International Economics 11/11/61 Session 18 Forward Exchange and International Financial Investment Aj. Noom (anuphak@gmail.com) Tel.0835426434

Negotiate to buy goods today Agreement bases on paying in dollar Exchange Rate Risk 25 Bath/ 1 dollar Negotiate to buy goods today U.S Exporter Thai Importer Agreement bases on paying in dollar Goods Money What would happen if the money will be paid in the next 3 months by using the spot rate on the due date ? Could . “Lost” (i.e. if 26 Bath/ 1 dollar)

Negotiate to buy goods today Agreement bases on paying in bath 25 Bath/ 1 dollar Negotiate to buy goods today U.S Exporter Thai Importer Agreement bases on paying in bath Goods Money What would happen if the money will be paid in the next 3 months by using the spot rate on the due date ? Could . “Lost” (i.e. if 24 Bath/ 1 dollar)

Basic Approach to Avoid Exchange Rate Risk Bank Borrow the money (Thai Baht) Interest Difference = Importer lost Bank Deposit in dollar Interest Sometimes in the future Exchange “Baht” to “Dollar” U.S Exporter Thai Importer Negotiate to buy goods today Agreement bases on paying in dollar

Thai bath is returned by due date Difference = Exporter lost Bank Borrow the money (Thai Baht) Interest Bank Deposit in dollar Interest Exchange “Baht” to “Dollar” U.S Exporter Thai Importer Negotiate to buy goods today Agreement bases on paying in baht Thai bath is paid by due date

The Market Basics of Forward Foreign Exchange The agreement to exchange on currency for another in some date in the future at a price set now (the Forward Exchange Rate). Bank Forward Foreign exchange contract (to buy) Fee Sometimes in the future (Normally, 30, 90, and 180 days) 25 Bath/ 1 dollar U.S Exporter Thai Importer Negotiate to buy goods today Agreement bases on paying in dollar Hedging Using Forward Foreign Exchange

Thai bath is sold by due date Bank Forward Foreign exchange contract (to Sell) Dollar is returned 25 Bath/ 1 dollar U.S Exporter Thai Importer Negotiate to buy goods today Agreement bases on paying in baht Thai bath is paid by due date

Speculating Using Forward Foreign Exchange Bull Speculator Bull Market Expect the value of other currency will appreciate. (i.e., from 25 baht/ 1dollar to 24 baht/1dollar) Bank Buy other currency (Thai bath*) Bull Speculator (US) Bank Other currency will be sold sometimes in the future (Baht will be sold) Right prediction = profit Wrong prediction = lost *In the meantime, this amount of money will be deposited in the bank for the interest

Borrow other currency (Thai bath) Bear Speculator Bear Market Expect the value of other currency will depreciate. (i.e., from 25 baht/ 1dollar to 26 baht/1dollar) Bank Borrow other currency (Thai bath) Sometimes in the future, their own currency will be exchanged back into other currency; and other currency be will returned to the bank. In this case, the rest of other currency is profit. (Dollar to bath ; and bath will be returned) Bear Speculator (US) Exchange it into its currency by using spot rate (Thai bath to dollar*) Right prediction = profit Wrong prediction = lost *In the meantime, this amount of money will be deposited in the bank for the interest.

Financial Investment on Spot Exchange Rate Basis Sell & Buy on spot rate basis Current $ Current £

Financial Investment on Forward Exchange Rate Basis Buy $ (Sell £ for $) Future £ Future $ Buy £ (Sell $ for £) Borrow in the U.S. Invest in the U.S. Borrow in the U.K. Invest in the U.K. Current $ Current £

Interest Arbitrage 1) Covered Interest Arbitrage The process for buying a country’s currency spot and selling that country’s currency forward; this is the riskless procedure which could also make a net profit from the combination of the different in interest rates between countries and the forward premium on that country’s currency. 2) Uncovered Interest Arbitrage The process for buying a country’s currency spot and selling that country’s currency without forward ; this is the high-risk procedure which could also make a net profit from the combination of the different in interest rates between countries and the forward premium on that country’s currency.