Ch005 Market for Foreign Exchange

Eun & Resnick 4e CHAPTER 5 The Market for Foreign Foreign Exchange Function and Structure of the of  the FX Market International Finance in Practice: The Mouse Takes Over the Floor  FX Market Participants Correspondent Banking Relationships International Finance in Practice: Where Money Talks Very Loudly The Spot Market Spot Rate Quotations The Bid-Ask Spread  Spot FX Trading Cross-Exchange Rate Quotations  Alternative Expressions Expressions for the Cross-Exchange Cross-Exchange Rate The Cross-Rate Trading Desk  Triangular Arbitrage Spot Foreign Exchange Market Microstructure The Forward Market Forward Rate Quotations  Long and Short Forward Forward Positions Forward Cross-Exchange Rates Swap Transactions Forward Premium Summary MII CA!E: Shrewsbury erbal !roducts" Ltd#

Function an" !tructure of  the F# Market $ The world%s lar&est forei&n e'chan&e tradin& center is( a) *ew +o +ork   b) Toky Tokyo o c ) L ond on d) on& ,o ,on& -nswer( c)

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On avera&e" worldwide w orldwide daily tradin& of forei&n e'chan&e is a) impossible to estimate  b) /$0 billion c) /012 billion d) /$#33 trillion -nswer( d) 4

The forei&n e'chan&e market closes a)  *ever   b) 2(11 p#m# 5ST 6*ew +ork time) c) 2(11 p#m# 7MT 6London time) d) 2(11 p#m# 6Tokyo time) -nswer( a)  FX Market Participants 5un89esnick 2e

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Most forei&n e'chan&e transactions are for( a) ;ntervention by central banks  b) ;nterbank trades between international banks or nonbank dealers c) retail trade d)  purchase of hard currencies -nswer( b) 0

The difference between a broker and a dealer is a) the ask price is the price he char&es to sell# -nswer a) is a bit tricky" but the dealer%s historical cost is not necessarily the price at which he will be willin& to buy more $? Suppose the spot ask e'chan&e rate" Sa6/N)" is /$#:1 I $#11 and the spot bid e'chan&e rate" S b6/N)" is /$#3: I $#11# ;f you were to buy /$1"111"111 worth of =ritish pounds and then sell them five minutes later" how much of your /$1"111"111 would be CeatenD by the bidKask spread a) /$"111"111  b) /0.":$1#10 c) /$11"111 d) /0."?4$#03 -nswer( d) $#11 First" buy /$1m in pounds( /$1"111"111× = 0".?4"$0@#3:0 /$#:1 /$#3: 9ationale( then sell the pounds for dollars( 0".?4"$0@#3:0× = /:":2@"4?3#2. $#11  *et loss to bidKask spread I /$1" 111" 111 − /:":2@" 4?3#2. = /0." ?4$#03 $@ ;f the /8 bid and ask prices are /$#01 and /$#0$" respectively" the correspondin& 8/  bid and ask prices are( 5un89esnick 2e

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a) 1#???@ and 1#??.4  b) /$#0$ and /$#01 c) 1#??.4 and 1#???@ d) cannot be determined with the information &iven -nswer( c) 9ationale( $8/$#0$ I ask price I 1#??.4 bid price8/$> $8/$#01 bid price I 1#???@ ask price8/$# See eEuation 0K4( $ $ 1#??.4 a S  6/N) = b = = /$#11 S  6/ N ) /$#0$ Spot FX Trading $3 ;n conversation" ;nterbank FX trades use a shorthand abbreviation in e'pressin& spot currency Euotations# Aonsider a /8 bidKask Euote of /$#:[email protected]/$#:1@@# The Cbi& fi&ureD" assumed to be known to all traders is( a) /$#:1@@  b) $ c) $#:1 d) @@ -nswer( c)

$: in the ;nterbank market" the standard siBe of a trade amon& lar&e banks in the maor  currencies is a) for the #S#Kdollar eEuivalent of /$1"111"111"111  b) for the #S#Kdollar eEuivalent of /$1"111"111 c) for the #S#Kdollar eEuivalent of /$11"111# d) for the #S#Kdollar eEuivalent of /$"111 -nswer( b) .1 - dealer in =ritish pounds who thinks that the pound is about to appreciate a) May want to widen his bidKask spread by raisin& his ask price  b) May want to lower his bid price c) May want to lower his ask price d)  *one of the above -nswer( c) 9ationale( - dealer who thinks that the pound is about to appreciate will want to increase his inventory" none of the strate&ies listed will accomplish this# While a)

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Cross-Exchange Rate Quotations Countr% +ritain ,Poun"- ./01522 3 Month Forar"  Months Forar" / Months Forar" 30 Months Forar" Euro 6/01522 3 Month Forar"  Months Forar" / Months Forar" 30 Months Forar"

'!' ( e)ui*' Tues"a% Mon"a% $#?111 $#?$11 $#?$11 $#?411 $#?411 $#??11 $#??11 $#@.11 $#@.11 $#3111 $#.111 $#.111 $#.$11 $#.$11 $#.411 $#.411 $#.?11 $#.?11 $#.:11 $#4.11

Currenc% $er '!' ( Tues"a% Mon"a% 1#?.0 1#?.$$ 1#?.$$ 1#?$@4 1#?$@4 1#?1.2 1#?1.2 1#03$2 1#03$2 1#000? 1#344444 1#344444 1#3.?20 1#3.?20 1#3$4113 1#3$4113 1#@:4?0$ 1#@:4?0$ 1#@@0$:2 1#@0@0@03

.$ sin& the table shown" what is the spot crossKe'chan&e rate between pounds and euro a)  G$#11 I 1#@0  b) $#44 I G$#11 c) $#11 I G1#@0 d) none of the above -nswer( a) /$#.1 $#11 × = 1#@0  you also &et the same result with indirect Euotes 9ationale(  G$×  G$ /$#?1 .. The dollarKeuro e'chan&e rate is /$#.0 I G$#11 and the dollarKyen e'chan&e rate is P$11 I /$#11# What is the euroKyen cross rate a) P$.0 I G$#11  b) P$#11 I G$.0 c) P$#11 I G1#31 d)  *one of the above -nswer( a) .4 The -