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1、INTERNATIONALFINANCIALMANAGEMENTEUN/RESNICKSecond Edition4Chapter FourThe Market for Foreign ExchangeChapter Objectives:This chapter serves to introduce the student to the institutional framework within which exchange rates are determined.This chapter lays the foundation for much of the discussion t
2、hroughout the remainder of the text,thus it deserves your careful attention.Chapter OutlinelFunction and Structure of the FOREX MarketlThe Spot MarketlThe Forward Market1Chapter OutlinelFunction and Structure of the FOREX MarketnFX Market ParticipantsnCorrespondent Banking RelationshipslThe Spot Mar
3、ketlThe Forward Market2Chapter OutlinelFunction and Structure of the FOREX MarketlThe Spot MarketnSpot Rate QuotationsnThe Bid-Ask SpreadnSpot FX TradingnCross Exchange Rate QuotationsnTriangular ArbitragenSpot Foreign Exchange Market MicrostructurelThe Forward Market3Chapter OutlinelFunction and St
4、ructure of the FOREX MarketlThe Spot MarketlThe Forward MarketnForward Rate QuotationsnLong and Short Forward PositionsnForward Cross-Exchange RatesnSwap TransactionsnForward Premium4The Function and Structure of the FOREX MarketlFOREX Market ParticipantslCorrespondent Banking Relationships5FOREX Ma
5、rket ParticipantslThe FOREX market is a two-tiered market:nInterbank Market(Wholesale)uAbout 700 banks worldwide stand ready to make a market in Foreign exchange.uNonbank dealers account for about 20%of the market.uThere are FX brokers who match buy and sell orders but do not carry inventory and FX
6、specialists.nClient Market(Retail)lMarket participants include international banks,their customers,nonbank dealers,FOREX brokers,and central banks.6Correspondent Banking RelationshipslLarge commercial banks maintain demand deposit accounts with one another which facilitates the efficient functioning
7、 of the forex market.lInternational commercial banks communicate with one another with:nSWIFT:The Society for Worldwide Interbank Financial Telecommunications.nCHIPS:Clearing House Interbank Payments System nECHO Exchange Clearing House Limited,the first global clearinghouse for settling interbank F
8、OREX transactions.7The Spot MarketlSpot Rate QuotationslThe Bid-Ask SpreadlSpot FX tradinglCross Rates8Spot Rate QuotationslDirect quotationnthe U.S.dollar equivalentne.g.“a Japanese Yen is worth about a penny”lIndirect Quotationnthe price of a U.S.dollar in the foreign currencyne.g.“you get 100 yen
9、 to the dollar”.9Spot Rate QuotationsThe direct quote for British pound is:1=$1.68810Spot Rate QuotationsThe indirect quote for British pound is:.5924=$111Spot Rate QuotationsNote that the direct quote is the reciprocal of the indirect quote:12The Bid-Ask SpreadlThe bid price is the price a dealer i
10、s willing to pay you for something.lThe ask price is the amount the dealer wants you to pay for the thing.lThe bid-ask spread is the difference between the bid and ask prices.13Spot FX tradinglIn the interbank market,the standard size trade is about U.S.$10 million.lA bank trading room is a noisy,ac
11、tive place.lThe stakes are high.lThe“long term”is about 10 minutes.14Cross RateslSuppose that S($/DM)=.50n i.e.$1=2 DM land that S(/DM)=50n i.e.DM1=50lWhat must the$/cross rate be?15Triangular Arbitrage$Credit Lyonnais S(/$)=1.50Credit AgricoleS(/)=85BarclaysS(/$)=120Suppose we observe these banks p
12、osting these exchange rates.First calculate the implied cross rates to see if an arbitrage exists.16Triangular Arbitrage$Credit Lyonnais S(/$)=1.50Credit AgricoleS(/)=85BarclaysS(/$)=120The implied S(/)cross rate is S(/)=80Credit Agricole has posted a quote of S(/)=85 so there is an arbitrage opport
13、unity.So,how can we make money?17Triangular Arbitrage$Credit Lyonnais S(/$)=1.50Credit AgricoleS(/)=85BarclaysS(/$)=120As easy as 1 2 3:1.Sell our$for,2.Sell our for,3.Sell those for$.18Triangular ArbitrageSell$100,000 for at S(/$)=1.50 receive 150,000 Sell our 150,000 for at S(/)=85 receive 12,750,
14、000Sell 12,750,000 for$at S(/$)=120receive$106,250profit per round trip=$106,250-$100,000=$6,25019Spot Foreign Exchange MicrostructurelMarket Microstructure refers to the mechanics of how a marketplace operates.lBid-Ask spreads in the spot FX market:nincrease with FX exchange rate volatility and nde
15、crease with dealer competition.lPrivate information is an important determinant of spot exchange rates.20The Forward MarketlForward Rate QuotationslLong and Short Forward PositionslForward Cross Exchange RateslSwap TransactionslForward Premium21The Forward MarketlA forward contract is an agreement t
16、o buy or sell an asset in the future at prices agreed upon today.lIf you have ever had to order an out-of-stock textbook,then you have entered into a forward contract.22Forward Rate QuotationslThe forward market for FOREX involves agreements to buy and sell foreign currencies in the future at prices
17、 agreed upon today.lBank quotes for 1,3,6,9,and 12 month maturities are readily available for forward contracts.lLonger-term swaps are available.23Forward Rate QuotationslConsider the example from above:for Japanese yen,the spot rate is 115.75=$1.00While the 180-day forward rate is 112.80=$1.00lWhat
18、s up with that?24Spot Rate QuotationsClearly the market participants expect that the yen will be worth MORE in dollars in six months.25Long and Short Forward PositionslIf you have agreed to sell anything(spot or forward),you are“short”.lIf you have agreed to buy anything(forward or spot),you are“lon
19、g”.lIf you have agreed to sell forex forward,you are short.lIf you have agreed to buy forex forward,you are long.26Payoff Profiles0S180($/)F180($/)=.009524Short positionlossprofitIf you agree to sell anything in the future at a set price and the spot price later falls then you gain.If you agree to s
20、ell anything in the future at a set price and the spot price later rises then you lose.27Payoff Profilesloss0S180(/$)F180(/$)=105-F180(/$)profitWhether the payoff profile slopes up or down depends upon whether you use the direct or indirect quote:F180(/$)=105 or F180($/)=.009524.short position28Payo
21、ff Profilesloss0S180(/$)F180(/$)=105-F180(/$)When the short entered into this forward contract,he agreed to sell in 180 days at F180(/$)=105 profitshort position29Payoff Profilesloss0S180(/$)F180(/$)=105-F180(/$)120If,in 180 days,S180(/$)=120,the short will make a profit by buying at S180(/$)=120 an
22、d delivering at F180(/$)=105.15profitshort position30Payoff Profilesloss0S180(/$)F180(/$)=105Long position-F180(/$)F180(/$)short positionprofitSince this is a zero-sum game,the long position payoff is the opposite of the short.31Payoff Profilesloss0S180(/$)F180(/$)=105Long position-F180(/$)profitThe
23、 long in this forward contract agreed to BUY in 180 days at F180(/$)=105 If,in 180 days,S180(/$)=120,the long will lose by having to buy at S180(/$)=120 and delivering at F180(/$)=105.1201532Forward Cross Exchange RateslIts just an“delayed”example of the spot cross rate discussed above.lIn generic t
24、erms33SWAPSlA swap is an agreement to provide a counterparty with something he wants in exchange for something that you want.lSwap transactions account for approximately 51 percent of interbank FX trading,whereas outright trades are less than 9 percent.34Comparative Advantage as the Basis for SwapsC
25、onsider two firms A and B:firm A is a U.S.based multinational and firm B is a U.K.based multinational.Both firms wish to finance a project in each others country of the same size.Their borrowing opportunities are given in the table below.35A is the more credit-worthy of the two firms.A pays 2%less t
26、o borrow in dollars than B and A pays.4%less to borrow in pounds than B:Comparative Advantage as the Basis for SwapsA has a comparative advantage in borrowing in dollarsB has a comparative advantage in borrowing in pounds.36One Feasible Swap:Company ASwap Bank$8%12%$8%11%12%$9.4%Company B37$8%12%$8%
27、11%12%$9.4%As net position is to borrow at 11%One Feasible Swap:Company ASwap BankCompany B38$8%12%$8%11%12%$9.4%Bs net position is to borrow at$9.4%One Feasible Swap:Company ASwap BankCompany B39$8%12%$8%11%12%$9.4%One Feasible Swap:Company ASwap BankCompany BA saves.6%40$8%12%$8%11%12%$9.4%B saves
28、$.6%One Feasible Swap:Company ASwap BankCompany BA saves.6%41$8%12%$8%11%12%$9.4%B saves$.6%One Feasible Swap:Company ASwap BankCompany BA saves.6%The swap bank makes money too.42SWAPSlA swap can be viewed as a portfolio of spot and forward positions.lIn the above example,firm A would borrow in doll
29、ars and then swap for pounds with the bank and simultaneously enter into a series of forward contracts with the bank to exchange dollars for pounds.43Forward PremiumlIts just the interest rate differential implied by forward premium or discount.lFor example,exhibit 4.4 shows the DM appreciating from S($/DM)=.5235 to F180($/DM)=.5307lThe forward premium is given by:44End Chapter Four45