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E333_ch13_10_28 - THE FOREIGN EXCHANGE MARKET Chapter 13...

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THE FOREIGN EXCHANGE  MARKET Chapter 13
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Exchange Rates Exchange rate (XR): The price of foreign  currency. Foreign exchange market The most important center:  London The most heavily traded currency:  US dollar 2
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The Foreign Exchange Market Exchange rate quotations: Direct quotes  $/   = 1.42 Indirect quotes   /$ = 0.7 3
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Appreciation and Depreciation Depreciation: A decrease in the value of a  currency.   Appreciation: An increase in the value of a  currency.  2005:  AUS 1 = US .78 2008: AUS 1 = US .60 5
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Exchange Rates Spot rate: The exchange rate for trade for  current delivery (within two business days) Exchange rates are quoted for large trades (above $1 million) as the average of the buying price and the  selling price 6
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Bid-Ask Spreads Midrange quotes Spread: The difference between the  buying price and the selling price. Spread gets larger for currencies  which are less frequently traded riskier to trade 7
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Currency Spreads 8
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Arbitrage Arbitrage: Taking advantage of the differences in  exchange rates by simultaneously buying a  currency in one market while selling in another. Arbitrage process causes the exchange rates in  different financial markets to converge.   Suppose that AUS dollar is more expensive in London  market than in the New York market.  How can you profit from this difference? 9
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Arbitrage: Example Suppose that $/Can$ = 1.01 in London,  and $/Can$ = 1.03 in Frankfurt, and you  have $1,000  US How do you profit from this discrepancy? 10
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Triangular Arbitrage The exchange rate between US dollar and  British pound (£) and the exchange rate between  US dollar and Swiss Franc (SF) also determine  the exchange rate between £ and SF (the cross  rate).  If these three rates are not consistent, then it will  be possible to profit from this inconsistency. The process of making money taking advantage  of inconsistent exchange rates is called the  triangular arbitrage . 11
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Cross Rates The value of one Canadian dollar in terms  of euro ( /Can$): The value of one Canadian dollar in terms  of US dollars: $/Can$ The value of one US dollar in terms of  euro:  /$ /$ = ( /Can $) x (Can $/$) The value of one Canadian dollar in terms  of euros: /Can$ = ( /$) x ($/Can$) 12
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Example: Cross Rates $/Malaysian ringgit = .2967 $/Indian rupee = .02553 
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