Topic 2 – Spot Exchange Markets
You need to buy CHF 1,000,000 to pay your Swiss watch supplier. Your bank quotes bid-ask rates of CHF/USD 1.3990 – 1.4000. What will be your dollar cost of the CHF 1,000,000? The bid-ask rates of USD/CHF are:
The dollar cost:
USD 714, 796.28
CHF 1, 000, 000
As a FX trader, you see the following quotes:
Is there an arbitrage opportunity, and if so, how would you exploit it? The direct quote for the cross-rate of MXN/CAD 6.4390 should equal the implied cross-rate using the dollar as an intermediary currency; otherwise there exists a triangular arbitrage opportunity. The indirect cross rate is:
To exploit the arbitrage opportunity:
Borrow USD 1.
Sell USD 1 for CAD, you get CAD 1.4190.
Sell CAD 1.4190 for MXN, you get MXN 9.1372.
Convert MXN 9.1372 into USD, you get USD 1.0438.
This would yield a profit of USD 0.0438.
In this situation, buying the CAD with MXN by first buying USD with MXN and then buying the CAD with the USD and finally selling that amount of CAD directly for MXN would make a profit because we would be buying the CAD at a low MXN price and selling the CAD at a high MXN price.
HSBC quotes bid-ask rates of USD/EUR 1.3005 – 1.3007 and JPY/USD 104.30 – 104.40. What would be HSBC’s direct asking price of JPY/EUR?
The direct asking price of yen per euro (¥/€) is the amount of yen that the bank charges someone who is buying euros with yen. The bank would want this to be the same as the price at which it sells dollars for yen (the bank’s ask price) times the price at which it sells euros for dollars (also the bank’s ask price). Thus, the asking price of yen per euro should be: JPY 104.40 USD 1.3007
JPY EUR 135.79
Topic 3 – Understanding Forward Exchange Contracts
Consider the following spot and forward rates for JPY/EUR:
Is the EUR at a forward premium or discount? What are the magnitudes of the forward premiums or discounts when quoted in percentage per annum for a 360-day year? The forward rates of yen per euro are lower than the spot rates. Therefore, the euro is at a discount in the forward market. The annualized forward premium or discount for the n day forward contract is:
St Ft ,T 360
If the value of this calculation is negative, say -2%, we say there is a 2% discount. Therefore, the discounts are 4.51% for 30 days, 4.72% for 60 days, 4.24% for 90 days, 4.01% for 180 days, and 5.78% for 360 days.
You see the following quotes on your Reuters screen:
(a) What are the outright forward bid and ask quotes for the USD/EUR at the 3-month maturity? The spot bid and ask quotes for USD/EUR are 1.0435/45. These quotes mean that the bank buys euros with dollars spot at $1.0435/€, and the bank sells euros for dollars at $1.0445/€. Because the forward points at the 3-month maturity are 75/90, we know that we must add the points to get the outright forward bid and ask rates. Adding the points makes the bid-ask spread in the forward market larger than the bid-ask spread in the spot market. Consequently, the forward bid rate is $1.0435/€ + $0.0075/€ = $1.0510/€, and the forward ask quote is $1.0445/€ + $0.0090/€ = $1.0535/€.
(b) Suppose you want to swap out of USD 10,000,000 and into JPY for 2 months. What are the cash flows associated with the swap?
When you swap out of $10,000,000 into yen in the spot market, you are selling dollars to the bank. The bank buys dollars at its low...
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