Forex Management

Forex Management
Motives for Using

International Financial Markets
• The markets for real or financial assets are prevented from full
integration by barriers like tax differentials, tariffs, quotas, labor
immobility, communication costs, cultural and financial reporting
differences.
• Market imperfections also create unique opportunities for specific
geographic markets, helping these markets attract foreign creditors
and investors.
• Investors invest in foreign markets:
• to take advantage of favorable economic conditions;
• when they expect foreign currencies to appreciate against their own; and
• to reap the benefits of international diversification.
Motives for Using
International Financial Markets
• Creditors provide credit in foreign markets:
• to capitalize on higher foreign interest rates;
• when they expect foreign currencies to appreciate against their own; and
• to reap the benefits of diversification.
• Borrowers borrow in foreign markets:
• to capitalize on lower foreign interest rates;
• and when they expect foreign currencies to depreciate against their own.
Foreign Exchange Market
• The foreign exchange market allows currencies to be exchanged in
order to facilitate international trade or financial transactions.
• The system for exchanging foreign currencies has evolved from the
gold standard, to agreements on fixed exchange rates, to a floating
rate system.
• The market for immediate exchange is known as the spot market.
• Trading between banks occurs in the interbank market. Within this
market, brokers sometimes act as intermediaries.
• The forward market enables an MNC to lock in the exchange rate at
which it will buy or sell a certain quantity of currency on a specified
future date.
• Customers in need of foreign exchange are concerned with quote
competitiveness, special banking relationship, speed of execution,
advice about current market conditions, and forecasting advice
Foreign Exchange
Transactions
• Banks provide foreign exchange services for a fee: a bank’s bid (buy)
quote for a foreign currency will be less than its ask (sell) quote.
ask rate – bid rate
bid/ask spread =
ask rate
Example Suppose bid price for £ = $1.52, ask price = $1.60.
(1.60 – 1.52)
Spread = = .05 or 5%
1.60
Foreign Exchange
Transactions
• The spread on currency quotations is positively influenced by order
costs, inventory costs, and currency risk, and negatively
influenced by competition, and volume.
• The markets for heavily traded currencies like the $,€, £, and ¥ are
very liquid.
Interpreting
Foreign Exchange Quotations
• The exchange rate quotations published in newspapers normally
reflect the ask prices for large transactions.
• Direct quotations represent the value of a foreign currency in
rupees, while indirect quotations represent the number of units of a
foreign currency per rupee.
• Indirect quotation = 1
Direct quotation
Interpreting
Foreign Exchange Quotations
• A cross exchange rate reflects the amount of one foreign currency
per unit of another foreign currency.
Example Direct quote: $1.50/£, $.009/¥
Indirect quote: .67£/$, 111.11¥/$
value of £ in $
Value of £ in ¥ =
value of ¥ in $
$1.50/£
=
$.009/¥
= 166.67¥/£
Currency Futures and Options Market
• Currency futures contracts specify a standard volume of a particular
currency to be exchanged on a specific settlement date. They are
sold on exchanges, unlike forward contracts.
• Currency call (put) options give the right to buy (sell) a specific
currency at a specific price (called the strike or exercise price) within
a specific period of time.
Cross Rate
• The cross rate refers to the exchange rate between two currencies,
each of which has an exchange rate quote against a common
currency.
• A cross rate is an exchange rate of two currencies expressed in a
third different currency, such as the exchange rate between the euro
and the yuan expressed in yen.
• https://www.youtube.com/watch?v=Jjcqj68vgXM
Arbitrage
• Geographical arbitrage; Buying currency from a forex market where

it is cheaper and sell in another forex market where it is costly.
• Triangular arbitrage: It involves three foreign currencies involving
three different currencies involving three different foreign exchange
markets.(Three-point arbitrage)
• The arbitrage process will set in whenever there are significant
differences between cross rates and quoted rates and this process
continues till there is a realignment between these rates.
• https://www.youtube.com/watch?v=jZpocmakOxk
• Arbitrage in forward market: The difference between spot rate and
forward rate is not matched by the interest rate differentials of the
two currencies. This kind of arbitrage is called covered interest
arbitrage (CIA).
CIA
• Covered interest Arbitrage (CIA): Refers to the spot purchase of the

foreign currency to make the investment and offsetting the
simultaneous forward sale to cover the foreign exchange risk.

Forex Management

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Forex Management

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Forex Management

Motives for Using

• Geographical arbitrage; Buying currency from a forex market where

• Covered interest Arbitrage (CIA): Refers to the spot purchase of the

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