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The Gold Standard The Inter-War Years Brenton Woods Fixed Exchange Rates Electric Currency Arrangement Floating Exchange Rates

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Egypt Greeks and Romans Gold as medium of exchange Rules of the Games Maintaining Gold Reserves was keyeserves was key Gold Rquate US declared Gold at $20.67 per ounce British Pound was kept at 4.2474 per ounce

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Chaotic Speculators short sold weak currencies Long with Strong Currencies Convertibility became an issue

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U.S Dollar based International Monetary System IMF and IBRD formed Only dollar remained convertible to Gold $35 per ounce

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Exchange arrangement without legal tender Currency board arrangements Fixed Peg Fixed peg wit horizontal Bands Crawling Pegs Crawling Bands Managed Floating Rates Independent Floating Rates

1. The currency of another country circulates as the sole legal tender or the country belongs to a monetary or currency union (e.g. Euro) in which the same legal tender is shared by the members of the union 2. Under currency board system, the country fixes the rate of its domestic currency in terms of a foreign currency 3. The country pegs its currency( formally or de facto) at a fixed rate to a major currency or a basket of currencies with a 1% fluctuation allowed

4. The country pegs its currency( formally or de facto) at a fixed rate to a major currency or a basket of currencies with more than a 1% fluctuation allowed 5. The currency is adjusted periodically in small amounts at a fixed pre announced rate 6. The currency is maintained within certain fluctuation margins around a central rate that is adjusted periodically

Depends on inflation, unemployment, interest rate levels, trade balances, and economic growth
Fixed Rates provide stability Fixed Rates are anti-inflationary, can be burdensome Fixed Rates necessitates large reserves of hard currency and gold Fixed Rates might get inconsistent with growing economy

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It is a process of buying and selling the same asset at the same time, to profit from price discrepancies within a market or across different markets. It can be One way arbitrage Two way arbitrage Three way arbitrage

In terms of Forex, arbitrage opportunities exist when there is a considerable difference between exchange rates provided in two different Forex markets. Hence, if the currency is bought in one market and sold elsewhere at a better price, profit can be realized

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Triangle or triangular arbitrage is a Forex trading strategy, which is theoretically risk free. As the name suggest, triangle arbitrage includes trading 3 different currency pairs almost simultaneously to profit from exchange rate difference between them.

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In global Forex market, the price of one currency pair depends on the price of one or more other currency pairs. The basic formula for the relationship of three related currency pairs, having 3 different currencies, is as follows. AAA/BBB x CCC/AAA = CCC/BBB Chance of triangular arbitrage occurs whenever this equation goes wrong.

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A triangle arbitrator buys BBB spending AAA, then buys CCC spending BBB and lastly returns to AAA selling CCC, capturing a small profit. The chance of profit is maximized by utilizing margin from brokers and trading with higher amounts. Confusing? For example take exchange rates EUR/USD = 0.6522, EUR/GBP = 1.3127 and USD/GBP = 2.0129. With $500,000 one can buy 326100 Euros, using that he can buy 248419.29 Pounds. He can now sell the pounds for $500043.19. Thus he can earn a profit of $43.19.

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Suppose we observe these banks posting these exchange rates. First calculate the implied cross rates to see if an arbitrage exists.

$
Barclays S(/$)=120 Credit Lyonnais S(/$)=0.67

Credit Agricole S(/)=185

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The implied S(/) cross rate is S(/) = 180

$
Barclays S(/$)=120 Credit Lyonnais
1.50 $1 1 v ! S(/$)=1.50 $1 120 80

Credit Agricole has posted a quote of

S(/)=85 so there is an arbitrage opportunity.

Credit Agricole S(/)=85

So, how can we make money?

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As easy as 1 2 3: 1. Sell our $ for , 2. Sell our for , 3. Sell those for $.
Barclays S(/$)=120

$
Credit Lyonnais
1.50 $1 1 v ! S(/$)=1.50 $1 120 80

Credit Agricole S(/)=85

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Sell $100,000 for at S(/$) = 0.67 receive 67,000 Sell r 67,000 f r t S(/) = receive 1, Sell 1, ,9 ,000 f r $ t S(/$) = 120 receive $1,0 ,291 profit per round trip = $ 10 ,291 - $100,000 = $ ,291
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,9 ,000

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Inflation rates Interest rates Balance of payment position Volume of International reserves Level of activity and employment

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Inflation rates:
In case domestic inflation is higher than the foreign countrys, then prices of domestic goods increases faster, making the foreign goods relatively cheaper. This increases demand for foreign goods, which in turn, appreciates the foreign currency.

Interest rates:

If interest rates are higher in the US than in Japan, Japanese funds are more likely to get attracted to the US as Japanese banks and firms will yield higher by parking their funds in the US. The flight of capital funds from Japan to the US will increase demand for USD in Japan, which will lead to appreciation of the USD

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Balance of Payment position

Deficits require payments in foreign currency Therefore, monetary authority has to deliberately devalue the currency. This will enhance the foreign currency making the foreign good more expensive; and increases exports as home currency is cheaper. Also, devaluing the currency will help in paying the foreign debt as the net amount reduces.

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Value of Forex reserves

The level of forex reserves (including gold) the Central Bank possesses. Releasing/selling FC appreciates the rupee Buying FC depreciates rupee (appreciates FC) In case of inadequate reserves, the Central bank will be helpless and will not be able to stabilise.

Level of activity and employment

Higher level of economic activity and employment leading to a sizeable foreign trade will appreciate domestic currency. Low level of activity may depreciate the domestic currency.

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