Lecture 4 (2)

Question 1

In general, we use S(j/k) to denote the price of one unit of currency k in terms of currency j in the spot market. Thus, denominator is referring to one unit of currency k

Question 2

Cross-exchange rate

Answer 2

is an exchange rate between a currency pair where neither currency is the U.S dollar.

Question 3

The cross-exchange rate can be calculated from the U.S. dollar exchange rates for the two currencies, using either european or american term quotations

Answer 3

S(j/k) = S($/k) x S(j/$)

S(k/j) = S(k/4) x S($/j)

Example S($/euro) = 1.1235

Question 4

Bid price

Answer 4

Price at which the bank buys the currency at

E.g. Dealer will buy euros from you at the bid price of 1.25 per euro

Question 5

Ask price

Answer 5

Price at which the bank sells the currency at

E.g. dealer will sell euros to you at the ask price of 1.26$

Question 6

The bid ask spread

Answer 6

Difference between the bid and ask prices

It represents the dealers expected profit

The bid ask spread level varies across market levels

It is extremely narrow in the interbank market

Question 7

mid rates

Answer 7

Average of the bid and ask rates are called

Question 8

in the interbank market the standard size of trad is about _____ and bid ask quotes are normally in _____ decimal places

Answer 8

10 million

Four decimal places

Question 9

Currency against currency trade

Answer 9

is when a customer wants to trade out a nondollar currency for another nondollar currency

Question 10

Incorporating bid-ask spreads into cross-exchange rates gives us

Answer 10

S^b(SFr/pounds) = S^b($/pounds) x S^b(SFR/$)

E.g. $/£ bid–ask prices are $1.3442 to $1.3447

Question 11

arbitrage

Answer 11

A zero-risk, zero-investment strategy from which a profit is guaranteed

Question 12

The purpose of triangular arbitrage

Answer 12

To earn an arbitrage profit by trading among three currencies when the quoted cross-exchange rate is not in alignment with the implied cross-exchange rate

Question 13

forward market

Answer 13

involves contracting today for the future purchase or sale of FX

no money changes hands upon entering the contract today

May be used to hedge FX exposure or to speculate in FX market

Forward price is usually higher (at a premium) or lower (at a discount) than spot price

Question 14

Forward rate quotations use the following notations

Answer 14

FN(j/k) is the notation used to refer to the price of one unit of currency k in terms of currency j for delivery in N months

F notations is used to denote a forward exchange rate

Like spot quotes, forward quotes are either direct or indirect with one being the reciprocal of the other

Question 15

Forward market (some info)

Answer 15

Common to express the premium or discount of a forward rate as an annualized percentage deviation from the spot rate

Forward premium (or discount) is useful for comparing against the interest rate differential between two countries

Forward premium or discount can be calculated using american or european term quotations

Question 16

The formula for calculating the forward premium or discount for currency j over N period in american terms is

Answer 16

f-N,j = F-N($/j) - S($/j) / S($/j) x 360/days

Question 17

The forward market some stuff

Answer 17

Due to government instituded capital controls, currencies of some emerging market countries are not freely traded

Not possible to obtain these currencies offshore in the spot market to settle a forward position

For many of these currencies, trading in non-deliverable forward (NDF) contracts exists

Question 18

An NDF contract

Answer 18

Unlike a deliverable forward (DF) is settled in cash at the difference between the spot exchange on the maturity date of the contract and the NDF rate times the notional amount of the contract

Question 19

From the banks standpoint an outright forward transactions is

Answer 19

An uncovered speculative position in a currency, even though it might be a part of a currency hedge to the bank customer on the other side of the transaction

Question 20

Swap transactions

Answer 20

Provide a means for the bank to mitigate the currency exposure in a forward trade

Question 21

Exchange-traded fund (ETF)

Answer 21

is a portfolio of financial assets in which shares representing fractional ownership of the fund trade on an organized exchange

Allow small investors the opportunity to invest in portfolios of financial assets that they would find difficult to construct individually

Assets invested in the global ETF industry reach a new record of 10,27 trillion at the end of december

Currency ETFs were first offered by Guggenheim investments in 2005 and traded on the NYSE