CHAPTER 32. INTERNATIONAL CORPORATE .

ADR [American Depository Receipt] Eurocurrency : Money deposited outside of the country whose is involved. [e.g., eurodollars] Definition of Foreign Exchange [FX] : A network of , foreign exchange brokers, and dealers whose function is to bring buyers (demanders) and sellers (suppliers) of foreign exchange together. Interbank Market An informal arrangement of the larger commercial banks and a number of FX brokers for buying and selling foreign . Interbank Market n The spot market and the forward market Size of FX market n Daily volume approximately $1 Trillion or $250 Trillion per year. n Daily trading volume on the NYSE is about $7 Billion [0.7%] Participants of FX markets n Typically larger commercial banks. n Stand ready to buy or sell currencies on a continuous basis. n Compensated for making a market by ‘Bid-Ask Spread’ n FX brokers n Maintain lists of demanders and suppliers of currencies n Connect two parties [i.e., demanders and suppliers] n Approx. 60% of FX transactions occur through brokers. n Commercial customers : Large multinational corporation. n Central Banks : Intervention.

I. The Spot Market.

Definition n In the spot market, currencies are traded for immediate delivery. n are quoted in pairs. n Bid : The at which will buy the currencies. n Ask : The price at which bank will sell the currencies. n Bank Profit = Ask - Bid = Bid-ask spread

PAGE 1 Example quotes shown in WSJ.

EXCHANGE RATES Thursday, November 13, 1997 The New York foreign exchange selling rates below apply to trading among banks in amounts of $1 million and more, as quoted as 4 p.m. Eastern time by Dow Jones Telerate Inc. and other sources. Retail transaction provide few units of foreign currency per dollar. U.S. $ equiv. Currency per U.S. $ Country Thu Wed Thu Wed Japan (Yen) .007957 .007903 125.68 126.54

Direct Quotation n Home currency price per unit of foreign currency. n $ / Yen in U.S.

Indirect Quotation n Foreign currency price per unit of home currency. n Yen / $ in U.S.

Cross Rates - Many currency pairs are only inactively traded, so their is determined through their relationship to a widely traded third currency.

EXAMPLE : An Australian tourist wants to purchase Danish currency to pay for a visit to Copenhagen. The Australian dollar (symbol A$) is not actively traded with the Danish Krone(symbol DK). However, both currencies are actively traded with the U.S. dollar. Given the following quotes, what is the exchange rates between A$ and DK? [A$0.21345 / DK] Australian dollar : A$1.3806/US$ Danish krone : DK6.4680/US$

PAGE 2 Intermarket Triangular Aribitrage - Cross rates can be used to check on opportunities for intermarket arbitrage.

EXAMPLE : Suppose the following exchange rates are available. Assume that there is no transaction costs. Dutch guilders (DG) per US $ : DG2.00/US$ Canadian dollars(C$) per US $ : C$ 1.25/US$ Then the cross rate between Dutch guilders and Canadian $ is DG1.60 / C$ However, the cross rate is not the same as the actual quotation of DG1.70 / C$ Is there any arbitrage opportunity ?

..Netherlands.. DG 1,062.5 DG 1,000

Multiplied by Divided by DG 1.70 / C$ DG 2.00 / US$

C$625 Multiplied by US$500,000 ..Canada.. C$1.25 /US$ ..United States..

PAGE 3 II. The Forward Market.

Definition n In the forward market, currencies are traded for future delivery. n The exchange rate is established at the time the contract is agreed on, but payment and delivery are not required until maturity [1,2,3,6,12 months] Terminology n One can speak of "buying forward" or "selling forward" to describe the same transaction. n A contract to deliver $ for Yen in 6 months might be referred to as "buying Yen forward for $" or selling $ forward for Yen. Why 'forward'? n To lock in the price of a currency needed in the future n To eliminate the uncertainty of future exchange rate movements.

Example : A U.S company buys machines from Japan with payment of Yen 1 Million due in 90 days. During the next 90 days, the Japanese Yen can appreciate against the US$ [If this happens, the importer's cost will ????] The importer can this risk by buying the Yen in the forward market. ® We say the importer took a in the to offset a position in the spot market.

Note : A forward contract is an obligation not an . n Bank is required to sell the Yen n Importer is required to buy the Yen. Forward premium or discount Parity [IRP] n The difference in the national interest rates for securities of similar risk and maturity should be equal to the difference between the forward and spot exchange rates. F (1+ iY ) = S (1+i $ ) n Example on Page 820.

The law of one price [ or purchasing power parity ] n Example on Page 820.

III. Assigned problems from the textbook. Q1 – Q3

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