When other factors are the same people will buy assets in New York and stop

When other factors are the same people will buy

This preview shows page 16 - 22 out of 41 pages.

When other factors are the same, people will buy assets in New York and stop buying them in Hong Kong, so that their price in New York rises and their price in Hong Kong falls, until they are equal in the two markets. 16
Image of page 16
Spot Rates and Forward Rates Spot rates are exchange rates for currency exchanges on the spot, or when trading is executed in the present. Typically a spot transaction must be executed within two days. Forward rates are exchange rates for currency exchanges that will occur at a future (for- ward) date. ° forward dates are typically 30, 90, 180 or 360 days in the future. ° rates are negotiated between individual institutions in the present, but the exchange occurs in the future. ° the forward rate is set by contract today. 17
Image of page 17
18
Image of page 18
Exchange rate instruments Foreign exchange swaps: a combination of a spot sale with a forward repurchase, both negotiated between individual institutions. ° swaps often result in lower fees or transactions costs because they combine two transactions. And they allow parties to meet each others needs for a temporary amount of time. Futures contracts: a contract designed by a third party for a standard amount of foreign currency delivered/received on a standard date. ° contracts can be bought and sold in markets, and only the current owner is obliged to ful°ll the contract. ° futures contract are standardized and can be resold before settlement. ° similar to a forward contract, with the key di/erence being that a futures contract is traded on an exchange while a forward contract is a private contract between the two parties. ° advantage of futures contract is its liquidity and lack of default risk. Options contracts: a contract designed by a third party for a standard amount of foreign currency delivered/received on or before a standard date. 19
Image of page 19
° contracts can be bought and sold in markets. ° a contract gives the owner the option, but not obligation, of buying or selling currency if the need arises. 20
Image of page 20
Demand for foreign currency assets What in²uences the demand (willingness to buy) for deposits denominated in domestic or foreign currency? 1. Returns: (a) Rate of return: the percentage change in value that an asset o/ers during a time period. The annual return for $100 savings account with an interest rate of 2% is $100 x 1.02 = $102, so that the rate of return = ($102 - $100)/$100 = 2% (b) Real rate of return: in±ation-adjusted rate of return. It is stated in terms of real purchasing power: the amount of real goods & services that can be purchased with the asset. The real rate of return for the above savings deposit when in±ation is 1.5% is: 2% ²1.5% = 0.5%. After accounting for the rise in the prices of goods and services, the asset can purchase 0.5% more goods and services after 1 year. (c) If prices are °xed, the in±ation rate is 0% and (nominal) rates of return = real rates of return. Because trading of deposits in di/erent currencies occurs on a daily basis, we often assume that prices do not change from day to day. This is a good assumption to make for the short run.
Image of page 21
Image of page 22

You've reached the end of your free preview.

Want to read all 41 pages?

  • FORGOT
  • Exchange Rate, Foreign exchange market, foreign exchange markets, United States dollar

  • Left Quote Icon

    Student Picture

  • Left Quote Icon

    Student Picture

  • Left Quote Icon

    Student Picture

Stuck? We have tutors online 24/7 who can help you get unstuck.
A+ icon
Ask Expert Tutors You can ask You can ask You can ask (will expire )
Answers in as fast as 15 minutes