宁波工程学院国商教研室蒋力编 Chapter 1 The Foreign- Exchange Market

1-2 宁波工程学院国商教研室蒋力编 Topics to be Covered Foreign Exchange Market Spot Rates Arbitrage Short/Long term FX movement

1-3 宁波工程学院国商教研室蒋力编 Foreign Exchange Market The Foreign Exchange Market (FEM) is a place where one country’s money is traded for that of another country.

1-4 宁波工程学院国商教研室蒋力编 The FEM consists primarily of large commercial banks in world financial centers such as New York or London. The top three banks accounted for 36.98% of the total market in 2011, The market share for the top 10 FX roviders was at about 77%. 1. Deutsche Bank （德意志银行） 2. Barclays （巴 克莱银行） 3. UBS （瑞士联合银行） 4. Citi （花旗） 5. JPMorgan （摩根大通） 6. HSBC （汇丰银行） 7. Royal Bank of Scotland （皇家苏格兰银行） 8. Credit Suisse （瑞士信贷集团） 9. Goldman Sachs （高盛） 10. Morgan Stanley （摩根士丹利）

1-5 宁波工程学院国商教研室蒋力编 Foreign Exchange Market Trading Volume (by country 2013) (Reported by The Bank for International Settlements (BIS) ) Foreign exchange market activity has become ever more concentrated in a handful of global financial centres. The vast majority of global FX trading in 2013 has occurred in five jurisdictions: the United Kingdom (41%), the United States (19%), Singapore (5.7%), Japan (5.6%) and Hong Kong SAR (4.1%). The share of the top five global FX trading centres moved up by 4 percentage points to 75% in Singapore overtook Japan as the world’s third major FX trading centre in And Hongkong overtook Switerland as the world’s fifth top FX trading centre

1-6 宁波工程学院国商教研室蒋力编 FIGURE 1.1 The World of Foreign-Exchange Dealing(p5)

1-7 宁波工程学院国商教研室蒋力编 Figure 1.2 Average daily trading value Yen V.S. Dollar (p7)

1-8 宁波工程学院国商教研室蒋力编 TABLE 1.1 Estimation of Average Daily Volume of Foreign-Exchange Market Activity

1-9 宁波工程学院国商教研室蒋力编 TABLE 1.3 Foreign exchange market turnover by currency 2013

1-10 宁波工程学院国商教研室蒋力编 TABLE 1.4 Foreign exchange market turnover by currency pair 2013

1-11 宁波工程学院国商教研室蒋力编 TABLE 1.5 Foreign exchange market turnover by instruments 2013

1-12 宁波工程学院国商教研室蒋力编 Exchange Rate What is the Exchange Rate? Exchange Rate (XR)—the price of one money in terms of another. The XR helps determine the value of a product priced in a different currency.

1-13 宁波工程学院国商教研室蒋力编 Exchange Rate Basic Types of Exchange Rates: Spot XR The Spot XR are quoted at a specific day and time.

1-14 宁波工程学院国商教研室蒋力编 Qutotation Method $ is local currency: U.S. $ per foreign currency £1 = $ (Direct);Direct Foreign currency per U.S. $ £ = $1 (Indirect Quotation)Indirect

1-15 宁波工程学院国商教研室蒋力编 ￥ 6.20

1-16 宁波工程学院国商教研室蒋力编 How many things can ￥ 1 buy? 0.15 Can Bottle0.014 Bottle0.026 Bag $0.16

1-17 宁波工程学院国商教研室蒋力编 Exchange Rate Spread—the difference between the buying and selling price of a currency. The spread will tend to be higher for thinly or low-volume traded currencies (quick returns and small margins) or for high-risk currencies. International currency symbols p10

1-18 宁波工程学院国商教研室蒋力编 Pricing currency/Unit currency Here USD is unit currency, JPY is pricing currency, so means the price of one USD is JPY. The following currency pairs are similar.

1-19 宁波工程学院国商教研室蒋力编 Arbitrage Arbitrage—the activity of simultaneously buying a currency in one market while selling in another to take advantage of profit opportunities. For example: in our textbook the XR quotation is pricing currency/unit currency Citibank quoting SF/$= Dresdner Bank quoting SF/$=

1-20 宁波工程学院国商教研室蒋力编 In the real world case Jan 7 th 2016 CNY/USD is at mainland market, however at the offshore market of CNY the XR is The arbitrage is so obvious.

1-21 宁波工程学院国商教研室蒋力编 Cross Rate Arbitrage could involve more than two currencies arbitrage Cross Rate—the third exchange rate implied by any two exchange rates involving three currencies. JPY/USD=124.84, USD/GBP=1.5720; JPY/GBP= Since the dollar is actively traded with many currencies, any two exchange rates involving dollars can be used to determine cross rates.

1-22 宁波工程学院国商教研室蒋力编 Triangular Arbitrage $ £ ¥ Bank 2 S($/£)=1.50 Bank 3 S (¥/£) =160 Bank 1 S(¥/$)=120 The implied S(¥/£) cross rate is 180 Bank 3 has posted a quote of S (¥/£) =160, so there is an arbitrage opportunity. So, how can we make money with $100 initially?

1-23 宁波工程学院国商教研室蒋力编 Triangular Arbitrage $ £ ¥ Bank 2 S($/£)=1.50 Bank 3 S (¥/£) =160 Bank 1 S(¥/$)=120 As easy as 1 – 3 – 2: 1.Sell our $ for ¥, ¥12000 at bank 1 2. Sell our ¥ for £, £75 at bank 3 3. Sell those £ for $. $ at bank 2 What if I have no $ at all? Perhaps I can do…

1-24 宁波工程学院国商教研室蒋力编 Triangular Arbitrage $ £ ¥ Bank 2 S($/£)=1.50 Bank 3 S (¥/£) =160 Bank 1 S(¥/$)=120 As easy as 1 – 3 – 2: 1.Sell our $ for ¥, ¥ Sell our ¥ for £, £75 3. Sell those £ for $. $ If everyone takes the arbitrage, what will happen?

1-25 宁波工程学院国商教研室蒋力编 Short -term movements Depreciation—when the value of one currency falls relative to another. For example, if the U.S. dollar depreciates against the Swiss franc, then it takes more dollars to buy one franc. Appreciation—when the value of one currency rises relative to another.

1-26 宁波工程学院国商教研室蒋力编 Depreciation & Appreciation

1-27 宁波工程学院国商教研室蒋力编 Short -term movements Why exchangge rates changes throughtout the day? Inventory control effects p14-15 Asymmetric information effects p16

1-28 宁波工程学院国商教研室蒋力编 Long term movements Trade flow model P17 Refer to Figure 1.3 Dollar/YEN Market Demand for DOLLAR curve—comes from the Japanese demand for U.S goods, services, and financial assets. Supply of DOLLAR curve—comes from the USA demand for Japanese goods, services, and financial assets. Equilibrium exchange rate—found at the intersection of the demand and supply curves.

1-29 宁波工程学院国商教研室蒋力编 FIGURE 1.5 Centra bank intervention Suppose the U.S. demand for British goods ↑, which causes the demand for pounds to shift to the right. As a result, the dollar ↓ and pound ↑. The Bank of England may intervene to stop the pound appreciation by supply more pounds in the foreign exchange market.

1-30 宁波工程学院国商教研室蒋力编 Exchange Rate Index

1-31 宁波工程学院国商教研室蒋力编 Exchange Rate Index Exchange Rate Index – a weighted average of a currency’s value relative to other currencies, where the weights are based on the relative trade importance of each currency. Page 21

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