LM 8: Currency Exchange Rates

Question 1

What are currency exchange rates, specifically A/B?

Answer 1

A/B = number of units of currency A for one unit of currency B

A = price currency
B = base currency

Question 2

Calculate HKD/USD given the following three spot exchange rates:

JPY/USD 132.12
JPY/CAD 94.51
HKD/CAD 5.75

Answer 2

8.04 (HKD/USD) = 132.13 * 1/94.51 * 5.75

Question 3

What is points/pips formula?

Answer 3

points = forward rate - spot rate

points are positive if forward rate > spot rate

Question 4

What is the forward rate formula?

Answer 4

spot + (forward rate/ (10,000))
+
(forward points/10,000)

Question 5

What is the formula for avoiding arbitrage opportunities between a domestic currency and a foreign currency?

Answer 5

1 + domestic currency rate = exchange rate of currency * [ 1+ foreign currency rate] *

Question 6

What is the real exchange rate formula?

Answer 6

Sd/f×(Pf/Pd)

Sd/f = is the spot exchange rate (number of units of domestic currency per one unit of foreign currency)
Pf = is the foreign price level quoted in foreign currency
Pd = domestic price level quoted in domestic currency

Question 7

What does the real exchange rate tell us?

Answer 7

represents the real price you pay to purchase foreign goods and services

Question 8

What are the majority of activities in FX markets?

Answer 8

capital transactions

Question 9

What are spot transactions?

Answer 9

Spot transactions are used to exchange currencies immediately

Question 10

What are forward transactions?

Answer 10

Forward transactions are agreements to exchange currencies further in the future.

Question 11

What is the difference between futures contracts and forwards contracts in terms of contracts?

Answer 11

forward contracts can be negotiated

futures contracts have specific date, amount, etc.

Question 12

What is the difference between forward and future contracts in terms of where they trade?

Answer 12

forward contracts trade OTC

future contracts trade on exchanges

Question 13

What is the difference between forward contracts and future contracts in terms of collateral?

Answer 13

forwards don’t require collateral

futures require collateral usually in form of margin

Question 14

What are FX options?

Answer 14

foreign exchange markets: give the right (not obligation) to make an FX transaction in the future. A fee must be paid upfront to purchase this option.

Question 15

What is foreign exchange swaps?

Answer 15

foreign currency swap is an agreement between two parties to swap interest rate payments on their respective loans in their different currencies.

Question 16

What are the 7 types of market participants? CRLRGC

Answer 16

1. Corporate accounts
2. Real money accounts (accounts managed by entities, eg. mutual funds, endowments, insurance.)
3. Leveraged accounts (hedge funds)
4. Retail accounts (individuals)
5. Governments
6. Central banks
7. Sovereign wealth funds (SWFs)

Question 17

What is the difference between indirect quote and direct quote?

Answer 17

direct quote = (domestic currency) / (foreign currency)

indirect quote = foreign currency / domestic currency

Question 18

What is bid price vs ask price in currency exchange?

Answer 18

bid price = price bank is willing to buy the currency (buying base currency)
ask price = price bank is willing to sell currency (selling base currency)

Question 19

What is EUR/USD exchange rate 0.9214 - 0.9216 mean

Answer 19

0.9214 = dealer willing to buy one US dollar for 0.9214 euro

0.9216 = dealer willing to sell one US dollar for 0.9216 EURO

Question 20

How will an increase in exchange rate affect the currency?

Answer 20

an increase in exchange rate will appreciate the base currency and depreciate the foreign currency

Question 21

What is the equation for forward FX rates for two currencies to make it not possible to earn arbitrage profits?

Answer 21

Ff/d=Sf/d(1+if)/ (1+id)

Ff/d = forward rate
Sf/d = current spot rate
iF = foreign risk free rate
iD = domestic risk free rate