Download - FOREX Participants[1]
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London is Most Active FX Market
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Daily Trading Volumes by Hour
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Correspondent Banking
Relationships
Large commercial banks maintaindemand deposit accounts with oneanother which facilitates the efficient
functioning of the forex market. International commercial banks
communicate with one another with: SWIFT: The Society for Worldwide
Interbank Financial Telecommunications. CHIPS: Clearing House Interbank PaymentsSystem
ECHO Exchange Clearing House Limited, the
first global clearinghouse for settlinginterbank FOREX transactions.
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Correspondent Banking
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FX Turnover
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Spot Rate Quotations
Direct quotation
the U.S. dollar equivalent
e.g.a Japanese Yen is worth about apenny
Indirect Quotation
the price of a U.S. dollar in the foreign
currency
e.g.you get 100 yen to the dollar
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Spot Rate Quotations
The directquote for
British pound
is:
1 = $1.5627
Country USDequivFriday
USD equivThursday
Currency perUSD Friday
Currency perUSD Thursday
Argentina (Peso) 0.3309 0.3292 3.0221 3.0377
Australia(Dollar)
0.5906 0.5934 1.6932 1.6852
Brazil (Real) 0.2939 0.2879 3.4025 3.4734
Britain (Pound) 1.5627 1.566 0.6399 0.6386
1 MonthForward
1.5596 1.5629 0.6412 0.6398
3 MonthsForward
1.5535 1.5568 0.6437 0.6423
6 MonthsForward
1.5445 1.5477 0.6475 0.6461
Canada (Dollar) 0.6692 0.6751 1.4943 1.4813
1 MonthForward
0.6681 0.6741 1.4968 1.4835
3 Months
Forward
0.6658 0.6717 1.502 1.4888
6 Months 0.662 0.6678 1.5106 1.4975
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Spot Rate Quotations
The indirect
quote for
Britishpound is:
.6399 = $1
1.49751.51060.66780.6626 Months Forward
1.48881.5020.67170.66583 Months Forward
1.48351.49680.67410.66811 Month Forward
1.48131.49430.67510.6692Canada (Dollar)
0.64610.64751.54771.54456 Months Forward
0.64230.64371.55681.55353 Months Forward
0.63980.64121.56291.55961 Month Forward
0.63860.63991.5661.5627Britain (Pound)
3.47343.40250.28790.2939Brazil (Real)
1.68521.69320.59340.5906Australia (Dollar)
3.03773.02210.32920.3309Argentina (Peso)
Currency per
USD Thursday
Currency per
USD Friday
USD equiv
Thursday
USD equiv
FridayCountry
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Spot Rate Quotations
Note that
the direct
quote is thereciprocal
of the
indirect
quote:
11.5627
.63991.49751.51060.66780.6626 Months Forward
1.48881.5020.67170.66583 Months Forward
1.48351.49680.67410.66811 Month Forward
1.48131.49430.67510.6692Canada (Dollar)
0.64610.64751.54771.54456 Months Forward
0.64230.64371.55681.55353 Months Forward
0.63980.64121.56291.55961 Month Forward
0.63860.63991.5661.5627Britain (Pound)
3.47343.40250.28790.2939Brazil (Real)
1.68521.69320.59340.5906Australia (Dollar)
3.03773.02210.32920.3309Argentina (Peso)
Currency per
USD Thursday
Currency per
USD Friday
USD equiv
Thursday
USD equiv
FridayCountry
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The Bid-Ask Spread
The bid price is the price a dealer iswilling to pay you for something.
The ask price is the amount thedealer wants you to pay for thething.
The bid-ask spread is the differencebetween the bid and ask prices.
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Spot FX trading
In the interbank market, thestandard size trade is about U.S. $10million.
A bank trading room is a noisy,active place.
The stakes are high.
The long term is about 10 minutes.
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Cross Rates
Suppose that S($/) = .50
i.e. $1 = 2
and that S(/) = 50 i.e. 1 = 50
What must the $/ cross rate be?$ $
since ,
$1 1 $1($ / ) .01 or $1 100
2 50 100
S
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Triangular Arbitrage
$
Credit
Lyonnais
S(/$)=1.50
Credit Agricole
S(/)=85
Barclays
S(/$)=120
Suppose we
observe these
banks posting
these exchange
rates.
First calculate theimplied cross
rates to see if an
arbitrage exists.
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Triangular Arbitrage
$Credit
Lyonnais
S(/$)=1.50
Credit Agricole
S(/)=85
Barclays
S(/$)=120
80
1
120
1$
1$
50.1
The implied S(/) cross
rate is S(/) = 80
Credit Agricole has
posted a quote of
S(/)=85 so there is anarbitrage opportunity.
So, how can we make money?
Buy the @ 80; sell @ 85. Then trade yen for dollars.
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Triangular Arbitrage
$Credit
Lyonnais
S(/$)=1.50
Credit Agricole
S(/)=85
Barclays
S(/$)=120
As easy as 1 23:
1. Sell our $ for ,
2. Sell our for ,
3. Sell those for $.
1
2
3
$
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Triangular Arbitrage
Sell $100,000 for at S(/$) = 1.50
receive 150,000
Sell our 150,000 for at S(/) = 85
receive 12,750,000
Sell 12,750,000 for $ at S(/$) = 120
receive $106,250
profit per round trip = $ 106,250- $100,000 = $6,250
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Spot Foreign Exchange
Microstructure Market Microstructure refers to the
mechanics of how a marketplace operates.
Bid-Ask spreads in the spot FX market:
increase with FX exchange rate volatility and decrease with dealer competition.
Private information is an importantdeterminant of spot exchange rates.
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The Forward Market
A forward contract is an agreementto buy or sell an asset in the futureat prices agreed upon today.
If you have ever had to order an out-of-stock textbook, then you haveentered into a forward contract.
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Forward Rate Quotations
The forward market for FOREX involvesagreements to buy and sell foreigncurrencies in the future at prices agreed
upon today. Bank quotes for 1, 3, 6, 9, and 12 month
maturities are readily available for forwardcontracts.
Longer-term swaps are available.
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Forward Rate Quotations
Consider the example from above:
for British pound, the spot rate is
$1.5627 = 1.00While the 180-day forward rate is
$1.5445 = 1.00
Whats up with that?
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Spot Rate Quotations
Clearly the
market
participantsexpect that
the pound
will be
worth lessin dollars in
six months.1.49751.51060.66780.6626 Months Forward
1.48881.5020.67170.66583 Months Forward
1.48351.49680.67410.66811 Month Forward
1.48131.49430.67510.6692Canada (Dollar)
0.64610.64751.54771.54456 Months Forward
0.64230.64371.55681.55353 Months Forward
0.63980.64121.56291.55961 Month Forward
0.63860.63991.5661.5627Britain (Pound)
3.47343.40250.28790.2939Brazil (Real)
1.68521.69320.59340.5906Australia (Dollar)
3.03773.02210.32920.3309Argentina (Peso)
Currency per
USD Thursday
Currency per
USD Friday
USD equiv
Thursday
USD equiv
FridayCountry
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Long and Short Forward
Positions If you have agreed to sell anything (spot
or forward), you are short.
If you have agreed to buy anything
(forward or spot), you are long. If you have agreed to sell forex forward,
you are short.
If you have agreed to buy forex forward,
you are long.
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Payoff Profiles
0S180($/)
F180($/) = .009524
Short positionloss
profitIf you agree to sell anythingin the
future at a set price and the spot
price later falls then you gain.
If you agree to sell anythingin the
future at a set price and the spot
price later rises then you lose.
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Payoff Profiles
loss
0 S180(/$)
F180(/$) = 105
-F180(/$)
profit
Whether thepayoff profile
slopes up or down
depends upon
whether you usethe direct or
indirect quote:
F180(/$) = 105 or
F180($/) = .009524.
short position
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Payoff Profiles
loss
0S180(/$)
F180(/$) = 105
-F180(/$)
When the short entered into this forward contract,
he agreed tosell in 180 days atF180(/$) = 105
profitshort position
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Payoff Profiles
loss
0S180(/$)
F180(/$) = 105
-F180(/$)
120
If, in 180 days, S180(/$) = 120, the short will
make a profit by buying at S180(/$) = 120 and
delivering atF180(/$) = 105.
15
profitshort position
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Payoff Profiles
loss
0S180(/$)
F180(/$) = 105
Long position-F180(/$)
F180(/$)short position
profitSince this is a zero-sum game,
the long position payoff is the
opposite of the short.
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Payoff Profiles
loss
0S180(/$)
F180(/$) = 105
Long position
-F180(/$)
profitThe long in this forward contract agreed to BUY
in 180 days atF180(/$) = 105
If, in 180 days, S180(/$) = 120, the long will
lose by having to buy at S180(/$) = 120and delivering atF180(/$) = 105.
120
15
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SWAPS
A swap is an agreement to provide acounterparty with something hewants in exchange for something
that you want. Swap transactions account for
approximately 56 percent ofinterbank FX trading, whereasoutright trades are 11 percent.
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Forward Premium
Its just the interest rate differentialimplied by forward premium or discount.
For example, suppose the is
appreciating from S($/) = .5235 toF180($/) = .5307
The forward premium is given by:
180
180, $
($ / ) ($ / ) 360 .5307 .5235.01375
($ / ) 180 .5235v
F Sf
S