5014 - Finance of International Trade - Exchange Rate Quotations p67 - 80

Question 1

What is an Exchange Rate?

Answer 1

Price of one currency in terms of another

Question 2

What are the two methods of expressing the price between two currencies?

Answer 2

Indirect

Direct

Question 3

Indirect Quote

Answer 3

Foreign currency units per unit of the domestic currency
e.g.
$1.2040 = £1 so 1/1.2040 means £0.83 = $1

Question 4

Direct Quote

Answer 4

Domestic currency units per unit of the foreign currency
e.g.
So, if £0.83 = $1 then 1/0.83 means $1.204 = £1

Question 5

Spot Rates

Answer 5

Todays exchange rate

Question 6

Forward Rates

Answer 6

Future rates of exchange agreed today

Question 7

Buying (Bid) and Selling (Ask) Rates

Answer 7

Bid is what someone is selling at, Ask is what someone is buying at

Question 8

On Jan 1st: £/$
Ask: 1.5
Bid: 1.5205

Forward Rate for Exchange April 1st:
Ask: 1.51
Bid: 1.53

Is the forward rate better or worse than today 1st Jan?

Is it better or worse than the spot rate on 1st April

Answer 8

The forward rate gets you more dollars per pound

Lecturer didn’t provide April 1st spot rate, if the ask is below 1.51 its worse, if he bid is below 1.53 its worse, and vice versa

Question 9

Spread

Answer 9

The difference between Buying (Bid) and Selling (Ask)

Question 10

What does the size of the spread depend on

Answer 10

Depends on which two parties are trading, at the top level is the interbank market, who operate under low spreads but high volumes at the bottom level is retail

Question 11

What makes us the interbank market

Answer 11

Commercial banks and securities dealers

Question 12

What is a cross rate?

Answer 12

A cross rate is defined as an exchange between two currencies which is derived from their common relationship with a third currency

The majority of these are only quoted against the dollar, pound, euro and yen

Question 13

Calculate the theoretical cross rate if:
€/$ = $1.2760 €
£/$ = $1.9040 £

Answer 13

If $1.9040 = £1 and $1.2760 = €1 then,

£1.9040 = €1.2760, so

£1.9040/€1.2760 = €1.4921 = £1

Question 14

Direct Quote Calculation Example

Answer 14

€/$ = $1.2760 €
£/$ = $1.9040 £

€1.2760/£1.9040 = £0.67 = €

Question 15

Triangular Arbitrage

Answer 15

Is the result of a discrepancy between three foreign currencies that occurs when the currencies exchange rates do not exactly match

Question 16

Triangular Arbitrage example

Answer 16

Say €1.4921 = £1

A dealer is offering €1.52 for £1 in a Cross rate between €/£/$

You buy €1.52 for £1

Exchange the €1.52 for $ at €1.2760 giving him:

€1.5200 x $1.2760 = $1.93952

Exchange the $1.93952 back to £ at a rate of $1.9040 so…

$1.93952/$1.9040 giving you £1.0186554, a 1.8% gain with no risk, which if you did with a million pounds would net you £18,655.40 with no risk

Question 17

Why does London have an upper hand on the FOREX arbitrage markets?

Answer 17

The time zone in London overlaps with the opening and closing of many other markets