CHAPTER 5 The Market for Foreign Exchange.docx
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CHAPTER5TheMarketforForeignExchange
CHAPTER5TheMarketforForeignExchange
FunctionandStructureoftheFXMarket
InternationalFinanceinPractice:
TheMouseTakesOvertheFloor
FXMarketParticipants
CorrespondentBankingRelationships
InternationalFinanceinPractice:
WhereMoneyTalksVeryLoudly
TheSpotMarket
SpotRateQuotations
TheBid-AskSpread
SpotFXTrading
Cross-ExchangeRateQuotations
AlternativeExpressionsfortheCross-ExchangeRate
TheCross-RateTradingDesk
TriangularArbitrage
SpotForeignExchangeMarketMicrostructure
TheForwardMarket
ForwardRateQuotations
LongandShortForwardPositions
ForwardCross-ExchangeRates
SwapTransactions
ForwardPremium
Summary
MINICASE:
ShrewsburyHerbalProducts,Ltd.
FunctionandStructureoftheFXMarket
1Theworld’slargestforeignexchangetradingcenteris:
a)NewYork
b)Tokyo
c)London
d)HongKong
Answer:
c)
2Onaverage,worldwidedailytradingofforeignexchangeis
a)impossibletoestimate
b)$15billion
c)$504billion
d)$1.88trillion
Answer:
d)
3Theforeignexchangemarketcloses
a)Never
b)4:
00p.m.EST(NewYorktime)
c)4:
00p.m.GMT(Londontime)
d)4:
00p.m.(Tokyotime)
Answer:
a)
FXMarketParticipants
4Mostforeignexchangetransactionsarefor:
a)Interventionbycentralbanks
b)Interbanktradesbetweeninternationalbanksornonbankdealers
c)retailtrade
d)purchaseofhardcurrencies
Answer:
b)
5Thedifferencebetweenabrokerandadealeris
a)Dealersselldrugs,brokerssellhouses.
b)Brokersbringtogetherbuyersandsellers,butcarrynoinventory.Dealersstandreadytobuyandsellfromtheirinventory.
c)Brokerstransactinstocksandbonds;currencyisboughtandsoldthroughdealers.
d)Noneoftheabove
Answerb)
Rationale:
ifsomeonecomplainsabouta)beingcorrect,askthemwhowouldsellacrackhouseoramethlab.
6MostInterbanktradesare
a)Speculativeorarbitragetransactions
b)Simpleorderprocessingfortheretailclient
c)Overnightloansfromonebanktoanother
d)Brokeredbydealers
Answera)
7Atthewholesalelevel
a)MosttradingtakesplaceOTCbetweenindividualsontheflooroftheexchange
b)Mosttradingtakesplaceoverthephone
c)MosttradingflowsoverReutersandEBSplatforms
d)Mosttradingflowsthroughspecialized“broking”firms
Answer:
c)
8Interventionintheforeignexchangemarketistheprocessof:
a)Acentralbankrequiringthecommercialbanksofthatcountrytotradeatasetpricelevel.
b)Commercialbanksindifferentcountriescoordinatingeffortsinordertostabilizeoneormorecurrencies.
c)Acentralbankbuyingorsellingitscurrencyinordertoinfluenceitsvalue.
d)Thegovernmentofacountryprohibitingtransactionsinoneormorecurrencies.
Answer:
c)
CorrespondentBankingRelationships
9ConsideraU.S.importerdesiringtopurchasemerchandisefromaDutchexporterinvoicedineuros,atacostof€512,100.TheU.S.importerwillcontacthisU.S.bank(whereofcoursehehasanaccountdenominatedinU.S.dollars)andinquireabouttheexchangerate,whichthebankquotesas€1.0242/$1.00.Theimporteracceptsthisprice,sohisbankwill____________theimporter’saccountintheamountof____________.
a)Debit,$500,000
b)Credit,€512,100
c)Credit,$500,000
d)Debit€512,100
Answer:
a)
Rationale:
debit,sincetheimporterispaying.$500,000=€512,100×$1.00/€1.0242
TheSpotMarket
10Thespotmarket
a)Involvesthealmost-immediatepurchaseorsaleofforeignexchange.
b)Involvesthesaleoffutures,forwards,andoptionsonforeignexchange
c)Takesplaceonlyonthefloorofaphysicaltradingfloor
d)Alloftheabove.
Answer:
a)
11Spotforeignexchangetrading
a)accountsforabout5percentofallforeignexchangetrading
b)accountsforabout20percentofallforeignexchangetrading
c)accountsforabout35percentofallforeignexchangetrading
d)accountsforabout70percentofallforeignexchangetrading
Answer:
d)
SpotRateQuotations
Country
U.S.$equiv.
CurrencyperU.S.$
Tuesday
Monday
Tuesday
Monday
Britain(Pound)£62,500
1.6000
1.6100
0.625
0.6211
1MonthForward
1.6100
1.6300
0.6211
0.6173
3MonthsForward
1.6300
1.6600
0.6173
0.6024
6MonthsForward
1.6600
1.7200
0.6024
0.5814
12MonthsForward
1.7200
1.8000
0.5814
0.5556
12Usingthetableshown,whatisthemostcurrentspotexchangerateshownforBritishpounds?
Useadirectquote
a)$1.61=£1.00
b)$1.60=£1.00
c)$1.00=£0.625
d)$1.72=£1.00
Answer:
b)
13ItiscommonpracticeamongcurrencytradersworldwidetobothpriceandtradecurrenciesagainsttheU.S.dollar.Infact,BISstatisticsindicatethatabout__percentofcurrencytradingintheworldinvolvestheU.S.dollarononesideofthetransaction
a)90percent
b)75percent
c)45percent
d)15percent
Answer:
a)
14Supposethatthecurrentexchangerateis€0.80=$1.00.Thedirectquote,fromtheU.S.perspectiveis
a)€1.00=$1.25
b)€0.80=$1.00
c)£1.00=$1.80
d)Noneoftheabove
Answer:
a)
Rationale:
Thedirectquotation,fromtheU.S.perspective,thepriceofoneunitoftheforeigncurrencypricedinU.S.dollars.
TheBid-AskSpread
15TheBidprice
a)Isthepricethatthedealerhaspaidforsomething,hishistoricalcost
b)Isthepricethatadealerstandsreadytopay
c)RefersonlytoauctionslikeeBay,notoverthecountertransactionswithdealers
d)Isthepricethatadealerstandsreadytosellat
Answer:
b
Thebidpriceisthepriceadealerwillpay;theaskpriceisthepricehechargestosell.Answera)isabittricky,butthedealer’shistoricalcostisnotnecessarilythepriceatwhichhewillbewillingtobuymore
16Supposethespotaskexchangerate,Sa($|£),is$1.90=£1.00andthespotbidexchangerate,Sb($|£),is$1.89=£1.00.Ifyouweretobuy$10,000,000worthofBritishpoundsandthensellthemfiveminuteslater,howmuchofyour$10,000,000wouldbe“eaten”bythebid-askspread?
a)$1,000,000
b)$52,910.05
c)$100,000
d)$52,631.58
Answer:
d)
Rationale:
17Ifthe$/£bidandaskpricesare$1.50and$1.51,respectively,thecorresponding£/$bidandaskpricesare:
a)£0.6667and£0.6623
b)$1.51and$1.50
c)£0.6623and£0.6667
d)cannotbedeterminedwiththeinformationgiven
Answer:
c)
Rationale:
£1/$1.51=askprice=£0.6623bidprice/$1;
£1/$1.50bidprice=£0.6667askprice/$1.
Seeequation5-3:
SpotFXTrading
18Inconversation,InterbankFXtradesuseashorthandabbreviationinexpressingspotcurrencyquotations.Considera$/£bid-askquoteof$1.9072-$1.9077.The“bigfigure”,assumedtobeknowntoalltradersis:
a)$1.9077
b)1
c)1.90
d)77
Answer:
c)
19intheInterbankmarket,thestandardsizeofatradeamonglargebanksinthemajorcurrenciesis
a)fortheU.S.-dollarequivalentof$10,000,000,000
b)fortheU.S.-dollarequivalentof$10,000,000
c)fortheU.S.-dollarequivalentof$100,000.
d)fortheU.S.-dollarequivalentof$1,000
Answer:
b)
20AdealerinBritishpoundswhothinksthatthepoundisabouttoappreciate
a)Maywanttowidenhisbid-askspreadbyraisinghisaskprice
b)Maywanttolowerhisbidprice
c)Maywanttolowerhisaskprice
d)Noneoftheabove
Answer:
c)
Rationale:
Adealerwhothinksthatthepoundisabouttoappreciatewillwanttoincreasehisinventory,noneofthestrategieslistedwillaccomplishthis.Whilea)
Cross-ExchangeRateQuotations
Country
U.S.$equiv.
CurrencyperU.S.$
Tuesday
Monday
Tuesday
Monday
Britain(Pound)£62,500
1.6000
1.6100
0.625
0.6211
1MonthForward
1.6100
1.6300
0.6211
0.6173
3MonthsForward
1.6300
1.6600
0.6173
0.6024
6MonthsForward
1.6600
1.7200
0.6024
0.5814
12MonthsForward
1.7200
1.8000
0.5814
0.5556
Euro€62,500
1.2000
1.2000
0.833333
0.833333
1MonthForward
1.2100
1.2100
0.82645
0.82645
3MonthsForward
1.2300
1.2300
0.813008
0.813008
6MonthsForward
1.2600
1.2600
0.793651
0.793651
12MonthsForward
1.2900
1.3200
0.775194
0.7575758
21Usingthetableshown,whatisthespotcross-exchangeratebetweenpoundsandeuro?
a)€1.00=£0.75
b)£1.33=€1.00
c)£1.00=€0.75
d)noneoftheabove
Answer:
a)
Rationale:
youalsogetthesameresultwithindirectquotes
22Thedollar-euroexchangerateis$1.25=€1.00andthedollar-yenexchangerateis¥100=$1.00.Whatistheeuro-yencrossrate?
a)¥125=€1.00
b)¥1.00=€125
c)¥1.00=€0.80
d)Noneoftheabove
Answer:
a)
23TheAUD/$spotexchangerateisAUD1.60/$andtheSF/$isSF1.25/$.TheAUD/SFcrossexchangerateis:
a)0.7813
b)2.0000
c)1.2800
d)0.3500
Answer:
c)
Rationale:
AlternativeExpressionsfortheCross-ExchangeRate
24Theeuro-poundcrossexchangeratecanbecomputedas:
a)S(€/£)=S($/£)×S(€/$)
b)
c)
d)alloftheabove
Answer:
d)
TheCross-RateTradingDesk
25SupposeabankcustomerwishestotradeoutofBritishpoundsandintoSwissfrancs.
a)Indealerjargon,thisisacurrencyagainstcurrencytrade
b)ThebankwillfrequentlyhandlesuchatradebysellingBritishpoundsforU.S.dollarsandthenbuyingfrancswithU.S.dollars.
c)ThebankwouldselltheBritishpoundsdirectlyforSwissfrancs.
d)a)andb)butnotc)
Answer:
d)
26Includingthetransactionscostsofthebid-askspread,theeuro-poundcrossexchangerateforacustomerwhowantstoselleuroandbuypoundscanbecomputedas
a)Sb(£/€)=Sb($/€)×Sb(£/$)
b)Sa(€/£)=Sa(€/$)×Sa($/£)
c)Sb(€/£)=Sb($/€)×
d)Alloftheabove
Answer:
d)
Rationale:
Thebankcouldalternativelyquoteitscustomeranaskpriceforpoundsintermsofeuroorquoteabidpriceforeurointermsofpounds.Someonewhosellseurowillsellthemtothedealerfordollarsatthedealer’sbidprice,Sb($/€),thenhewillbuypoundswithdollarsfromthedealerathisaskingprice
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