Professional Documents
Culture Documents
(Shapiro, Chapter 7)
INTRODUCTION
A. The Foreign Exchange (Forex or FX) Market:
where money denominated in one currency is
bought and sold with money denominated in another
currency.
B. International Trade and Capital Transactions:
facilitated with the ability to transfer
purchasing power between countries.
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C. Participants by Market
1. Spot Market
- commercial banks
- brokers
- customers of commercial & central banks
2. Forward Market: arbitrageurs, traders,
hedgers, and speculators
ELECTRONIC TRADING
A. Automated Trading - genuine screen-based
market
B.Results:
1. Reduces cost of trading
2. Threatens traders oligopoly of information
3. Provides liquidity
Transactions Costs
- Bid-Ask Spread: used to calculate the profit
charged by the bank.
Bid = the price at which the bank is
willing to buy
Ask = the price it will sell the currency
Eg., USD0.8600/30/AUD
The bid for Australian dollar (AUD) is
USD0.8600 and the ask is 0.8630. Bid-ask
spread is USD0.0030. This is the profit made
by the bank in a round trip transaction, a cost
to the client.
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Ask Bid
PS
x100
Ask
D. Cross Rates: the exchange rate between 2
non-US$ currencies.
2. CALCULATING CROSS RATES
Suppose you want to calculate the / cross rate.
You know 0.5556/$ and 0.8334/$, then
/ = ($/)(/$)
= (1/0.8334)(0.5556) = 0.6667/
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to
Triangular arbitrage:
1 $
(/1)($/)(/$)
= 0.6670(1/0.5556)(0.8334)
= 1.0005
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Eg.,
0.7240
-10
0.7230
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F S 12
100
S n
where
F = the forward rate of exchange
S = the spot rate of exchange
n = the number of months in the forward
contract
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C. Target-Zone Arrangement
Rate Determination:
a. Market forces constrained to upper and
lower range of rates.
b. Members to the arrangement adjust their
national economic policies to maintain
target.
D. Fixed Rate System
1. Rate determination
- Government maintains target rates.
- If rates are threatened, central
banks buy/sell currency to maintain
the fixed rates.
- Monetary policies coordinated.
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