forex session 3

8/3/2019 Forex Session 3

1/21

The Gold Standard

The Inter-War Years

Brenton Woods Fixed Exchange Rates

Electric Currency Arrangement

Floating Exchange Rates

1


2/21

Egypt

Greeks and Romans

Gold as medium of exchange Rules of the Games

Maintaining Gold Reserves was keyeserveswas key Gold Rquate

US declared Gold at $20.67 per ounce British Pound was kept at 4.2474 per ounce

2


3/21

Chaotic

Speculators short sold weak currencies

Long with Strong Currencies Convertibility became an issue

3


4/21

U.S Dollar based International MonetarySystem

IMF and IBRD formed Only dollar remained convertible to Gold

$35 per ounce

4


5/21

Exchange arrangement without legal tender

Currency board arrangements

Fixed Peg Fixed peg wit horizontal Bands

Crawling Pegs

Crawling Bands

Managed Floating Rates

Independent Floating Rates

5


6/21

1. The currency of another country circulatesas the sole legal tender or the country

belongs to a monetary or currency union (e.g.Euro) in which the same legal tender is sharedby the members of the union

2. Under currency board system, the country

fixes the rate of its domestic currency interms of a foreign currency

3. The country pegs its currency( formally orde facto) at a fixed rate to a major currencyor a basket of currencies with a 1%fluctuation allowed

6


7/21

4. The country pegs its currency( formally orde facto) at a fixed rate to a major currencyor a basket of currencies with more than a 1%fluctuation allowed

5. The currency is adjusted periodically insmall amounts at a fixed pre announced rate

6. The currency is maintained within certain

fluctuation margins around a central rate thatis adjusted periodically

7


8/21

Depends on inflation, unemployment, interestrate levels, trade balances, and economicgrowth Fixed Rates provide stability

Fixed Rates are anti-inflationary, can beburdensome

Fixed Rates necessitates large reserves of hard

currency and gold

Fixed Rates might get inconsistent with growingeconomy

8


9/21

It is a process of buying and selling the sameasset at the same time, to profit from pricediscrepancies within a market or acrossdifferent markets.

It can be

- One way arbitrage

- Two way arbitrage

- Three way arbitrage

9


10/21

In terms of Forex, arbitrage opportunitiesexist when there is a considerable differencebetween exchange rates provided in twodifferent Forex markets.

Hence, if the currency is bought in onemarket and sold elsewhere at a better price,profit can be realized

10


11/21

Triangle or triangular arbitrage is a Forextrading strategy, which is theoretically riskfree.

As the name suggest, triangle arbitrageincludes trading 3 different currency pairsalmost simultaneously to profit fromexchange rate difference between them.

11


12/21

In global Forex market, the price of onecurrency pair depends on the price of one ormore other currency pairs.

The basic formula for the relationship ofthree related currency pairs, having 3different currencies, is as follows.AAA/BBB x CCC/AAA = CCC/BBB

Chance of triangular arbitrage occurswhenever this equation goes wrong.

12


13/21

A triangle arbitrator buys BBB spending AAA,then buys CCC spending BBB and lastly returns toAAA selling CCC, capturing a small profit. Thechance of profit is maximized by utilizing marginfrom brokers and trading with higher amounts.

Confusing?

For example take exchange rates EUR/USD =0.6522, EUR/GBP = 1.3127 and USD/GBP =2.0129. With $500,000 one can buy 326100

Euros, using that he can buy 248419.29 Pounds.He can now sell the pounds for $500043.19.Thus he can earn a profit of $43.19.

13


14/21

14

$

Credit

Lyonnais

S(/$)=0.67

Credit Agricole

S(/)=185

Barclays

S(/$)=120

Suppose we

observe these

banks posting

these exchange

rates.

First calculate theimplied cross

rates to see if an

arbitrage exists.


15/21

15

$

CreditLyonnais

S(/$)=1.50

Credit Agricole

S(/)=85

Barclays

S(/$)=120

80

1

120

1$

1$

50.1

The implied S(/) cross

rate is S(/) = 180

Credit Agricole has

posted a quote of

S(/)=85 so there is anarbitrage opportunity.

So, how can we make money?


16/21

16

$

CreditLyonnais

S(/$)=1.50

Credit Agricole

S(/)=85

Barclays

S(/$)=120

80

1

120

1$

1$

50.1

As easy as 1 23:

1. Sell our $ for ,

2. Sell our for ,

3. Sell those for $.


17/21

17

Sell $100,000 for at S(/$) = 0.67

receive 67,000

Sell our 67,000 for at S(/) = 185

receive 1,23,95,000

Sell 1,23,95,000for $ at S(/$) = 120receive $1,03,291

profit per round trip = $ 103,291 - $100,000 = $3,291


18/21

Inflation rates

Interest rates

Balance of payment position

Volume of International reserves

Level of activity and employment

18


19/21

Inflation rates: In case domestic inflation is higher than the foreign

countrys, then prices of domestic goods increasesfaster, making the foreign goods relatively cheaper.

This increases demand for foreign goods, which inturn, appreciates the foreign currency.

Interest rates:

If interest rates are higher in the US than in Japan,Japanese funds are more likely to get attracted to theUS as Japanese banks and firms will yield higher byparking their funds in the US.

The flight of capital funds from Japan to the US willincrease demand for USD in Japan, which will lead toappreciation of the USD

19


20/21

Balance of Payment position

Deficits require payments in foreign currency

Therefore, monetary authority has to deliberatelydevalue the currency. This will enhance the foreigncurrency making the foreign good more expensive;and increases exports as home currency is cheaper.

Also, devaluing the currency will help in paying theforeign debt as the net amount reduces.

20


21/21

Value of Forex reserves

The level of forex reserves (including gold) the CentralBank possesses. Releasing/selling FC appreciates the rupee Buying FC depreciates rupee (appreciates FC) In case of inadequate reserves, the Central bank will

be helpless and will not be able to stabilise.

Level of activity and employment Higher level of economic activity and employment

leading to a sizeable foreign trade will appreciate

domestic currency. Low level of activity may depreciate the domestic

currency.

21

forex session 3

Documents