While implementing those strategies, there would be existing several risks that the company might face in the future and therefore offer some

QUESTION 1 Trading strategy According to forecasts based on the market view on stage one, the exchange rate of the US dollar to the Japanese yen will show an upward trend in the next si

Higher education cover sheet

for submission of work assessment

School School of Economics, Finance and Marketing

Course/unit name Financial Makets Course/unit code BAFI1002

Name of lecturer/teacher Obaid Awan

Name of tutor/marker Pete Fernandes

Assignment no 02 Due date (DD/MM/YYYY) 29 May 2020 Class day/time Wednesday 16:3—17:30 Campus City

Student/s

Family name Phung Given name Ha Chi Student no s3757245 Family name Yang Given name Yi Student no s3798354 Family name Chen Given name Wenzhao Student no s3714451

Declaration and statement of authorship

1 I/we hold a copy of this work that can be produced if the original is lost/damaged.

2 This work is my/our original work and no part of it has been copied from any other student’s work or from any other source except where due acknowledgement is made.

3 No part of this work has been written for me/us by any other person except where such collaboration has been authorised by the lecturer/teacher concerned.

4 I/we have correctly acknowledged the -use re of any of my/our own previously submitted work within this submission.

5 I/we give permission for this work to be reproduced, communicated, compared and archived for the purpose of detecting plagiarism.

6 I/we give permission for a copy of my/our marked work to be retained by the school for review and comparison, including review by external examiners.

I/we understand that:

7 plagiarism is the presentation of the work, idea or creation of another person as though it is my/our own It is a form of cheating and is a very serious academic offence that may lead to exclusion from the University Plagiarised material can be drawn from, and presented in, written, graphic and visual form, including electronic data and oral presentations Plagiarism occurs when the origin of the material used

is not appropriately cited.

8 plagiarism includes the act of assisting allowing another person or to plagiarise or to copy my/our work.

Student signature/s

I/we declare that I/we have read and understood the declaration and statement of authorship.

Further information relating to the penalties for plagiarism, that range from a notation on your student file to expulsion from the University, is contained in the Student Conduct Regulation, Division 2 Academic Misconduct and the Assessment Policy that are available on the Policies and Procedures website

at rmit.edu.au/about/governance-management/policies

Copies of this form can be downloaded from the student forms webpage at rmit.edu.au/students/student-essentials/forms/assessment-forms

Office use only

Date stamp

ASSESSMENT TASK 2

BAFI1002

Session attended: 03

Name of FX Session Instructor: Rui Huo

ASSIGNMENT GROUP STAGE 2: FX REPORT 32

CONTRIBUTION PAGE

Student’s Name Student’s ID Contribution Percentage

Phung Ha Chi s3757245 33.33%

Chen Wenzhao s3714451 33.33%

I INTRODUCTION

Our group is working for a renowned FX trading company, Xhi-Trade The company

specializes in trading major currencies such as Australian dollar (AUD), United States dollar (USD), Japanese Yen (JPY), Euro (EUR) and Great British Pound (GBP) Our main

responsibility is trading foreign currencies in order to improve the firm's trading strategy and profits We will be devising trading strategies that help companies take advantage of our predicted changes in the exchange rates While implementing those strategies, there would be existing several risks that the company might face in the future and therefore offer some recommendations which will be discussed below

II QUESTION 1

Trading strategy

According to forecasts based on the market view on stage one, the exchange rate of the

US dollar to the Japanese yen will show an upward trend in the next six months which means the US dollar will appreciate against the Japanese yen Therefore, the general strategy is to short the Japanese yen and go long on the US dollar for the maximum of the profits at the end

For the pair of USD/JPY and as a price taker, first of all we sell the US dollar and buy the Japanese yen at the bid rate which means make the US dollar at a short position and the Japanese yen at a long position As an Australian company, we transact both the US dollar and the Japanese yen to the Australian dollar at the mid rate to get the profit After that we sell the Japanese yen and buy the US dollar at the ask rate which equalative to shorting the Japanese yen and making the US dollar at the long position as we expected

• The first step

The senior management has allocated 400,000,000 as the initial balance for speculation strategy for speculating on AUD, USD, EUR or GBP and 25,000,000,000 for speculating on JPY For instance, we are speculating on USD/JPY and decided to short the USD then we have been allocated 400,000,000 US dollars for this purpose As a price taker, the long position of the Japanese yen should be calculated using bid rates provided in Table 1 which is 110.62 Based on this position, we estimate the opening AUD value of the current portfolio

for the first stage The data shows below in Table 2

Currenc

y

Opening Position (current)

Position in AUD (Current)

Net Trade

s

Net Position (Expected )

Net Position

in AUD (Expected )

Change

in Positio

n (AUD)

AUD

-696,621,386.276

6

GBP

EUR

0

696,818,897.637

8

Net

Position

(AUD)

197,511.3612

Table 2: FX portfolio position summary

III QUESTION 2

Calculate bid rate, ask rate and mid rate

Comm /

Mid

EUR/JPY 119.3698 119.4138 119.3918

GBP/JPY 134.1952 134.2757 134.2355

At the beginning for this stage, the first goal is to go long on the US Dollar, increase its price

by maintaining a long-term position of the currency at the end of the session Next is the risk management recommendation for senior managers by eliminating the positions of currencies not speculation while simultaneously maximizing profits during the session

We sold the total amount of 400,000,000 USD then collected 44,248,000,000 JPY as the bank quote for USD/JPY is 110.62/64 Our current position in AUD of USD and JPY is 696,818,897.6378 and 696,818,897.6378 respectively We use the ask rate of table 3 to calculate the net trade which is 409,969,424.6271 When we have an opening position and net trade, therefore we can calculate the net position which equals 9,969,424.6271 From that, a

When the session ended, we had gained 16,044,627.1645 AUD as net profits for the company

Since the session was over, our group has seen risks and obstacles when implementing big

changes in currency and exchange rates since it might be hard for them to expect their

K & Werner, R 2015) Therefore, a financial instrument - a forward exchange contract can be

exchange contract is an agreement whereby a business agrees to buy or sell a certain amount

of foreign currency on a specific date in the future (RBA, 2006) By using this instrument, the business can protect itself from exchange rate’s movements and minimize their loss (Marc,

G, Tim, K & Werner, R 2015) Although this risk is not a long-term problem and can be defined clearly, the company should pay attention to it otherwise the company will lose a plenty of profit when they can not control the purchase and sale transactions

bid/ask rates

Curre

ncy

Opening

Position

(current)

Position in AUD (Current)

Net Trades

Net Position (Expected )

Net Position in AUD (Expected)

Change in Position (AUD)

AUD

USD

-400,000,0

00

-696,621,386 2766

409,969,424

6271

16,242,138

5257

GBP

EUR

.6378

-44,248,000, 000

0 Net

Positio

n

(AUD)

197,511.361 2

16,242,138

5257

16,044,627 1645 Table 2 updated: FX portfolio position summar

IV QUESTION 3

IDENTIFY POTENTIAL ARBITRAGE OPPORTUNITIES IN AUD, USD AND GBP

CURRENCIES

From the expected exchange rates in Question 2 table 3, we can see that there is a price difference between buying and selling from AUD, USD and GBP currency, therefore the company can generate profits through the triangular arbitrage

The way of triangle arbitrage is to let the traders convert one currency (A) to another currency (B) in one bank, after that they will convert the second currency (B) to another currency (C) in the second bank, and finally convert the third currency (C) to the original currency (A) in the third bank The same bank will have information efficiency to ensure that all its currency exchange rates keep the same consistently, so different financial institutions will gain profits better in real life It would be better if a company can choose the institution with the lowest buying and the highest selling exchange rate according to different financial institutions in the future, the company will be able to generate more profits from interest rate differences in different financial markets But for this problem, if the exchange rates of all the financial institutions' currencies in the market are the same, then the earned interest rate difference should be considered according to the exchange rates between the currencies themselves

According to Table 1, we can analyse if there is a chance for Australian Dollars, the US Dollars and the Great Britain Pounds According to the strategy mentioned above, if we first use USD as the principal, so we will purchase AUD by 1 million USD, then convert AUD to GBP, and then convert GBP to USD, we will gain 1189 USD as profit Second, we use AUD

as the principal, so we will purchase GBP by 1 million AUD, then convert GBP to USD and then convert USD back to AUD, we will gain 927 AUD as profit Third, we use GBP as the

convert USD back to GBP, as a result, we will lose profit So, the result proves that the triangle arbitrage between these three currencies cannot be all profitable When using the US dollars and Australian dollars as the principal, the company can get a profit Therefore, we can advise Australian companies to use the Australian dollars as the principal for the triangular arbitrage between these three currencies

Table 4: Expected exchange rates of AUD, GBP and USD

According to the exchange rates of the three currencies of AUD, USD and GBP provided in the figure above (Table 4), the traders can generate profits by buying currency with high Bid rate and selling convert another currency with low Bid rate So the traders can exchange the amount currency at one exchange rate (country B / country A), which is GBP/AUD, then convert it as another rate (B / C), which is GBP/USD, and finally convert it the third currency back to the original currency (A / C), which is AUD/USD, the traders will generate profits by this triangular arbitrages as well as we assume the transaction cost is low According to the profit principle of arbitrage, only buying a currency with a high exchange rate and selling it with a currency with low exchange rate can gain profits Therefore, according to the exchange rate shown in the table, the highest exchange rate of the three currencies is GBP / AUD, so you can buy pounds with Australian dollars, then buy US dollars with the pounds you hold, and finally buy Australian dollars back with the US dollars In this way, the initial Australian dollars will be profitable through triangle arbitrage

Now the company has 200,000,000 AUD, which can be brought in for calculation through the triangular arbitrage method mentioned above

We will use the bid rate to calculate the profits The bid rate between the three currencies listed below:

According to the triangle arbitrage mentioned above, first, the company will convert 200,000,000 AUD to GBP at the exchange rate of 2.0291, which is 200,000,000 AUD multiple 2.20291 equals 405,820,000 GBP, so the company now has 405,820,000 Pounds Next, the company convert holding 405,820,000 Pounds to US dollars at the exchange rate of 1.2437, which is 405,820,000 GBP divide 1.2437 equals to 326,300,555 USD, so the company now have 326,300,555 US dollars Then, the company using the holding US dollars converts it back to the Australian dollars at the exchange rate of 0.6135, 326,300,555 USD multiple 0.6135 equals to 200,185,390 AUD So, after triangle arbitrage of AUD, USD and GBP, the company finally has 200,185,390 AUD assets Subtracting the 200,000,000 AUD initial principal, the final total profit from a risk-free arbitrage is 185,390 AUD

In general, through the triangular arbitrage method of AUD, GBP and USD currency exchange rate, the company can finally make a profit That is, first use the Australian dollar

to buy the Pounds through the GBP / AUD bid rate, then convert the Pounds into the US dollars through the GBP / USD bid rate, and finally convert the US dollars into the Australian dollar through the AUD / USD bid rate In the end, the company gained a profit of 185,390 Australian Dollars

The best condition for using the arbitrage trading method is that the main trend direction of the currency pair is consistent with the arbitrage direction, but it should be noted that there is

a considerable risk in the arbitrage trading strategy If there is no proper risk management, the trader may be evacuated due to the unexpected sudden reversal of the market trend

V CONCLUSION

This report includes two parts The first part is a trading strategy that includes two steps in total and the second part explains what the triangular arbitrage is and to show how much profit can we get using the predicted exchange rate based on the triangular arbitrage

This report is based on forecasting currency exchange rates in the coming six months at the

the Japanese yen will show an upward trend in the next six months which means the US dollar will appreciate against the Japanese yen

During the trading strategy, our team was first asked to calculate and predict the profits

according to the exchange rate of USD to JPY as a price taker We short the US dollar at the bid price, the profit in this step comes from the exchange rate difference between this pair of currencies The data was shown above in Table 2 Next, we short the Japanese yen at the ask price to buy back the US dollar at a lower rate to get the profit After that we estimate the opening AUD value of the current portfolio using the mid rates to calculate the final profit because we are in an Australia company The final profit should be the current net position minus the net position of the first stage and the result is also shown in the updated Table 2

As predicted, this trading strategy has brought us profits, so we have been asked to determine the potential arbitrage opportunities for AUD, USD and GBP currencies based on the

expected exchange rate and explain the triangular arbitrage from the perspective of price taker The triangular arbitrage is the result of a discrepancy between three foreign currencies that occurs when the currency's exchange rates do not exactly match up According to the calculation above, we expect to get 185,390 Australian dollars as the profit if we got

200,000,000 Australian dollars at the beginning