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7/29/2019 WHAT DRIVES THE CURRENT MARKET
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What drives the currency
markets?
By
A.V. Vedpuriswar
Feb 10, 2008
7/29/2019 WHAT DRIVES THE CURRENT MARKET
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Acknowledgment
This presentation draws heavily from Investopedia.com
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The five factors
In order of importance, they are:
Interest Rates
Economic GrowthGeo-Politics
Trade and Capital Flows
Merger and Acquisition Activity
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GEN0190n.ppt 20
Problem - 1
3 month interest rates were quoting as follows on
January 19th
, 2008:
Dollar - 3.74%
Yen - 0.74%
Sterling - 5.58%
The exchange rates quoted in the market were asfollows:
Yen 121/ $ .51/$
What should the three month forward rates be toprevent arbitrage?
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GEN0190n.ppt 21
Solution
/$5123.
0094.1
01395.1.51
/$)4/0374.1(
.0558/4)(1.51
rateExchange
.0558/4)(1.51)4
0374.1($
$/09.120
0094.1
)00185.1(121
)4
0074.1(121)4
0374.1(1$
Yen
rateExchange
Yen
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GEN0190n.ppt 22
Problem - 2
Inflation in the US is currently 4.1%, that in Japan,0.6% and in Britain, 2.1%. The current exchange ratesare Yen 121/$, .51/$. What will be the exchange rate
after one year if purchasing power parity holds?
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.50/$
/$)041.1(1
)021.1(51.rateExchange
.021).51(1)041.1(1$
$/93.116$/)041.1(1
)006.1(121
)041.1(1$)006.1(121
YenYenrateExchange
Yen
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GEN0190n.ppt 24
Problem - 3
The rates currently quoted are Yen 120/$. .50/$ and
Yen 220/ . Is there any scope for triangular arbitrage.
Borrow Yen 220
Sell for 1
Sell 1 to get $ 2
Sell $ 2 to get Yen 240
Profit = Yen 20
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GEN0190n.ppt 25
Problem - 4
A Japanese importer needs $1,320,000 a year from
now. The current rate is Yen 120/$. How can theexporter hedge the risk in the money market. If the 1year $ interest is 10%?
$ needed 1 year from now = $ 1,320,000
$ needed to be invested today = $ 1,320,000/1.1
= $ 1,200,000
Yen needed today = Y 144,000,000
Borrow Yen 144,000,000 convert into $, invest for ayear.
The payable exposure is fully hedged.
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GEN0190n.ppt 26
Problem - 5
3 Month Dollar interest rate - 2.5%
3 Month Sterling interest rate - 5.0%
The spot exchange rate is /$ .51 / .53
What should be the 3 month forward rate to preventarbitrage?
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GEN0190n.ppt 27
Solution Borrow $ 100
Convert into . We get 51
Invest 51 for 3 months. We get 51 (1+.05/4)
Convert into $. We get 51 (1+.05/4)/F = 51.64/F
For no arbitrage, 100 51.64/F
Or F .5164
Borrow 100
Convert into $. We get $ 100/.53
Invest for 3 months. We get $100/.53 (1+.025/4) = 189.86 Convert back into sterlings. We get 189.86F
For arbitrage, 100 189.86 F
Or F 100/189.86 = .5267
So for no arbitrage, F .5164 and F .5267