Page 1

Chapter 5 Chapter 5

Currency Derivatives

Source: http://www.mcdonalds.com/corp/invest/pub/2006_Annual_Report.html McDonald’s Corporation 2006, Annual Report, p 46

1

Forward Contracts

Source: http://www.mcdonalds.com/corp/invest/pub/2006_Annual_Report.html McDonald’s Corporation 2006, Annual Report, p 36

2

Suppose an American tourist plans to go to England six months (180 days) from today and he plans to spend $1,000 while he is there. What choices does he have for getting the £’s he will need? 1. Buy £’s today at the current spot rate of S0 = $1.48/ £

Agree today on a price to be paid in the future for a specified amount of foreign currency at a specified delivery date When you enter into a Forward Contract, four important things must be agreed upon:

How many £’s will he get?

• Whether you will buy or sell the foreign currency • How much of the foreign currency is involved • The exchange rate • When the exchange will take place

1,000  £676 1.48 3

4

Today’s Spot Rate (S) and Today’s Forward Rate (F)

2. Buy £’s with a Forward Contract today at the current forward rate of F180 = $1.44/£

F = S(1 + p) p is the forward premium as a percentage F FS  1 S S In the previous example: $1.44  $1.48  $0.04    2. 7 % $1.48 $1.48 A negative number indicates a Forward Discount A positive number indicates a Forward Premium (rates are direct from American point of view)

$1,000  £694 $1.44 / £

p

3. Wait six months and buy £’s at the then current spot rate Which of the three is the best course of action? He will not know until six months from today but he must make a decision today.

Frequently calculated as an annual rate, but we won’t in this class 5

6


Chapter 5

Forward Discount The Forward Rate is better for buying the foreign currency than the current Spot Rate (in direct quotations, the Forward Rate is less than the Spot Rate)

Forward Premium The Forward Rate is worse for buying the foreign currency than the current Spot Rate (in direct quotations, the Forward Rate is more than the Spot Rate) 7

What influences today’s Forward Rate (F180)? A major influence is what people today expect the Spot Rate (S180 ) to be 180 days from now Suppose today F180 = $1.50/£ > $1.40/£ = E[S180] What will happen in the market for £ Forward Contracts under these conditions? More people will want to sell £’s at $1.50/£ than will want to buy them at that price  A surplus will exist  The 180-day Forward Rate of $1.50/£ will decrease until it is equal to E[S180 ] Later in the semester we will investigate other factors which influence today’s Forward Rates

Wall Street Journal

¥ vs $

Tuesday, July 10, 2007

Currencies

Monday, July 9, 2007

U.S.- dollar foreign-exchange rates in late New York trading

Country/currency

----- Mon ----In US$ per US$

US$ vs YTD chg (%)

2.0150 2.0140 2.0121 2.0083

- 2.8 - 2.8 - 2.7 -2.5

Spot Rate

Europe UK pound 1-mos forward 3-mos forward 6-mos forward

0.4963 0.4965 0.4970 0.4979

On Monday, what was the market expecting the value of the $ to do over the next 180 days? The $ will appreciate against the £ over the next 6 months (180 days)

8

9

On Tuesday, October 6, 1998, the spot rate for the yen was ¥130.18/$. The next day the spot rate dropped to ¥120.55/$. Wednesday’s Wall Street Journal reported that some analysts were predicting “the U.S. currency could rally to ¥140/$ in six months”. Wednesday’s 6-month forward rate was ¥117.45/$. Assume you believed the analysts’ prediction and you had $500. How could you have used a forward contract to make a profit? Should you “buy” or “sell” yen at the forward rate of ¥117.45/$?

10

Wednesday Oct 7

CAUTION

Enter into a forward contract

To apply the rule “buy low and sell high”, think in terms of $/¥ rather than ¥/$ 

Sell ¥ forward 6 months at a rate of ¥117.45/$ How many ¥?

Spot market in 6 months: ¥140/$ = $0.007143/¥ 6-months forward rate: ¥117.45/$ = $0.008514/¥

You anticipate buying ¥ in the spot market in 6 months at a rate of ¥140/$

Sell yen forward at $0.008514/¥ anticipating being able to buy yen in six months at $0.007143/¥

$500(¥140/$) = ¥70,000 11

12


Chapter 5

Six Months Later

Non-Deliverable Forward Contracts Frequently used for currencies in emerging markets

Use your $500 in the spot market to buy ¥70,000

Similar to Forward Contract: specified currency, specified amount, specified future settlement date, specified rate (reference index)

Deliver the ¥70,000 on the forward contract and receive 70,000  $596 117.45

Different from Forward Contract: no actual exchange of currencies in future, instead a $ payment is made based on reference index at the settlement date

Dollar profit = $96

13

14

Futures Contracts Specifies a standard amount of a currency to be delivered at a specified settlement date in the future at a specific price Source: http://www.cme.com/trading/prd/fx/

Source: http://www.cme.com/files/renminbi_factcard.pdf

15

Wall Street Journal

Comparison of Forward and Futures Contracts

Size of contract

CURRENCY FUTURES Friday, April 11, 2008 Japan Yen (CME) 12.5 million; $ per 100¥ CME = Chicago Mercantile Exchange June 08 Sep 08

Open High .9858 .9971 .9914 1.0010

Low .9810 .9855

Settle .9951 .9991

16

Forward: Tailored to individual needs Futures: Standardized

Open Chg Interest +.0102 176,133 +.0102 3,033

Delivery date Forward: Tailored to individual needs (30, 60, 90 or 180 days) Futures: Standardized (third Wednesday in March, June, September, December)

June contracts opened at $0.009858/¥ At the end of the trading day Friday, there were 176,133 June contracts outstanding 17

18


Chapter 5 Participants

Security deposit (collateral)

Forward: Banks, brokers, MNC’s (public speculation not encouraged) Futures: Banks, brokers, MNC’s (Qualified public speculation is encouraged)

Forward: Usually none (relationship with bank) but compensating balance or line of credit sometimes required Futures: Small security deposit required (buy on margin, subject to daily margin calls)

Marketplace Forward: Over the telephone, worldwide Futures: Central exchange floor with worldwide communications 19

Liquidation

20

Regulation

Forward: Most settled by actual delivery (Some by offset, at a cost) Futures: Most by offset (very few by delivery)

Forward: Self-regulating Futures: Commodity Futures Trading Commission, National Futures Association

Transactions costs

Terminology

Forward: Set by “spread” between bank’s buy & sell prices Futures: Negotiated brokerage fees

Forward: you enter into a forward contract Futures: you buy or sell futures contracts 21

22

Closing out your position

Futures Contract

January 5

Suppose three weeks after purchasing the contract you decide you do not want Swiss Francs in March Sell a March SF contract at the current price of $0.74/SF  you would receive 0.74(125,000) = $92,500

125,000 Swiss Francs per contract $0.76/SF on a March contract The buyer of this contract agrees to purchase 125,000 Swiss Francs on the third Wednesday in March for $0.76(125,000) = $95,000

On this investment you lost $95,000 - $92,500 = $2,500 or 2.63% of your investment

The seller of this contract agrees to deliver 125,000 Swiss Francs on the third Wednesday in March and will receive $95,000

Approximately 44% annual rate 23

24


Chapter 5 Why is the CME in business?

Suppose the buyer and seller put up a margin of $1,500 on January 5 when they bought/sold the $0.76/SF March futures contract

To make money by “making a market”. What concern does the buyer of a futures contract have about the seller of the contract?

If the price of SF’s falls the next day to $0.755, the contract is worth only $94,375. Who might not show up, the buyer or the seller?

That the seller won’t deliver the foreign currency. What concern does the seller of a futures contract have about the buyer of the contract?

CME may choose to increase the buyer’s margin by $95,000 - $94,375 = $625

That the buyer won’t deliver the home currency. What can the CME do to make sure both parties honor the contract? The CME guarantees delivery on contracts by requiring a margin when the contract is sold. 25

Source: http://www.mcdonalds.com/corp/invest/pub/2006_Annual_Report.html 27 McDonald’s Corporation 2006, Annual Report, p 36

If the buyer refuses, CME will sell an offsetting futures contract for $94,375 and close out buyer’s position and give buyer $1,500 - $625 = $875

Source: http://www.mcdonalds.com/corp/invest/pub/2006_Annual_Report.html McDonald’s Corporation 2006, Annual Report, p 36

26

28

Currency Options

Call Option Grants the right to buy a specific amount of a specific currency At a specific price (strike price or exercise price) Within a specific period of time (expires on Saturday before third Wednesday of contract month) The “premium” is what it costs to buy the Call Option “European style” can be exercised only on the expiration date Sold on exchanges and offered by commercial banks and brokerage firms 29

Why do people buy automobile insurance?

30


Chapter 5 So that if their car is in an accident, the insurance will pay for repairing the car.

Insurance provides protection for the car’s owner in the event something “bad” happens to the car. Currency options are similar to insurance in that they provide protection against something “bad” happening to the value of a foreign currency. The cost of automobile insurance (the premium) depends on the total amount of coverage and the size of the deductible. 31

British Pound (£) Options £62,000 per contract cents per pound

Strike Price 1500 1525 1550 1575 1600 1625

How much did it cost on January 5 to buy a March Call with a strike price of $1.50? 6.5¢/£  0.065(62,000) = $4,030

Premium (price) for these options

Suppose on January 5 the Premium on a March Call with a strike price of $1.50 is 2¢/£ instead of 6.5¢/£. The spot rate on January 5 is $1.56/£. Any ideas about how you could make money under these circumstances?

January 5

Calls Jan 6.06 3.71 1.26 0.16 0.14 0.10

Feb 6.23 3.94 2.12 0.92 0.34 0.16

Puts March 6.50 4.42 2.80 1.62 0.86 0.42

Jan ---0.04 0.20 1.60 4.01 6.54

Feb 0.16 0.40 1.06 2.36 4.26 6.62

32

March 0.44 0.90 1.74 3.04 4.76 6.80

Current spot rate $1.56/£

33

34

General Observations about Call premiums

Step 1: Buy a Call option for (2¢)(62,000) = $1,240 Step 2: Exercise it immediately, receive £’s at $1.50/£ $1.50(62,000) = $93,000  total cost of $1,240 + $93,000 = $94,240

If markets are efficient then premium > spot - strike The lower the strike price is relative to the spot rate  higher premium

Step 3: Sell £’s in spot market at $1.56 and collect $1.56(62,000) = $96,720  profit of $96,720 - $94,240 = $2,480 with no risk

The longer until Call expires  higher premium The greater the variability in a currency  higher premium 35

36


Chapter 5

If the purchaser of the March Call exercises it, what is the cost of each £?

How is buying the March Call option

$1.50 + $0.065 = $1.565 per £

like buying insurance for an MNC? It guarantees the MNC that it can buy the £’s it needs in March for no more than $1.565 per £

Strike Price Premium 37

38

? In deciding whether or not to exercise the March Call, should the owner of the Call compare the current spot rate to

$1.50

Spot Market

Strike price

January 5

or

$1.565

Premium $4,030

Cost of £’s by exercising Call

Exercise Call 39

$1.50

Strike price

40

On January 5 an MNC bought a March call option because it must pay £’s in March to one of its British suppliers. The Call’s strike price was $1.50/£. It is now the Saturday before the third Wednesday in March and the spot rate is $1.53.

Since the premium is a sunk cost, it should be ignored in this decision. The owner of the Call wants to buy £’s where they are the cheapest.  If spot < $1.50  do not exercise March call  If spot > $1.50 

Should the Call be exercised ?

exercise March call 41

42


Chapter 5 ?

Calculate the total cost of the £’s if the MNC exercises the Call

Spot Market $1.53

January 5 Premium $4,030

( $1.50 + 6.5¢ )(62,000) = $93,000 + $4,030 = $97,030 Compare this to the total cost of the £’s if the MNC does not exercise the Call

Saturday before third Wednesday in March

Buying £’s in the spot market will cost ($1.53)(62,000) = $94,860 Exercise Call strike price $1.50

Remember that the MNC had to pay the $4,030 even if it does not exercise the option  Total cost of not exercising the Call is $94,860 + $4,030 = $98,890

43

44

? Spot Market $98,890 January 5

Saturday before

Premium $4,030

third Wednesday in March

Exercising the Call is less expensive than not exercising it by $98,890 - $97,030 = $1,860

Or, ignoring the premium (sunk cost) $94,860 - $93,000 = $1,860 Exercise Call $97,030 45

46

?

Suppose it is January 5 when the MNC is considering whether or not to purchase the March Call with a strike price of $1.50, and it forecasts the March spot rate to be $1.53

Uncovered forecast spot rate $1.53 January 5

Should the MNC purchase the March Call or go uncovered ?

Pay Toll

Buy Call Premium 6.5 ¢ 47

Exercise Call strike price $1.50 48


Chapter 5 ? Cost of the £’s if MNC purchases and exercises the Call

Uncovered $94,860

($1.50 + 6.5¢)(62,000) = $93,000 + $4,030 = $97,030

January 5

Cost of the £’s if the MNC goes uncovered and forecast is correct ($1.53)(62,000) = $94,860

Pay Toll

Exercise Call By going uncovered, MNC anticipates $97,030 buying £’s at a lower cost, thus saving $97,030 - $94,860 = $2,170 RISK 49

Under what circumstances would an MNC be interested in buying a Call option? 1. MNC must deliver the foreign currency in the future 2. MNC feels spot will rise above strike + premium

Under what circumstances would an MNC be interested in selling a Call option? 1. MNC has the foreign currency on hand and wants to make an additional return on it 2. MNC feels spot will go below the strike price (so the owner of the Call will not exercise it)

50

Speculators A speculator hopes to profit from changes in the exchange rate. He does not currently have the foreign currency, does not need to pay foreign currency in the future and will not receive foreign currency in the future Suppose a speculator thinks £’s will depreciate.

Would the speculator want to buy or sell a Call? Sell a Call, receive $4,030 and hope Call is never exercised so he gets to keep the entire $4,030 as profit

51

52

Under what circumstances would a speculator be interested in buying a Call option?

What happens if the spot rate is $1.53 and the Call is exercised?

1. He feels spot will rise above strike + premium

Under what circumstances would a speculator be interested in selling a Call option?

Speculator must buy £’s in spot market at $1.53 for $1.53(62,000) = $94,860 Delivers £’s and receives $1.50(62,000) = $93,000 for a profit of $93,000 + $4,030 - $94,860 = $2,170

1. He feels spot will fall below the strike price and the Call will never be exercised so the entire premium is profit 53

54


Chapter 5 General Conclusions

If strike < spot < strike + premium

Suppose the strike price of a Call Option is $1.40/£ and the premium is 5¢

$1.40 < spot < $1.45  Buyer exercises Call and recoups some of the Call’s premium  Seller’s profit is only part of the premium

If spot < strike

spot < $1.40  Buyer does not exercise the Call  Seller: entire premium is profit

If strike + premium < spot

If $1.35 < spot < $1.40 the buyer recoups part of the Call’s 5¢ premium by purchasing the foreign currency in the spot market If spot < $1.35 the buyer recoups more than Call’s 5¢ premium by purchasing foreign currency in spot market 55

$1.45 < spot  Buyer exercises Call and recoups more than the 5¢ premium  Seller loses all of the premium and more if the foreign currency must be purchased in the spot market

56

Buyer of Call

Contingency Graph This is a picture of the “profit/loss” position of a speculator buying or selling a Call Option or a Put Option. The magnitude of the profit or loss depends on what the strike price is and can be shown “per unit” of the foreign currency or for the entire size of the contract.

Net Profit per Unit in the money spot > strike

at the money 0¢ $1.40

Consider a Call Option with a strike price of $1.40/ £ and a premium of 5¢

- 5¢

$1.45

Spot Rate

out of the money spot < strike

57

Seller of Call

58

Put Option

Net Profit per Unit + 5¢

Grants the right to sell a specific amount of a specific currency At a specific price (strike price or exercise price)

0¢ $1.40

$1.45

Spot Rate

Within a specific period of time (expires on Saturday before third Wednesday of contract month) The “premium” is what it costs to buy a Put Option 59

60


Chapter 5 How much would it cost to buy a March Put with a strike price of $1.625?

British Pound (£) Options £62,000 per contract cents per pound Strike Price 1500 1525 1550 1575 1600 1625

The premium is 7¢/£  $0.07(62,000) = $4,340 Suppose on January 5 the premium on a March Put with a strike price of $1.625 was 4¢/£ instead of 7¢/£. The spot rate at that time was $1.56/£. Any ideas about how you could make money under these circumstances?

January 5 Calls Jan 6.06 3.71 1.26 0.16 0.14 0.10

Feb 6.23 3.94 2.12 0.92 0.34 0.16

Puts March 6.50 4.42 2.80 1.62 0.86 0.42

Jan 0.04 0.20 1.60 4.01 6.54

Feb 0.16 0.40 1.06 2.36 4.26 6.62

March 0.44 0.90 1.74 3.04 4.76 7.00

Current spot rate $1.56/£ 61

62

General Observations about Put premiums

Step 1: Buy Put option for (4¢)(62,000) = $2,480 Step 2: Buy £’s in spot market at $1.56 for $1.56(62,000) = $96,720  total cost is $96,720 + $2,480 = $99,200

If Markets are efficient then premium > strike - spot

Step 3: Exercise Put  deliver £’s and receive $1.625(62,000) = $100,750  profit = $100,750 - $99,200 = $1,550

The lower the spot price is relative to the strike price  higher premium The longer until put expires  higher premium

Or $1.625 - ($1.56 + $0.04) = $0.025/£

The greater the variability in a currency  higher premium

With NO RISK 63

If the purchaser of the March Put with a strike price of $1.625 exercises it, how much will he actually receive for each £ he sells?

64

How is buying the March Put option like buying insurance for an MNC?

$1.625 - $0.07 = $1.555 per £

It guarantees the MNC that it can sell the £’s it receives in March for a minimum of $1.555 per £

Strike Price Premium 65

66


Chapter 5 ? In deciding whether or not to exercise the March Put, should the owner of the Put compare the current spot rate to

$1.625

Spot Market

Strike price

January 5

or

$1.555

Premium $4,340

Received for £’s by exercising Put

Exercise Put 67

$1.625

68

Strike price On January 5 an MNC bought a March Put option because it will receive £’s in March from one of its British customers. The Put’s strike price is $1.625/£. It is the Saturday before the third Wednesday in March and the spot rate is $1.58.

The owner wants to sell £’s where he receives the most for each £. Since the premium is a sunk cost, it should be ignored when making this decision.  If spot < $1.625  exercise March Put

Should the Put be exercised ?

 If spot > $1.625  do not exercise March Put 69

? Spot Market $1.58

January 5

Saturday before

Premium $4,340

third Wednesday in March

Exercise Put strike price $1.625 71

70

Calculate the total revenue the MNC receives from selling £’s if it exercises the Put ( $1.625 - 7¢ )(62,000) = $100,750 - $4,340 = $96,410 Compare this to the total revenue from the sale of the £’s if the NMC does not exercise the Put and sells them in the spot market $1.58(62,000) = $97,960 from selling £’s in the spot market Remember that the NMC had to pay the $4,340 premium even if it does not exercise the option  Total revenue if MNC sells £’s in spot market instead of exercising Put is $97,960 - $4,340 = $93,620 72


Chapter 5 ? Spot Market $93,620

January 5

Saturday before

Premium $4,340

third Wednesday in March

Exercising the Put generated more revenue than selling the £’s in the spot market by $96,410 - $93,620 = $2,790

Or, ignoring the premium (sunk cost) $100,750 - $97,960 = $2,790

Exercise Put $96,410 73

74

?

Suppose it is January 5 when the MNC is considering whether or not to purchase the March Put with a strike price of $1.625/£, and it forecasts the March spot rate to be $1.58/£

Uncovered forecast spot rate $1.58 January 5

Should the MNC purchase the March Put or go uncovered ?

Pay Toll

Exercise Put strike price $1.625

Buy Put Premium 7¢ 75

76

?

Revenue from selling the £’s if MNC purchases a Put and exercises it.

Uncovered $97,960

($1.625 - 7¢ )(62,000) = $100,750 - $4,340 = $96,410 January 5

Revenue from selling the £’s if the MNC goes uncovered and its forecast is correct ($1.58)(62,000) = $97,960

Pay Toll

77

The MNC anticipates receiving more revenue by going uncovered than from selling £’s by exercising the Put $97,960 - $96,410 = $1,550

Exercise Put $96,410

RISK 78


Chapter 5 Under what circumstances would an MNC be interested in buying a Put option?

RECALL: A speculator hopes to profit from changes in the exchange rate. He does not currently have the foreign currency, does not need to pay foreign currency in the future and will not receive foreign currency in the future

Under what circumstances would an MNC be interested in selling a Put option?

Under what circumstances would a speculator be interested in buying a Put option?

1. It will receive foreign currency in the future 2. It feels spot will fall below strike - premium

1. He feels spot will fall below strike - premium Under what circumstances would a speculator be interested in selling a Put option?

1. It will deliver foreign currency in the future 2. It feels (strike - premium) < spot < strike NOTE: If MNC feels spot will rise above strike, buying a Call option is a better hedge 79

General Conclusions

1. He feels spot will rise above strike and the Put will never be exercised so the entire premium is profit

If strike - premium < spot < strike

Suppose the strike price is $1.60/£ and the premium is 6¢

$1.54 < spot < $1.60  Buyer exercises Put and recoups some of the 6¢ premium  Seller’s profit is only part of the 6¢ premium

If strike < spot $1.60 < spot  Buyer does not exercise Put  Seller: entire premium is profit If $1.60 < spot < $1.66 the buyer recoups part of the 6¢ premium by selling foreign currency in spot market If $1.66 < spot the buyer recoups more than the 6¢ premium by selling foreign currency in spot market

If spot < strike - premium

81

spot < $1.54  Buyer exercises Put and recoups more than the 6¢ premium  Seller loses all of the 6¢ premium and more if the foreign currency must be sold in the spot market

strike price is $1.60/£ and the premium is 6¢

Net Profit per Unit

Buyer of Put at the money

+ 6¢

out of the money spot > strike

0¢ $1.54

0¢ - 6¢

$1.54 in the money spot < strike

82

Seller of Put

Contingency Graph for Put Options

Net Profit per Unit

80

$1.60

$1.60

Spot Rate

Spot Rate

83

84


Chapter 5

¥ vs $

Strike Price 7600 7650 7700 7750 7800 7850

On Tuesday, October 6, 1998, the spot rate for the yen was ¥130.18/$ . The next day the spot rate dropped to ¥120.55/$. On Tuesday, the yen options prices as reported in the Wall Street Journal were as follows:

Japanese Yen (CME) Tuesday, Oct 6, 1998 12,500,000 yen; cents per 100 yen Calls - Settle Puts - Settle Oct Nov Dec Oct Nov 1.49 2.39 2.87 0.28 1.19 1.12 2.11 2.59 0.42 1.40 0.83 1.85 2.35 0.62 1.64 0.60 1.60 2.12 …. …. 0.42 1.40 1.91 1.21 …. 0.28 …. 1.71 …. ….

Dec 1.67 1.89 2.14 …. 2.69 ….

Strike price 7600 means $0.007600/¥

What should you have done on Tuesday in order to benefit from what happened on Wednesday? 85

Tuesday

Tuesday

Buy an October Call Option with a strike price of $0.0076/¥ for a premium of 1.49¢ per 100¥ cost: $0.0149(125,000) = $1,862.50

Should you use a Call or a Put? HINT: ¥120.55/$ = $0.008295/¥ tomorrow

CALL BUY

86

Wednesday Step 1: Exercise the Oct Call Option cost: $0.007600(12,500,000) = $95,000

Should you buy a call or sell a call?

Step 2: Sell ¥12,500,000 in the spot market at the current spot rate of $0.008295/¥ Receive: $0.008295(12,500,000) = $103,687.50 Profit: $103,687.50 - $95,000 - $1,862.50 = $6,825 87

88

Net Amount Received

Conditional Currency Option

$102,920

Currency Option with a conditional premium:

$100,440 $99,200

Payment of the premium is conditioned on the actual movement of the spot rate

$97,960

Normal Put Option 2¢ premium

EXAMPLE: £ Put Option with a strike price of $1.60 and a conditional premium of 4¢ with a trigger of $1.66. If the future spot rate is $1.66 or lower, the buyer does not pay the premium.

$1.60 $1.66 Spot Rate 89

90


Chapter 5 Building Blocks for FINC 445

STRADDLE

Skills: Communication Problem Solving

If a currency is highly volatile, a speculator may buy both a Call (anticipating appreciation) and a Put (anticipating depreciation) Forward Contracts: Forward Premium

Spot rate may fluctuate enough to exercise both and profit on both

MNCâ&#x20AC;&#x2122;s and consumers Investors Central Banks Speculators Motives: Involved in foreign financial markets

Spot may move strongly in one direction and profit on that option may exceed premium on the other option 91

Futures Contracts margin

Exchange Rate Determination: Exports and imports pair of currency markets supply, demand, equilibrium Familiar Setting: U.S. grocery store Buyer vs seller

Trade Agreements: U.S.-Canada, NAFTA, Mercosur, FTAA, CAFTA, Mexico, EU, GATT, WTO

FX Systems: Euro, Dollarization, Floating Exchange Rate System

Problem of Scarcity: Comparative Advantage Interdependence

Economic Systems: Capitalism, Socialism Communism

Arbitrage

Put Options

Adjustment of Market Equilibrium: Inflation, interest rates, income levels, expectations about future exchange rates

Currency Conversion: The basics, value, appreciate, depreciate, purchasing power

Balance of Payments: Current Account Capital Account Official Reserve Acct Goal of Corp: Max. wealth of shareholders

Call Options

Spot Market: Bid & ask rates, direct & indirect, cross rates, arbitrage

Trade Issues: Japan & China, deficits, surpluses, trading partners

Ethical Considerations

Perfect Markets: labor interest

Contingency Graph Speculating on anticipated exchange rate movement

Bank participation in foreign exchange markets

Economic Factors: Inflation, national income, interest rates, trade barriers, capital controls

Intl Agencies: World Bank IMF

MNC vs domestic firm

PV of MNCâ&#x20AC;&#x2122;s cashflows

Risk of doing business internationally

92

Dr. Wolken's Chapter 5: Currency Derivatives