TÀI CHÍNH QUỐC TẾ 2 Currency Market (Foreign Exchange Market)

3.Concept of Exchange Rate and its ClassificationConcept of Exchange rate • Exchange rate is the price of one currency expressed in another currency 20500VND/1USD ; 1,3 USD/1EURO • Commo

Tài chính quốc tế

(International Finance)

II Currency Market (Foreign

Exchange Market)

The best way to destroy the capitalist system is to

debauch the currency By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens

1 Concept of the FX, characteristics and participants

of the FX

2 Functions, transaction and classification of the FX

3 Concept of exchange rate and its classification

4 Direct and indirect quotation

5 Exchange rate point, reading and writting

6 Bid rate, ask rate and spread

7 Speculation and arbitrage

8 Cross rate

1.Concept of the FX, Characteristics

and Participants of the FX

Concepts of Foreign Exchange

Broadly meaning:Foreign exchange includes

foreign currencies, financial assets denominated

in foreign currencies (banknotes, checks, bonds, stock etc ), and standard gold

Narrowly meaning: Foreign exchange refers

foreign currencies

1.Concept of the FX, Characteristics and Participants of the FX

Concept of the Foreign Exchange

The FX market provides the physical and institutional

structure through which the money of one country is exchanged for that of another country (David Eiteman)The FX market is a place in which currencies are exchanged

1.Concept of the FX, Characteristics and Participants of the FX

Characteristics:

• Geographical extent and the actual marketplace is not

only a visible location but also anywhere currencies are exchanged (so called a space market)

• A non-stop global market (24-hour-a-day trading):

Sydney, Tokyo →Hong Kong, Singapore → Bahrain →

Frankfurt, Zurich, London → New York, Chicago, end San Francisco and Los Angeles

• The center of the FX market is the interbank market

• Participants in the market are trading though Tel, telex,

computer and fax

• Information asymmetry, huge trading volume (daily over

3.98 trillion USD-2010) and transaction costs are fairly

1.Concept of the FX, Characteristics and Participants of the FX

• The USD are traded mostly (90%)

• The FX market is extremely sensitive to political,

economic, social events, psychology and especially

monetary and fiscal policy

1.Concept of the FX, Characteristics

and Participants of the FX

(1) Retail clients: businesses, international investors,

multinational corporations, and the like who need foreign exchange for purposes of operating businesses (via

commercial banks)

(2) Commercial banks: carry out buy/sell orders from retail

clients  alter the structure of assets and liabilities in

different currencies

Banks can deal either directly other banks or foreign

exchange brokers

2 Functions, Transaction and

Classification of the FX

Functions:

• Service international trade activities

• Facilitate international capital movements

• Determine exchange rates

• Provide hedging instruments (forward, swap, option and

future)

• The place where central banks directly intervence in

exchange rate

2 Functions, Transaction and

2 Functions, Transaction and

Classification of the FX

Classifications:

(1) Based on the content of transtions

(2) Based on the transaction locations: Exchange and OTC

(over the counter)

(3) Based on the legal: official market and unofficial market

Primary

operation

Derivative operation

Spot Forward Swap Option Future

3.Concept of Exchange Rate and its Classification

Concept of Exchange rate

• Exchange rate is the price of one currency expressed in

another currency

20500VND/1USD ; 1,3 USD/1EURO

• Commodity currency (C) is the currency with one unit

• Term currency (T) is the currency doing the pricing (the

number of units of currency changed)

• Two-way quotation (special): bid rate and ask rate, bid

rate on the left and ask on the right and bid rate lower than ask one

3.Concept of Exchange Rate and its Classification

Exchange rate movements:

Graphical determination of the

VND depreciationE(USD/VND)

Tỷ giá USD/VND (end year 1991-2011)

Tỷ giá USD/CNY (end year 1991-2011)

3.Concept of Exchange Rate and its Classification

Classification :

• bid rate

• ask or offer rate

• spot rate: is the rate determined by supply and demand

of one currency in the FX market Transaction taking

place today and due up to two days

• derivative rates include rates in the forward, swap,

future and option Derivatives rate are not directly

formulated via supply and demand but computed from the available variables in the market such as spot rates, interest rates of two currencies

3.Concept of Exchange Rate and its Classification

• opening rate

• closing rate

• crossed rate:the exchange rate of a currency pairs is

determined through a third currency (U.S dollar)

4 Direct and indirect quotation

 Direct quotation

1kg meat = 25000 VND

1USD = 18932 VND

 Direct quotation is a home currency price of a

unit of foreign currency (U.S dollar)

 Indirect quotation

1VND = 0,00004 kg meat

1VND = 0,0000528 USD

 Indirect quotation is a foreign currency price of

a unit home currency

 Form of the quote depends on what the

4 Direct and indirect quotation

 Quotation in practice:

 On Interbank, most foreign currencies in the world are

stated in terms of the number of units of foreign

currency to buy one the dollar This is European Term

(except for the below currencies)

 Under American Term foreign exchange rate are stated

as the US dollar price of one unit of foreign currency:

5 Exchange rate point, reading and writting

Point

• Number of digits in an exchange rate is formed according

to routine and usually includes five significant digits from left to right

• Point is the last digit of an exchange rate (the fifth digit)

• Pip is an added digit (the sixth digit) following the point

and applying for professional traders

Example:

• Eur/USD =1.3182 → 0.0001 USD =1point

• USD/JPY = 77.256 → 0.001 JPY =1point

• USD/VND= 20831 → 1 VND =1point

5 Exchange rate point, reading and writting

 Reading

• 2 last digits read point, next 2 digits read digit

• VD: E(USD/VND)=19490 one-94 digit-90point

 Writting

- E(USD/VND) or E(VND/USD)

- Commodity currency/ term currency

- Full writting: USD/VND = 19450-19500 or

VND=19450-19500

- Simple writting way: USD/VND = 19450/00 hay

VND = 19450/00

6 Bid, Ask Rate and Spread

 Bid rate (buy) is the price (that is, exchange rate) in one

currency at which a dealer will buy another currency

 Ask or offer rate (sell) is the price (that is, exchange

rate) at which a dealer will sell the other currency

 Dealer bid (buy) at one price and ask (sell) at slightly

higher price, making their profit from the spread

between the buying and selling prices

 Mid rate is an average of bid and ask rate

 Depend on size of foreign exchange market

 Depend on volume of a sansaction

 Depend on foreign currency

6 Bid Rate, Aks Rate and Spread

 Rate point (absolute)

Spread = Ask rate – bid rate

Spread = 20830 – 20820 = 10VND (10 ñiểm)

 Percentage % (relative)

Spread = ask – bid*100%

bidSpread = 20830 – 20820*100% =0,048%

20820

USD/VND and EUR/USD

1,603197 21014,01

20682,43 September

2,188562 20946,68

20498,06 August

1,436165 20730,33

20436,83 July

1,647729 20767,18

20430,54 June

1,963672 20859,11

20457,39 May

1,261652 20989,63

20728,12 April

1,360891 20826,65

20547,03 March

1,480195 20151,35

19857,42 February

1,600705 19663,36

19353,57 January

spread (%) Ask

Bid

Average 2011 (USD/VND)

0,030425 1,38085

1,38043 September

0,034862 1,43472

1,43422 August

0,029358 1,43103

1,43061 July

0,025727 1,43856

1,43819 June

0,02859 1,43446

1,43405 May

0,028402 1,44395

1,44354 April

0,02357 1,4004

1,40007 March

0,027848 1,36492

1,36454 February

0,031453 1,33574

1,33532 January

Sread (%) Ask

Bid

Average 2011 (EUR/USD)

7 Arbitrage

Concept

• Arbitrage is the practice of taking advantage of a price

differential between two or more markets

• Currency markets at different places are linked by

arbitrage movements

• Implication

 Due to the fact that currencies are homogenous goods

and information is available at anytime and everywhere

 Arbitragers use the price differences between two

markets by buying low on one market (going long) and selling high (going short) on the other market

7 Arbitrage

 As a consequence the prices adjust in both markets as

long as the traders gain through additional transactions

 In contrast to goods markets, the transaction costs on

the currency market are small and arbitrage is fast (very short term)

8 Cross rate

Concept

• The exchange rate of a currency pairs is determined

through a third currency (U.S dollar)

• Why to canculate the cross rate?

• Why the U.S dollar is the benchmark

- Is the world‘s largest economy

- Major in international trade (15%)

- Major in international capital flows

Monetary standard

- The currency to store value

- A unit of accounting in international trade

8 Cross Rate

Cross rate calculation

• Simple cross rates are developed from the two original

rates without bid-ask spreads (mid rate)

• Case 1: given E(USD/VND)=20830 and

E(USD/SGD)=5.1324E(SGD/VND)=?= 20830/5.1324

• Case 2: given E(USD/VND)=20830 and

E(EUR/USD)=1.3128E(EUR/VND)=?=20830*1.3128

• Case 3: given E(AUD/USD)=0.8512 and

E(EUR/USD)=1.3128

8 Cross Rate

Compound cross rate

 USD play role as the commodity

currency in both the pairs of the

exchange rates

• E(USD/VND) = (a,b)

• E(USD/CNY) = (c,d)

? E(CNY/VND) = (x,y)

8 Cross Rate

 U.S dollar play role as the commodity currency

in one pair and as the term currency in the

other

• E(USD/VND) = (a,b)

• E(EUR/USD) = (c,d)

? E(EUR/VND) = (x,y)

 x=bid (USD/VND) * bid (EUR/USD) = a*c

 y=ask (USD/VND) * ask (EUR/USD)= b*d

 x=bid (GBP/USD): ask (AUD/USD)=c/b

 y=ask (GBP/USD): bid (AUD/USD)=d/a

• The FX market is a place in which currencies are

exchanged for others

• Foreign exchange refers to foreign currency

• Function of the FX market: determining the exchange

rate, facilitate international capital flows movements and international trade, provide derivatives and interventions

of central banks

• Foreign exchang rate is the price of one currency

expressed in term of another currency

• Depreciation of home currency when need more the

number of home units exchange for one unit of foreign currency and vice versa appreciation of home currency

• European terms quotation are the foreign currency price

• Quotation can also be direct and indirect a direct quote is

the home currency price of a unit of foreign currency

while an indirect quote is the foreign currency price of a unit of home currency

• In practice (interbank) most currencies are stated with

the U S dollar (direct quote) (exception 5 currencies:

Euro, AuD, NzD, GBP và SDR)

• Cross rate is an exchange rate between two currencies

calculated form their common relationships with a third currency