Chapter 14 Exchange Rates and The Foreign Exchange Market An Asset Approach
Chapter 14 Exchange Rates and The Foreign Exchange Market An Asset Approach
Chapter 14 Exchange Rates and The Foreign Exchange Market An Asset Approach
Lectureon3/9/2016
Copyright 2009 Pearson Addison-Wesley. All rights reserved.
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The basics of exchange rates
Exchange rates and the prices of goods
The foreign exchange markets
The demand of currency and other assets
A model of foreign exchange markets
role of interest rates on currency deposits
role of expectations of exchange rates
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Table 14-1:
Exchange
Rate
Quotations
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Forward contracts
Forward contracts: (most often used)
- specifies the amount of a particular currency that will be
purchased or sold by corporations.
- a specified future point in time.
- a specified exchange rate.
Commercial banks accommodate the corporations that desire
forward contracts. (contracts between commercial banks and
corporations)
To hedge the future payment that the corporations expect to
make or receive in a foreign currency. (do not worry about
fluctuations in the spot rate)
If, you sell pounds for dollars on a future date at a forward rate agreed
on today bought pound forward and sold pound forward.
Forward contracts
How to use the forward to hedge? An example:
Radio Shack (a retailer in US) knows that in 30 days, it must pay yen to a
Japanese supplier for a shipment of computer chips arriving then. RS can
sell each radio for $100 and must pay its supplier 9,000 per radio.
a. The current spot rate is $0.0105 per yen,
RS would pay ($0.0105 per yen)* 9000 per radio=$94.5 per radio.
profit of $5.5 per radio.
b. If the dollar unexpectedly depreciates to $0.0115 per yen,
RS would pay ($0.0105 per yen)* 9000 per radio=$103.5 per radio.
loss of $3.5 per radio
Forward contracts
To avoid the risk, RS can make a 30-day forward exchange deal with
Bank of America (BOA).
~ If BOA agrees to sell yen to RS in 30 days at a rate of $0.0107
~ RS is assured of paying exactly
($0.0107 per yen)*( 9000 per radio)=$96.3 per radio to the supplier.
A profit of $3.7 per radio is guaranteed.
The forward contracts help RS hedge its foreign currency risk.
The forward contracts are associated with the covered interest parity
condition (CIP).
Source:Datastream.Ratesshownare90dayforwardexchangeratesandspotexchangerates,atendofmonth.
Copyright 2009 Pearson Addison-Wesley. All rights reserved.
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Source:CentralBankofRepublicChina
45
40
35
30
25
65
60
55
50
45
40
0.4
0.35
0.3
0.25
0.2
0.15
0.1
0.05
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Example: Soho, Inc. needs to invest $1m euro in its German subsidiary
for the production of additional products today. It wants the subsidiary
to repay the euros in one year.
~Soho wants to lock in the rate at which the euro can be converted back
into dollars in one year -> it can use a one-year forward contract for
this purpose.
** Soho contacts its bank and requests the following swap transaction:
Today: The bank should withdraw dollars from Sohos US account,
convert the dollars to euro in the spot market, and transmit the euros to
the subsidiarys account.
In one year: The bank should withdraw $1m euros from the subsidiarys
account, convert them to dollars at todays forward rate, and transmit
them to Sohos US account.
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0.050
R$
0.069
0.079 0.100
Expected dollar return
on dollar deposits, R$
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No one is willing to
hold dollar deposits
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Individuals and
institutions now
expect the euro to
appreciate
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Summary
1. Exchange rates are prices of foreign currencies in terms
of domestic currencies, or vice versa.
2.
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Summary
3.
4.
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Summary (cont.)
5.
6.
7.
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Summary (cont.)
8.
9.
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AdditionalChapterArt
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Source:Datastream.Threemonthinterestratesareshown.
Copyright 2009 Pearson Addison-Wesley. All rights reserved.
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