Ch005 Market for Foreign Exchange.docx

Ch005 Market for Foreign Exchange.docx

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Ch005MarketforForeignExchange

Eun&Resnick4e

CHAPTER5TheMarketforForeignExchange

FunctionandStructureoftheFXMarket

InternationalFinanceinPractice:

TheMouseTakesOvertheFloor

FXMarketParticipants

CorrespondentBankingRelationships

InternationalFinanceinPractice:

WhereMoneyTalksVeryLoudly

TheSpotMarket

SpotRateQuotations

TheBid-AskSpread

SpotFXTrading

Cross-ExchangeRateQuotations

AlternativeExpressionsfortheCross-ExchangeRate

TheCross-RateTradingDesk

TriangularArbitrage

SpotForeignExchangeMarketMicrostructure

TheForwardMarket

ForwardRateQuotations

LongandShortForwardPositions

ForwardCross-ExchangeRates

SwapTransactions

ForwardPremium

Summary

MINICASE:

ShrewsburyHerbalProducts,Ltd.

FunctionandStructureoftheFXMarket

1Theworld’slargestforeignexchangetradingcenteris:

a）NewYork

b）Tokyo

c）London

d）HongKong

Answer:

c）

2Onaverage,worldwidedailytradingofforeignexchangeis

a）impossibletoestimate

b）$15billion

c）$504billion

d）$1.88trillion

Answer:

d）

3Theforeignexchangemarketcloses

a）Never

b）4:

00p.m.EST（NewYorktime）

c）4:

00p.m.GMT（Londontime）

d）4:

00p.m.（Tokyotime）

Answer:

a）

FXMarketParticipants

4Mostforeignexchangetransactionsarefor:

a）Interventionbycentralbanks

b）Interbanktradesbetweeninternationalbanksornonbankdealers

c）retailtrade

d）purchaseofhardcurrencies

Answer:

b）

5Thedifferencebetweenabrokerandadealeris

a）Dealersselldrugs,brokerssellhouses.

b）Brokersbringtogetherbuyersandsellers,butcarrynoinventory.Dealersstandreadytobuyandsellfromtheirinventory.

c）Brokerstransactinstocksandbonds;currencyisboughtandsoldthroughdealers.

d）Noneoftheabove

Answerb）

Rationale:

ifsomeonecomplainsabouta）beingcorrect,askthemwhowouldsellacrackhouseoramethlab.

6MostInterbanktradesare

a）Speculativeorarbitragetransactions

b）Simpleorderprocessingfortheretailclient

c）Overnightloansfromonebanktoanother

d）Brokeredbydealers

Answera）

7Atthewholesalelevel

a）MosttradingtakesplaceOTCbetweenindividualsontheflooroftheexchange

b）Mosttradingtakesplaceoverthephone

c）MosttradingflowsoverReutersandEBSplatforms

d）Mosttradingflowsthroughspecialized“broking”firms

Answer:

c）

8Interventionintheforeignexchangemarketistheprocessof:

a）Acentralbankrequiringthecommercialbanksofthatcountrytotradeatasetpricelevel.

b）Commercialbanksindifferentcountriescoordinatingeffortsinordertostabilizeoneormorecurrencies.

c）Acentralbankbuyingorsellingitscurrencyinordertoinfluenceitsvalue.

d）Thegovernmentofacountryprohibitingtransactionsinoneormorecurrencies.

Answer:

c）

CorrespondentBankingRelationships

9ConsideraU.S.importerdesiringtopurchasemerchandisefromaDutchexporterinvoicedineuros,atacostof€512,100.TheU.S.importerwillcontacthisU.S.bank（whereofcoursehehasanaccountdenominatedinU.S.dollars）andinquireabouttheexchangerate,whichthebankquotesas€1.0242/$1.00.Theimporteracceptsthisprice,sohisbankwill____________theimporter’saccountintheamountof____________.

a）Debit,$500,000

b）Credit,€512,100

c）Credit,$500,000

d）Debit€512,100

Answer:

a）

Rationale:

debit,sincetheimporterispaying.$500,000=€512,100×$1.00/€1.0242

TheSpotMarket

10Thespotmarket

a）Involvesthealmost-immediatepurchaseorsaleofforeignexchange.

b）Involvesthesaleoffutures,forwards,andoptionsonforeignexchange

c）Takesplaceonlyonthefloorofaphysicaltradingfloor

d）Alloftheabove.

Answer:

a）

11Spotforeignexchangetrading

a）accountsforabout5percentofallforeignexchangetrading

b）accountsforabout20percentofallforeignexchangetrading

c）accountsforabout35percentofallforeignexchangetrading

d）accountsforabout70percentofallforeignexchangetrading

Answer:

d）

SpotRateQuotations

Country

U.S.$equiv.

CurrencyperU.S.$

Tuesday

Monday

Tuesday

Monday

Britain（Pound）£62,500

1.6000

1.6100

0.625

0.6211

1MonthForward

1.6100

1.6300

0.6211

0.6173

3MonthsForward

1.6300

1.6600

0.6173

0.6024

6MonthsForward

1.6600

1.7200

0.6024

0.5814

12MonthsForward

1.7200

1.8000

0.5814

0.5556

12Usingthetableshown,whatisthemostcurrentspotexchangerateshownforBritishpounds?

Useadirectquote

a）$1.61=£1.00

b）$1.60=£1.00

c）$1.00=£0.625

d）$1.72=£1.00

Answer:

b）

13ItiscommonpracticeamongcurrencytradersworldwidetobothpriceandtradecurrenciesagainsttheU.S.dollar.Infact,BISstatisticsindicatethatabout__percentofcurrencytradingintheworldinvolvestheU.S.dollarononesideofthetransaction

a）90percent

b）75percent

c）45percent

d）15percent

Answer:

a）

14Supposethatthecurrentexchangerateis€0.80=$1.00.Thedirectquote,fromtheU.S.perspectiveis

a）€1.00=$1.25

b）€0.80=$1.00

c）£1.00=$1.80

d）Noneoftheabove

Answer:

a）

Rationale:

Thedirectquotation,fromtheU.S.perspective,thepriceofoneunitoftheforeigncurrencypricedinU.S.dollars.

TheBid-AskSpread

15TheBidprice

a）Isthepricethatthedealerhaspaidforsomething,hishistoricalcost

b）Isthepricethatadealerstandsreadytopay

c）RefersonlytoauctionslikeeBay,notoverthecountertransactionswithdealers

d）Isthepricethatadealerstandsreadytosellat

Answer:

b

Thebidpriceisthepriceadealerwillpay;theaskpriceisthepricehechargestosell.Answera）isabittricky,butthedealer’shistoricalcostisnotnecessarilythepriceatwhichhewillbewillingtobuymore

16Supposethespotaskexchangerate,Sa（$|£）,is$1.90=£1.00andthespotbidexchangerate,Sb（$|£）,is$1.89=£1.00.Ifyouweretobuy$10,000,000worthofBritishpoundsandthensellthemfiveminuteslater,howmuchofyour$10,000,000wouldbe“eaten”bythebid-askspread?

a）$1,000,000

b）$52,910.05

c）$100,000

d）$52,631.58

Answer:

d）

Rationale:

17Ifthe$/£bidandaskpricesare$1.50and$1.51,respectively,thecorresponding£/$bidandaskpricesare:

a）£0.6667and£0.6623

b）$1.51and$1.50

c）£0.6623and£0.6667

d）cannotbedeterminedwiththeinformationgiven

Answer:

c）

Rationale:

£1/$1.51=askprice=£0.6623bidprice/$1;

£1/$1.50bidprice=£0.6667askprice/$1.

Seeequation5-3:

SpotFXTrading

18Inconversation,InterbankFXtradesuseashorthandabbreviationinexpressingspotcurrencyquotations.Considera$/£bid-askquoteof$1.9072-$1.9077.The“bigfigure”,assumedtobeknowntoalltradersis:

a）$1.9077

b）1

c）1.90

d）77

Answer:

c）

19intheInterbankmarket,thestandardsizeofatradeamonglargebanksinthemajorcurrenciesis

a）fortheU.S.-dollarequivalentof$10,000,000,000

b）fortheU.S.-dollarequivalentof$10,000,000

c）fortheU.S.-dollarequivalentof$100,000.

d）fortheU.S.-dollarequivalentof$1,000

Answer:

b）

20AdealerinBritishpoundswhothinksthatthepoundisabouttoappreciate

a）Maywanttowidenhisbid-askspreadbyraisinghisaskprice

b）Maywanttolowerhisbidprice

c）Maywanttolowerhisaskprice

d）Noneoftheabove

Answer:

c）

Rationale:

Adealerwhothinksthatthepoundisabouttoappreciatewillwanttoincreasehisinventory,noneofthestrategieslistedwillaccomplishthis.Whilea）

Cross-ExchangeRateQuotations

Country

U.S.$equiv.

CurrencyperU.S.$

Tuesday

Monday

Tuesday

Monday

Britain（Pound）£62,500

1.6000

1.6100

0.625

0.6211

1MonthForward

1.6100

1.6300

0.6211

0.6173

3MonthsForward

1.6300

1.6600

0.6173

0.6024

6MonthsForward

1.6600

1.7200

0.6024

0.5814

12MonthsForward

1.7200

1.8000

0.5814

0.5556

Euro€62,500

1.2000

1.2000

0.833333

0.833333

1MonthForward

1.2100

1.2100

0.82645

0.82645

3MonthsForward

1.2300

1.2300

0.813008

0.813008

6MonthsForward

1.2600

1.2600

0.793651

0.793651

12MonthsForward

1.2900

1.3200

0.775194

0.7575758

21Usingthetableshown,whatisthespotcross-exchangeratebetweenpoundsandeuro?

a）€1.00=£0.75

b）£1.33=€1.00

c）£1.00=€0.75

d）noneoftheabove

Answer:

a）

Rationale:

youalsogetthesameresultwithindirectquotes

22Thedollar-euroexchangerateis$1.25=€1.00andthedollar-yenexchangerateis¥100=$1.00.Whatistheeuro-yencrossrate?

a）¥125=€1.00

b）¥1.00=€125

c）¥1.00=€0.80

d）Noneoftheabove

Answer:

a）

23TheAUD/$spotexchangerateisAUD1.60/$andtheSF/$isSF1.25/$.TheAUD/SFcrossexchangerateis:

a）0.7813

b）2.0000

c）1.2800

d）0.3500

Answer:

c）

Rationale:

AlternativeExpressionsfortheCross-ExchangeRate

24Theeuro-poundcrossexchangeratecanbecomputedas:

a）S（€/£）=S（$/£）×S（€/$）

b）

c）

d）alloftheabove

Answer:

d）

TheCross-RateTradingDesk

25SupposeabankcustomerwishestotradeoutofBritishpoundsandintoSwissfrancs.

a）Indealerjargon,thisisacurrencyagainstcurrencytrade

b）ThebankwillfrequentlyhandlesuchatradebysellingBritishpoundsforU.S.dollarsandthenbuyingfrancswithU.S.dollars.

c）ThebankwouldselltheBritishpoundsdirectlyforSwissfrancs.

d）a）andb）butnotc）

Answer:

d）

26Includingthetransactionscostsofthebid-askspread,theeuro-poundcrossexchangerateforacustomerwhowantstoselleuroandbuypoundscanbecomputedas

a）Sb（£/€）=Sb（$/€）×Sb（£/$）

b）Sa（€/£）=Sa（€/$）×Sa（$/£）

c）Sb（€/£）=Sb（$/€）×

d）Alloftheabove

Answer:

d）

Rationale:

Thebankcouldalternativelyquoteitscustomeranaskpriceforpoundsintermsofeuroorquoteabidpriceforeurointermsofpounds.Someonewhosellseurowillsellthemtothedealerfordollarsatthedealer’sbidprice,Sb（$/€）,thenhewillbuypoundswithdollarsfromthedealerathis