From a US’s point of view:

The Canadian dollar’s direct quotation changed from $.66 to $.70 over thesemester.This change reflects an appreciation of the Canadian dollar, as thecurrency’s value increased over the semester.

The Canadian dollar’s indirect quotation decreased from 1.51 to 1.43 overthe semester. This means that it takes fewer Canadian.

Practice-4

Which currencies have been depreciated against U.S. dollars?





Practice-5

You just came back from Canada, where the Canadian dollar was worth $.70. Youstill have C$ 200 from your trip and could exchange them for dollars at theairport, but the airport foreign exchange desk will only buy them for $.60. Nextweek, you will be going to Mexico and will need pesos. The airport foreignexchange desk will sell you pesos for $.10 per peso. You met a tourist at theairport who is from Mexico and is on his way to Canada. He is willing to buy yourC$ 200 for 1,250 pesos. Should you accept the offer or cash the Canadian dollarsin at the airport? Explain.

Practice-6

Today you notice the following exchange rate quotations:$1 = 3.00 Argentine pesos1 Argentine peso = .50 Canadian dollars

You need to purchase 100,000 Canadian dollars with U.S. dollars. How many U.S.dollars will you need for your purchase?


Cross Rates

Cross exchange rate reflects the amount of one foreign currency per unit ofanother foreign currency.

Cross exchange rates can be easily determined with the use of foreign exchangequotations.

Example

If the peso is worth $.07, and the Canadian dollar is worth $.70, the value of thepeso in Canadian dollars (C$) is calculated as follows:

Value of peso in C$ =Value of peso in $Value of C$ in $

=$0.07$0.70

= C$0.10

Practice-8

Assume Poland’s currency (the zloty) is worth $.17 and the Japanese yen is worth$.008. What is the cross rate of the zloty with respect to yen? That is, how manyyen equal a zloty?


Forward, Futures, and Options Markets

In addition to the spot market,Forward market for currencies enables an MNC to lock in the exchangerate (called a forward rate) at which it will buy or sell a currency.Futures contracts are somewhat similar to forward contracts except thatthey are sold on an exchange whereas forward contracts are offered bycommercial banks.Currency call option provides the right to buy a specific currency at aspecific price (called the strike price or exercise price) within a specific periodof time. It is used to hedge future payables.Currency put option provides the right to sell a specific currency at aspecific price within a specific period of time. It is used to hedge futurereceivables.


The End

Thanks for your attention!Questions?


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