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Eun/Resnick4e49Eun&Resnick4eCHAPTER5TheMarketforForeignExchangeFunctionandStructureoftheFXMarketInternationalFinanceinPractice:TheMouseTakesOvertheFloorFXMarketParticipantsCorrespondentBankingRelationshipsInternationalFinanceinPractice:WhereMoneyTalksVeryLoudlyTheSpotMarketSpotRateQuotationsTheBid-AskSpreadSpotFXTradingCross-ExchangeRateQuotationsAlternativeExpressionsfortheCross-ExchangeRateTheCross-RateTradingDeskTriangularArbitrageSpotForeignExchangeMarketMicrostructureTheForwardMarketForwardRateQuotationsLongandShortForwardPositionsForwardCross-ExchangeRatesSwapTransactionsForwardPremiumSummaryMINICASE:ShrewsburyHerbalProducts,Ltd.FunctionandStructureoftheFXMarket1Theworld’slargestforeignexchangetradingcenteris:a)NewYorkb)Tokyoc)Londond)HongKongAnswer:c)2Onaverage,worldwidedailytradingofforeignexchangeisa)impossibletoestimateb)$15billionc)$504billiond)$1.88trillionAnswer:d)3Theforeignexchangemarketclosesa)Neverb)4:00p.m.EST(NewYorktime)c)4:00p.m.GMT(Londontime)d)4:00p.m.(Tokyotime)Answer:a)Eun/Resnick4e50FXMarketParticipants4Mostforeignexchangetransactionsarefor:a)Interventionbycentralbanksb)Interbanktradesbetweeninternationalbanksornonbankdealersc)retailtraded)purchaseofhardcurrenciesAnswer:b)5Thedifferencebetweenabrokerandadealerisa)Dealersselldrugs,brokerssellhouses.b)Brokersbringtogetherbuyersandsellers,butcarrynoinventory.Dealersstandreadytobuyandsellfromtheirinventory.c)Brokerstransactinstocksandbonds;currencyisboughtandsoldthroughdealers.d)NoneoftheaboveAnswerb)Rationale:ifsomeonecomplainsabouta)beingcorrect,askthemwhowouldsellacrackhouseoramethlab.6MostInterbanktradesarea)Speculativeorarbitragetransactionsb)Simpleorderprocessingfortheretailclientc)Overnightloansfromonebanktoanotherd)BrokeredbydealersAnswera)7Atthewholesalelevela)MosttradingtakesplaceOTCbetweenindividualsontheflooroftheexchangeb)Mosttradingtakesplaceoverthephonec)MosttradingflowsoverReutersandEBSplatformsd)Mosttradingflowsthroughspecialized“broking”firmsAnswer:c)8Interventionintheforeignexchangemarketistheprocessof:a)Acentralbankrequiringthecommercialbanksofthatcountrytotradeatasetpricelevel.b)Commercialbanksindifferentcountriescoordinatingeffortsinordertostabilizeoneormorecurrencies.c)Acentralbankbuyingorsellingitscurrencyinordertoinfluenceitsvalue.d)Thegovernmentofacountryprohibitingtransactionsinoneormorecurrencies.Answer:c)Eun/Resnick4e51CorrespondentBankingRelationships9ConsideraU.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,$500,000b)Credit,€512,100c)Credit,$500,000d)Debit€512,100Answer:a)Rationale:debit,sincetheimporterispaying.$500,000=€512,100×$1.00/€1.0242TheSpotMarket10Thespotmarketa)Involvesthealmost-immediatepurchaseorsaleofforeignexchange.b)Involvesthesaleoffutures,forwards,andoptionsonforeignexchangec)Takesplaceonlyonthefloorofaphysicaltradingfloord)Alloftheabove.Answer:a)11Spotforeignexchangetradinga)accountsforabout5percentofallforeignexchangetradingb)accountsforabout20percentofallforeignexchangetradingc)accountsforabout35percentofallforeignexchangetradingd)accountsforabout70percentofallforeignexchangetradingAnswer:d)SpotRateQuotationsCountryU.S.$equiv.CurrencyperU.S.$TuesdayMondayTuesdayMondayBritain(Pound)£62,5001.60001.61000.6250.62111MonthForward1.61001.63000.62110.61733MonthsForward1.63001.66000.61730.60246MonthsForward1.66001.72000.60240.581412MonthsForward1.72001.80000.58140.555612Usingthetableshown,whatisthemostcurrentspotexchangerateshownforBritishpounds?Useadirectquotea)$1.61=£1.00b)$1.60=£1.00c)$1.00=£0.625d)$1.72=£1.00Answer:b)Eun/Resnick4e5213ItiscommonpracticeamongcurrencytradersworldwidetobothpriceandtradecurrenciesagainsttheU.S.dollar.Infact,BISstatisticsindicatethatabout__percentofcurrencytradingintheworldinvolvestheU.S.dollarononesideofthetransactiona)90percentb)75percentc)45percentd)15percentAnswer:a)14Supposethatthecurrentexchangerateis€0.80=$1.00.Thedirectquote,fromtheU.S.perspectiveisa)€1.00=$1.25b)€0.80=$1.00c)£1.00=$1.80d)NoneoftheaboveAnswer:a)Rationale:Thedirectquotation,fromtheU.S.perspective,thepriceofoneunitoftheforeigncurrencypricedinU.S.dollars.TheBid-AskSpread15TheBidpricea)Isthepricethatthedealerhaspaidforsomething,hishistoricalcostb)Isthepricethatadealerstandsreadytopayc)RefersonlytoauctionslikeeBay,notoverthecountertransactionswithdealersd)IsthepricethatadealerstandsreadytosellatAnswer:bThebidpriceisthepriceadealerwillpay;theaskpriceisthepricehechargestosell.Answera)isabittricky,butthedealer’shistoricalcostisnotnecessarilythepriceatwhichhewillbewillingtobuymore16Supposethespotaskexchangerate,Sa($|£),is$1.90=£1.00andthespotbidexchangerate,Sb($|£),is$1.89=£1.00.Ifyouweretobuy$10,000,000worthofBritishpoundsandthensellthemfiveminuteslater,howmuchofyour$10,000,000wouldbe“eaten”byth