International Finance 国际经济学 Lectured by Yuanfen Tu School of International Trade and Economics Email:jxnctyf@126.com

International Finance By Robert J. Carbaugh 13th Edition Chapter 2: Foreign Exchange

Arbitrage Exchange arbitrage Simultaneous purchase and sale of a currency In different foreign-exchange markets To profit from exchange-rate differentials in the two locations Brings about an identical price for the same currency in different locations Results in one market 3

Arbitrage Two-point arbitrage Two currencies are traded between two financial centers If ₤1=$2 in New York ₤1=$2.01 in London Foreign-exchange traders will purchase pounds at $2 per pound in New York and immediately resell them in London for $2.01 . This arbitrage process will continue until the exchange rate in New York is the same as that in London 4

Arbitrage

Arbitrage

Arbitrage Three-point arbitrage Triangular arbitrage Three currencies and three financial centers Switching funds among three currencies in order to profit from exchange-rate inconsistencies If ₤1=$1.5 in New York, ₤1=4francs in Geneva 1 franc=$0.50 in London Sell $1.5million for ₤1 million Simultaneously, sell ₤1 million for 4 million francs. At the same time, sell 4 million francs for $2 million 7

Forward Market Currencies bought and sold now for future delivery – typically 1, 3, or 6 months Exchange rate agreed on at the time of the contract Payment made only when actual delivery takes place Banks provide this service to earn profits Forward rate Rate of exchange used in the settlement of forward transactions

The Forward Market At a premium At a discount When a foreign currency is worth more in the forward market than in the spot market At a discount When a foreign currency is worth less in the forward market than in the spot market 9

Forward exchange rates: selected examples TABLE 2.8 Forward exchange rates: selected examples 10

Forward Rate What determines the forward rate? Interest-rate differentials between countries Why might it be at a premium or discount compared to the spot rate? One country’s interest rates higher than another’s, currency is a forward discount One country’s interest rates lower than another country’s, currency is a forward premium

The Forward Market Relation between the forward rate and spot rate Interest rate on six-month treasury bills is five percent in the U.S. and three percent in Swiss 12

Forward market functions Foreign exchange Hedging (套期保值)refers to the process of avoiding or covering a foreign-exchange risk. Case 1: U.S. importer hedges against a dollar depreciation import purchase foreign currency in the forward market in advance Case 2: U.S. exporter hedges against a dollar appreciation export sell foreign currency in the forward market in advance 13

Does Foreign-Currency Hedging Pay Off? Standard argument for hedging: Increased stability of cash flows and earnings Reasons companies may not view hedging as a benefit: Locks in an exchange rate costs up to half a percentage point per year of the revenue being hedged Fluctuations in a firm’s business can detract from the effectiveness of foreign-currency hedging The ups and downs for currencies would even out over the long run

Exchange-rate risk: the hazard of investing abroad Exchange-rate fluctuations Can substantially change the returns on assets denominated in a foreign currency Interest rates Key role in determining the relative attractiveness of assets denominated in domestic and foreign currencies Effects of exchange-rate changes Can swamp the effects of interest-rate differentials 15

Return on a three-month German investment TABLE 2.9 Return on a three-month German investment 16

Interest Arbitrage Interest arbitrage refers Moving funds into foreign currencies To take advantage of higher investment yields abroad Uncovered interest arbitrage When an investor does not obtain exchange-market cover To protect investment proceeds from foreign-currency fluctuations 17

uncovered interest arbitrage: an example TABLE 2.10 uncovered interest arbitrage: an example 18

Interest Arbitrage A U.S. investor’s extra rate of return On an investment in the United Kingdom as compared to the U.S. = interest-rate differential adjusted for any change in the value of the pound 19

Interest Arbitrage Covered interest arbitrage Investor exchanges domestic currency for foreign currency - at the current spot rate And uses the foreign currency to finance a foreign investment Investor contracts in the forward market To sell the amount of the foreign currency that will be received as the proceeds from the investment With a delivery date to coincide with the maturity of the investment 20

Covered interest arbitrage: an example TABLE 2.11 Covered interest arbitrage: an example 21

Interest Arbitrage Forward discount or premium On one currency against another Reflects the difference in the short-term interest rates between the two nations Forward discount The currency of the higher-interest-rate nation Forward premium The currency of the lower-interest-rate nation 22

Foreign-Exchange Market Speculation Attempt to profit by trading on expectations about prices in the future Speculation differs from arbitrage, in that it involves the purchase or sale of a currency in the expectation that its value will change in the future Deliberate assumption of exchange risk With arbitrage, a currency trader simultaneously buys a currency at a low price and sells that currency at a high price. 23

Foreign-Exchange Market Speculation Stabilizing speculation Goes against market forces by moderating or reversing a rise or fall in a currency’s exchange rate Useful function for bankers and businesspeople, who desire stable exchange rates 24

Foreign-Exchange Market Speculation Destabilizing speculation Goes with market forces by reinforcing fluctuations in a currency’s exchange rate Can disrupt international transactions High cost of hedging – impeding international trade Disrupt international investment activity 25

How to play the falling (rising) dollar Depreciating dollar Purchase foreign currency Purchase bonds denominated in a foreign currency Purchase stocks of foreign corporations, denominated in foreign currencies Savings account denominated in a foreign currency Variety of currency derivatives 26

Foreign Exchange Trading as a Career Foreign exchange traders Commercial Banks Companies Central Banks Professional traders Amateurs speculating in foreign currencies 27

Speculation in the spot market Foreign exchange Given: spot price is $0.40 per franc Assumption: in 3 months, the spot price of the franc will rise to $0.50. Procedure: 1.Purchase francs at $0.40 per franc and deposit them in a bank. 2.In 3 months, sell the francs at $0.50 per franc. 28

Speculation in the spot market Foreign exchange Given: spot price is $0.40 per franc Assumption: in 3 months, the spot price of the franc will fall to $0.25 Procedure: 1.Borrow francs today, exchange them for dollars at $0.40 per franc, and deposit the dollars in a bank 2.In 3 months, buy the francs at $0.25 per franc and use them to pay back the loan. 29

Speculation in the forward market Foreign exchange Forward market speculation occurs when a speculator believes that a currency’s spot price at some future date differ from today’s forward price for that same date. 30

Speculation in the forward market Foreign exchange Given: current price of the 3-month forward franc is $0.40 per franc Assumption: in 3 months, the prevailing spot price of the franc will be $0.50. Procedure: 1.Contract to purchase a specified amount of francs in the forward market, at $0.40 per franc, for 3-month delivery. 2.In 3 months, sell the francs at $0.50 per franc in the spot market. 31

Speculation in the forward market Foreign exchange Given: current price of the 3-month forward franc is $0.40 per franc Assumption: in 3 months, the prevailing spot price of the franc will be $0.30. Procedure: 1. Contract to sell a specified amount of francs in the forward market, at $0.40 per franc, for 3-month delivery. 2.In 3 months, purchase an identical amount of franc in the spot market at $0.30 per franc and deliver them to fulfill the forward contract. 32

Speculation in the forward market Foreign exchange Long position（多头）is the position speculator take when they purchase a foreign currency on the spot or forward market with the anticipation of selling it at a higher future spot price. Short position（空头）is the position speculator take when they borrow or sell forward a foreign currency with the anticipation of purchasing it at a lower price to repay the foreign-exchange loan or fulfill the forward sale contract. 33

多头套期保值案例 美国某进口商2月10日从德国购进价值125000马克的货物，1个月后支付货款。为防止德国马克升值而使进口成本增加，该进口商买入1份3月期德国马克期货合约，面值125000马克，价格为USD0.5841/DEM，1个月后德国马克果然升值，现汇价由USD0.5815/DEM变为USD0.5945/DEM，期货价变为USD0.5961/DEM，试计算该进口商的进口成本上的损益变化。

套期保值的基本特征是，在现货市场和期货市场对同一种类的商品同时进行数量相等但方向相反的买卖活动，即在买进或卖出实货的同时，在期货市场上卖出或买进同等数量的期货，经过一段时间，当价格变动使现货买卖上出现的盈亏时，可由期货交易上的亏盈得到抵消或弥补。从而在"现"与"期"之间、近期和远期之间建立一种对冲机制，以使价格风险降低到最低限度。期货市场毕竟是不同于现货市场的独立市场，它还会受一些其他因素的影响，因而期货价格的波动时间与波动幅度不一定与现货价格完全一致；加之期货市场上有规定的交易单位，两个市场操作的数量往往不尽相等，这些就意味着套期保值者在冲销盈亏时，有可能获得额外的利润或亏损。