International Finance Lecture: 2 Topic: International Finance Environment By: AJ

Cross Rates of Exchange An exchange rate between two currencies from the exchange rates of those currencies with a third currency is known as a Cross Rate of Exchange. A cross rate can be obtained by multiplying two exchange rates by each other so as to eliminate a third currency that is common to both rates. Spot market: The spot market is the market for immediate exchange of currencies. It is the market where transactions of buying and selling are done for immediate delivery. In real practice, the settlement is made after two working business days excluding holidays. Forward Market: A forward market is a market for exchange of foreign currencies at a future date. In the forward market, trades are made for delivery at some future date, according to an agreed upon delivery date, exchange rate and amount. Forward transactions: A forward transaction is defined as an agreement to buy or sell a specified amount of a foreign currency at any time. Forward Premium: If the forward rate is higher than the existing Spot rate in the Forward Market, the currency is trading at a Forward Premium. Forward Discounts: If the forward rate is lower than the existing Spot rate in the forward market, the currency is trading at a Forward Discount. Forward premiums are also quoted as an annualized percentage deviation from the current spot rate. The formula for the calculation is: Premium/Discount= Where n is the number of periods per year. SR= Spot Rate
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FR= Forward Rate

International Finance Lecture: 2 Topic: International Finance Environment By: AJ

Question for practice: 1. The following foreign quotations are given for a 90 day contract. Calculate the premium or discount on an annualized based. SR= $0.8576/pound sterling FR= $ 0.8500/ pound sterling 2. The Danish kroner is quoted in New York at $0.18536/DKr spot, $0.18524/DKr 30days forward, $0.18510/DKr 90dys forward, and $0.18485/DKr 180 days forward. Calculate the forward premium/discount on the Korner. 3. For the following Spot and Forward quotes, calculate forward Premiums/Discount on Japanese yen as an annualized percentage. Spot ($/*) Forward ($/*) Days Forward 0.009056355 0.008968508 30 0.009056355 0.008772955 90 0.00956355 0.008489201 180 0.009056355 0.007920282 360 Bid Price, Ask Price and Spread in Foreign Exchange Quotation Bid Price: (Buy) o A bid is the price in one currency in which a dealer will buy another Currency. Ask/Offer Price: (Sell) o An offer or ask is the price at which dealer will sell the other currency. Spread: o The difference between Bid Price and Ask Price is called a Spread. E.g. A dealer in New Delhi may give the following quotation USD $1= Rs. 57.6541-57.7654 Euro 1= Rs. 78.4567-78.5678

Percentage Spread =

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Question:

International Finance Lecture: 2 Topic: International Finance Environment By: AJ

1. A foreign exchange trader gives the following quotes for the Euro Spot, one month, three month and six months to a US based treasurer $0.02368/70 4/5 8/7 14/12 Calculate the outright quotes for one, three and six months forward. 2. You are interested in buying Swedish krona (SKr). Your bank quotes SKr 7.6040/$ Bid and SKr7.6150/$ Ask. What would you pay inn dollars if you bought SKr 1,000,000 at the current spot rate?

Arbitrage: The term arbitrage refers to the purchase of a currency by Speculators in the monetary center where it is cheaper for immediate resale in the monetary center where it is epensive so as to make a profit.

E.g. If the dollar price of pounds were $ 1.98 in New York and $2.01 in London, an arbitrager would purchase pounds at $1.98 in New York and immediately resell them in London for $2.01, thus realizing the profit of $.03 per pound. Interest arbitrage: It refers to the international flow of short-term liquid capital to earn a higher return abroad. Interest arbitrage can be covered or uncovered. Question: 1. Given the following data; Spot rate: Rs. 42.0010 = $1 6 month forward rate : Rs. 42.8020 = $1 Annualized interest rate on 6 month Rupee: 12 % Annualized interest rate on 6 month Dollar: 10 %
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Calculate the arbitrage possibilities.

International Finance Lecture: 2 Topic: International Finance Environment By: AJ

2. An American firm purchases $4000 worth of perfume (FF 20,000) from a French firm. The American distributor must make the payment in 90 days in French francs. The following quotation and expectations exist for the FF. Present spot rate $ 0.2000 90 days forward rate 0.2200 US interest rate 15% French interest rate 10%

Your expectation of the SR 90 days hence 0.2400 a. What is the premium or discount on the forward French francs? What is the interest differential between US and Franc? Is there an incentive for covered Interest Arbitrage? b. If there is a CIA, how can an arbitrageur tale advantage of the situation? Assume (i) the arbitrageur is willing to borrow $4000 or FF 20,000 and (ii) there are no transaction costs. c. If transaction cost is $50, would an opportunity still exist for CIA?

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