Question

Tutorial 3
5.4 Market Participants. For each of the foreign exchange market participants, identify their motive for
buying or selling foreign exchange.
a) Foreign exchange dealers are banks and a few non-bank institutions that "make a market" in foreign
exchange. They buy and sell foreign exchange in the wholesale market and resell or re-buy it from
customers at a slight change from the wholesale price.
b) Foreign exchange brokers (not to be confused with dealers) act as intermediaries in bringing dealers
together, either because the dealers do not want their identity revealed until after the transaction or
because the dealers find that brokers and "shop the market," i.e., scan the bid and offer prices of many
dealers very quickly.
c) Individuals and firms conducting international business consist primarily of three categories:
importers and exporters, companies making direct foreign investments, and securities investors buying
or selling debt or equity investments for their portfolios.
d) Speculators and arbitragers buy and sell foreign exchange for profit. Speculators and arbitragers
buy or sell foreign exchange on the basis of which direction they believe a currency's value will change
in the immediate or speculative horizon.
e) Central banks and treasuries buy and sell foreign exchange for several purposes, but most
importantly, for intervention in the marketplace. Direct intervention, in which the central bank will buy
(sell) its own currency in the market with its foreign exchange reserves to push its value up (down), is
a very common activity by government treasuries and central banking authorities.
5.5 Foreign Exchange Transaction. Define each of the following types of foreign exchange transactions:
a. Spot
b. Outright forward
c. Forward-forward swaps
a) A spot transaction is an agreement between two parties to exchange one currency for another,
with the transaction being carried out at once for commercial customers and on the second following
business day for most inter-bank (i.e., wholesale) trades.
b) A forward transaction is an agreement made today to exchange one currency for another, with the
date of the exchange being a specified time in the future - often one month, two months, or some
other definitive calendar interval. The rate at which the two currencies will be exchanged is set today.
c) Forward-forward swaps. A more sophisticated swap transaction is called a "forward-forward" swap.
A dealer sells £20,000,000 forward for dollars for delivery in, say, two months at $1.6870/£ and
simultaneously buys £20,000,000 forward for delivery in three months at $1.6820/£. The difference
between the buying price and the selling price is equivalent to the interest rate differential, i.e., interest
rate parity, between the two currencies. Thus a swap can be viewed as a technique for borrowing
another currency on a fully collateralized basis.
 5.9 Foreign Exchange Rate Quotations. Define and give an example of each of the following:
a. Bid rate quote
b. Ask rate quote
Interbank quotations are given as a bid and ask (also referred to as offer). A bid is the price (i.e.,
exchange rate) in one currency at which a dealer will buy another currency. An ask is the price (i.e.,
exchange rate) at which a dealer will sell the other currency. Dealers bid (buy) at one price and ask
(sell) at a slightly higher price, making their profit from the spread between the buying and selling
prices.
Bid and ask quotations in the foreign exchange markets are superficially complicated by the fact
that the bid for one currency is also the offer for the opposite currency. A trader seeking to buy
dollars with Swiss francs is simultaneously offering to sell Swiss francs for dollars. Assume a bank
makes the quotations shown in the top half of Exhibit 4.5 for the Japanese yen. The spot
quotations on the first line indicate that the bank's foreign exchange trader will buy dollars (i.e., sell
Japanese yen) at the bid price of ¥118.27 per dollar. The trader will sell dollars (i.e., buy Japanese
yen) at the ask price of ¥118.37 per dollar.

Problems
5.3 Japanese Yen Forward. Use the following spot and forward bid-ask rates for the Japanese yen/U.S.
dollar (¥/$) exchange rate from September 16, 2010, to answer the following questions:
Period ¥/$ Bid Rate ¥/$ Ask Rate a. Mid rate(¥) b. Annual Forward premium(¥)
Spot- 85.41 85.46 85.435
1 month 85.02 85.05 85.035 5.6447%
2 months 84.86 84.90 84.88 3.9232%
3 month 84.37 84.42 84.395 4.9292%
6 months 83.17 83.20 83.185 5.4096%
12 months 82.87 82.91 82.89 3.0703%
24 months 81.79 81.82 81.805 2.2187%
a. What is the mid-rate for each maturity? Mid rate = (Bid+Ask)/2
b. What is the annual forward premium for all maturities? Annual forward premium = (Spot-Forward)/
(Forward) x (360/days) f $ F-S
=
X
360

S I

c. Which maturities have the smallest and largest forward premiums?

The 24 month forward rate has the smallest premium, while the 1 month forward possesses the
largest premium.
5.4 Andreas Broszio (Geneva). Andreas Broszio just started his job as an analyst for Credit Suisse in
Geneva, Switzerland. He receives the following quotes for Swiss francs against the dollar for spot, 1
month forward, 3 months forward, and 6 months forward.
Spot exchange rate:
Bid rate SF1.2575/$
Ask rate. SF1.2585/$
1 month forward 10 to 15 ~ 0 0015
.

3 months forward 14 to 22
6 months forward. 20 to 30
a. Calculate out right quotes forbid and ask and the number of points spread between each.
b. What do you notice about the spread as quotes evolve from spot toward 6 months?
c. What is the 6-month Swiss bill rate? (Skip)
a Bic Ask Spread
1 month forward 1 2575
.
+ 0 001.
= 1 2585
.
1 .
2585 + 0 0015 . = 1 2600
.
0 0015
.

3 month forward 1. 2575 + 0 0014 .

= 1 2589
.
1 2585 .
+ 0 0022 . = 1 2607 . 0 0018
.

6 month forward 1 2575

.
+ 0 002 . = 1 2595 .
1 2585 .
+ 0 003 . = 1 2615 . 0 0020 .

b
. The spread from spot toward 6months widens ,
most likely a result of thinner s thinner trading volume.
The larger the spread -

The lower transactions

> the higher profit for dealers

.
c Spot rate ,
mid rate (SF/$ 1 2580
.
= (1 2575
.
+ 1 .
2585)/2

6 months forward rate ,

mid rate (SF/$) 1 2605
.
= (1 2595
.
+ 1 .
2615)/2

Maturity (days) 180

6 month U S .
dollar treasury rate (yield) 4. 2%

180
SF in 6 450 % .
1 2580 x
. 1 + 6 45 %
.
x

360
6 month forward 1 2719 .
=

1 2605 1 + 4 2% 180
. x .
x

368

5.5 Study Abroad: Paris to Moscow. On your summer study abroad program in Europe, you stay an
extra two weeks to travel from Paris to Moscow. You leave Paris with 2,000 euros (€ or EUR) in
your belt pack. Wanting to exchange all of these for Russian rubles ( or RUB), you obtain the
following quotes:
Spot rate dollar per euro (or USD/EUR) 1.1280 USD1.1280 = EUR1.00
Spot rate Rupee per dollar(or RUB/USD) 62.40 RUB62.40 = USD1.00
a. What is the Russian ruble to euro cross rate?
b. How many Russian rubles will you obtain for your euros?
RUB
A .

EUR
USD
=
1 1280
.
=
USD

EUR USB
=
62 40 .
=
RUB RUB x
USDp =
62 =
55 3191
. = 62 40
.
x

1 1280
. = 70 3872
.

70 .
3872
b
. =2 , 000 x 91 : RUB H2979 . 140 774 , .
4
5.8 Bloomberg Cross Rates. Use the table from Bloomberg below to calculate each of the following:
a. Japanese yen per U.S. dollar JPY108.75/USD
b. U.S. dollars per Japanese yen 1/108.75 = USD0.0092JPY
c. U.S. dollars per euro 1/0.9027 = USD1.1078/EUR
d. Euros per U.S. dollar EUR0.9027/USD
e. Japanese yen per euro JPY/EUR = JPY/USD : EUR/USD = 108.75/0.9027 = 120.4719
f. Euros per Japanese yen EUR/JPY = 1/120.4719 = 0.0083
g. Canadian dollars per U.S. dollar CAD/USD = 1.307
h. U.S. dollars per Canadian dollar USD/CAD = 1/1.307 = 0.7651
i. Australian dollars per U.S. dollar AUD/USD = 1.4669
j. U.S. dollars per Australian dollar USD/AUD = 1/1.4669 = 0.6817
k. British pounds per U.S. dollar GBP/USD = 0.7802
l. U.S. dollars per British pound USD/GBP = 1/0.7802 = 1.2817
m. U.S. dollars per Swiss franc USD/CHF = 1/0.9952 = 1.0048
n. Swiss francs per U.S. dollar CHF/USD = 0.9952

base

quote

5.9 Bid/Ask on Swiss franc/Euro Forwards. Use the following spot and forward bid-ask rates for the
Swiss franc/euro (CHF/€) from October 28, 2019, to answer the following questions:
a. What is the mid-rate for each maturity? Mid rate = (Bid+Ask)/2
b. What is the annual forward premium for all maturities? Annual forward premium = (Spot-Forward)/
(Forward) x (360/days) < month
1 > months
2

c. Which maturities have the smallest and largest forward premiums?

a .
Mid rate (CHF) .
b Annual forward premium (CHF)

slcot 1 103
.

1m ↓ 10325 -
0 2719 % 1 . 103-1 10325
. 360
. .
= <

1. 10325 30
2m 1 .
1052 -
1 1944 %
.

3m 1 104 .
-
0 3623 %
.

6 m 1 10495 .
-
0 3530 %.

12 M 1. 1068 -
0 .
3433 %

24m 1 .
1101 -
0 3198 % .
5.10 Swissie Triangular Arbitrage. The following exchange rates are available to you. (You can buy or
sell at the stated rates.) Assume you have an initial SF12,000,000. Can you make a profit via
triangular arbitrage? If so, show the steps and calculate the
amount of profit in Swiss francs (Swissies). SF $ # SF >
- >
-
>
-

Mt. Fuji Bank. ¥92.00/$SF12 000 $11 764 705 88 #92 00/8 #1 082 352
000 SF 12 026
941
x , 143 79
Mt.. Rushmore Bank. SF1.02/$ SF1
, , = , , = , , = ,
.

,
. .

02/$ # 90 00/SF
Mt. Blanc Bank. ¥90.00/SF
.
.

Initial investment SF 12 , 000 , 000 Cross rate :

#92 .
00/$ #90 20/SF
=
.

M SF 1 02 /$
Sell SF
sbuy $ at Mt Rushmore Bank $11 764 , 705 88
.

, .

Sell $s buy # at Mt Fuji Bank # 1 , 082

,
352 , 941 > Mt. Blanc Bank : #90 00/SF .

Sell I s buy SF at Mt Blanc Bank SF12 , 026 , 143 79 .

=> Arbitrage opportunity (SF is undervalued)
=> Profit = SF 26 , 143 79
.

5.12 Vienna Corporate Treasury. A corporate treasury working out of Vienna with operations in New
York simultaneously calls Citibank in New York City and Barclays in London. The banks give the
following quotes on the euro simultaneously: ④ Buy from Citibank & $0 7561

Resell & Bardays & $0 . 7545

.

&
E t
>
-
loss (Pbuy > Psell)

7575)
②
Buy from Barclays & 0 . >
-
loss
E E
Resell & Citibank & 0 7551
.

=> No arbitrage opportunity

Using $1 million or its euro equivalent, show how the corporate treasury could make geographic
arbitrage profit with the two different exchange rate quotes.
Strategy 1 :

Initial investment $1 ,
000 000 ,

from Citibank (at ask ratel $1 000 , 000

Buy NYC E 1 , 322 576 38 ,
E , .
=

$0 7561/t .

Sell - to Barclays London (at bid rate & 997 , 883 88 .

= t 1 322 , 576 38
, . x $0 7545/E
.

=> Loss

Strategy 2 :

Initial investment $ 1 000

, ,
000
$1 000 , ,
000

Buy t from Bardays London (at ask rate) => 1 , 320 , 132 01 . I

$ 0 7575. E .

Sell >
- to Citibank NYC (at bid rate $996 , 831 68 .
= 1 , 320 , 132 013 .
x $0 7551 .
E

=> Loss
5.20 Great Pyramids. Inspired by his recent trip to the Great Pyramids, Citibank trader Ruminder
Dhillon wonders if he can make an intermarket arbitrage profit using Libyan dinars (LYD) and Saudi
riyals (SAR). He has USD1,000,000 to work with so he gathers the following quotes. Is there an
opportunity for an arbitrage profit?

Crossrate SAR $1 9324 LYD SAR7 2456

$1 , 000
000 LYD > SAR1 9405 LYD
.

: >
-

=
, = . .

LYD $ 0 2667 SAR

SAR overvalued LYD is undervalued
.

=> is ,

=> Sell SAR , buy LYD

strategy : $ > SAR > LYD > $

$0 2667/SAR $1 9324/LYP
$1 , 000 , 000
: .

,
SAR 3 , 749 , 531 .
31
: SAR1 9405
.

LYD LYD 1 , 932 250 095

, .
< .

> $3 733 880 084

, , .

=> profit = $2 733 880 084

, ,
.

① Sell $ ,
buy SAR

② Sell SAR ,
buy LYD
③ Sell LYD , buy $