Lecture 11
THE FOREIGN-EXCHANGE MARKET
1. The participants
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Commercial banks
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Corporations
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Nonbank financial institutions
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Institutional investors
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Central banks
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Speculators (Rogues? Or just misunderstood?)
2. Bid and ask (offer) quotations
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Bid: Price at which trader is willing to buy foreign
currency
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Ask: Price at which trader is willing to sell foreign
currency
3. Spot rates and forward rates
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Spot: Rate quoted for current foreigncurrency transactions
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Forward: For transactions that call for delivery in
the future
3.1 Forward discount/premium
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Difference between spot rate and forward rate
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If forward rate < spot rate, currency is selling at discount
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Annualized forward premium:
3.2 Hedging
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Used by exporters and importers
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Protection against exchange-rate risk
4. Other transactions
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Currency futures
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Futures contracts traded on exchanges (CME)
Specific amount; specific maturity date
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Forward contracts can be tailored
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Foreign-exchange swaps
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Currency options
5. Arbitrage
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Profit opportunities due to price differentials
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With two currencies
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With three currencies (triangular arbitrage)
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Cross rates
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