int business part 3

imputed cross rate calculation

(1 pound/ # dollar) x (1 dollar/ yen) --> gives you 100 pounds/ 1 yen this may be different than the direct quote of 200 pounts per 1 yen, so opportunity for 3 point arbitrage

diff between PPP exchange rate and actual exchange rate

PPP rate - actual rate/ actual rate x 100 = % if positive- the yen is overvalued agains thte dollar by that percentage

what is geographic differences called

2 point abritrage

speculation

banks bet on direction they believe exchange rate will move by buying and selling currency accordingly extremely risky//profitable if right buy low at the bid price and sell high at the ask price

euroloan market

banks make loans of eurocurrencies (aka currency deposited in anotehr country other than the country it originated from) not subject to domestic govt regulations must be extremely large only credit worthy buyers can do this based on LIBOR rate

interest rates in Euroloan market

based on London Interbank Offered Rate (LIBOR) which is the interest rate London banks charge to other london banks for short term or overnight eurocurrency loans

futures transactions

currency future is exchange agreement to buy and sell currency at a specific price on a specific day in the future based on a contract only like 1% of transactions different from swap bc its not immediate, its at some point in future

if currency is selling at forward disct (forward rate < spot price), business should ___

decrease its assets and increase its liabilities denominated in that currency bc the currency is expected to depreciate in future

international fisher effect

differences in nominal interest rates between countries are ultimately determined by differences in expected inflation rates between the countries

exchange rates can be expressed either ___ or ___

directly or indirectly (they are recipricals of each other) direct exchange rate: price of foreign currency is in terms of home currency (## of dollars per pound) indirect exchange rate: price of home currency is in terms of foreign currency (## yen per $1)

demand for foreign exchange

downsloping ppl will have less demand at higher prices derived demand bc its based on demand created by foreign consumers for particular good/service--> so the greater the demand for goods and services, the greater the quantity of currency demanded from that country

commerical banking services

exchaging currency, providing advice, short term financing, electric fund transfers, forward purchases

2 types of bonds

foreign and eurobond and global bond foreign denominated in buyers currency euro- denominated in issuer's global- large highly liquid asset can be traded anywhere at any time

if forward discounts are widening...nominal rate ____ and inflation ____

increase and increase

if currency is selling at a forward premium (forward rate > spot price), a business should ____

increase its assets and reduce liabilities denominated in that currency bc the currency is expected to appreciate in the future

largest bank in world

industrial and commercial bank of china

arbitrage of money

interest rate parity 3 kinds: 2 point arbitrage aka geographic arbitrage 3 point arbitarge covered interest arbitrage

foreign bond

issued in one country to resident of another country, denominated in currency of buyer

affiliated banks

jointly owned with foreign partner

global bond

large highly liquid financial asset that can be traded anywhere at any time

investment banking service

lcoating debt and equity funding, arranging mergers/acquisitions

big mac index

list of exchange rate prices of a big mac in countries throughout the world helps think about PPP cost of big mac in Japan in yen = $$ cost in japan in dollars x (exchange rate of yen/ dollar) doesnt show differences in wage rates/income not a serious exercise bc PPP only applies in the long run and the big mac index is only in the immediate short run

USA has ___ inflation and trade ____

low inflation, trade defecit the low inflation makes dollar stronger the trade defecit makes dollar weaker

quantitative easing

monetary policy tool where central bank creates money and uses it to buy bonds and other assets from financial institutions this is in order to bring down long term interest rates and stimulate the economy it increases bond prices and lowers bond yeilds aka making it cheaper for govt to borrow money the usa does this, EU does this- helped avoid recession

if inflation is expected to increase

money value should be expected to fall in future forward premium should shrink and forward discount should widen nominal interest raet would be higher

country funds

mutual funds that invest in speicifc country's firms

branch banks

not seperately incorporated

spot transaction

one currency is exchanged for another within period of 2 days, considered immediate easiest kind of transaction and 33% of transactions are this

exchange rate

price of the currency set by supply/demand bc the USA uses a flexible exchange rate system

foreign exchange market (forex)

promotes efficient cross border trade by helping with currency conversion allows firms to find financing helps international investment and capital flows matches ppl and firms who need currency to ppl who have it

3 types of overseas banking operations

subsidiary banks - seperately incorporated branch banks - not seperately incorporated affiliated banks - jointly owned with foreign partner

forward transaction

takes place in forward market, currencies bought and sold for delivery in future, usually 1/3/6 months after transactions take place currenies that are expected to get weaker in future to sell at a disct (aka forward disct) and curencies that are expected to get stronger in future sell at a premium aka (forward premium)

equilibrium exchange rate

there is neither a surplus or a shortage of foreign exchange, its the point where demand intersects supply aka "market clearing price"

change in price of currency/change in exchange rate

this is a movement down along the demand curve and supply curve

currency option

transaction that gives holder the right but not the obligation to buy or sell currency at future date and a specific exchange rate call option: right to buy foreign currency put option: right to sell foreign currency 5% of transactions

2 point arbitrage

type of arbitrage of money aka geographic arbitrage overcomes geogrpahical differences in exchange rates rare bc geographic differences in exchange rates are corrected quickly in the market

calculating 3 point arbitrage

1 euro/ 1.5 dollars x (one dollar/ how many yen you get for 1 euro)

LIBOR

London Interbank Offered Rate (LIBOR) which is the interest rate London banks charge to other london banks for short term or overnight eurocurrency loans credit card rates and mortgage rates based on LIBOR calculated by throwing out outliers

international banking facilities (IBFs)

US bank entities that offer only international banking services and are not subjected to US bank regulations helped US banks compete with foreign banks issuing dollar denominated assets bc those transactions werent being regulated only can offer international bank services must be legally seperate from bank domestic operations must follow some rules of Fed can only accept deposits or make loans to ppl who arent residents of USA

eurodollars

US dollars deposited in european banks eventually this became to mean us dollars deposited anywhere outside america

annual forward premium/disct calculation***

[ (forward price - spot price) / spot price ] x number of periods in a year = annual prem/disct in decimal form percentage aka if 3 month forward price --> n = 4 if your answer is negative- its selling at a disct and currnecy is expected to depreciate in future

major banks earn ___ based on ____

a profit on foreign exchange based on the "spread" between bid and ask prices for foreign excange or by speculating on future exchange rate movements through arbitrage

forward rate

aka forward price reflects the market's prediction of how the spot price will change in the future if forward rate>spot price, markte expects currency in future to appreciate and the currency will sell at a forward premium (countries with low inflation and trade surpluses) if forward rate < spot price, mkt expects currency to depreciate in the future and currency will sell at a forward dist (countries with high inflation and trade defecit)

oversupply/surplus of currency

any point above the equilibrium point currency will depreciate

undersupply/shortage of currency

any point below the equilibrium point currency will appreciate

eurobond

bond issued in one country and denominated in that country's currency (issuer's currency) but sold to ppl in other countries

3 point arbitrage

buying and selling 3 different currencies currency is traded in pairs, its possible for opportunities to exist when the cost of buying currency directly differs from the cross rate of exchange or implied exchange rate calculated through the use of a 3rd currency aka mostly the dollar ex. convert pounds to yen, and then yen to dollars to get more dollars rather than if you simply converted from pounds to dollars evenutally the 3 will reach equilibrium

call vs. put option

call- right to buy foreign currency put - right to sell foreign currency

categories of clients for banks' foreign exchange depts

commercial customers- like ppl who need currency for normal business like importing/exporting/buying/selling assets, etc speculators - ppl who bet on the exchange rate arbitrageaurs - simultaneously buy and sell currency to take advantage of small differences in exchange rates in diff markets - dont face same amt of risk that speculators face bc doing it at same time central banks/treasury depts

foreign exchange

commodity consisting of currencies issued by countries other than one's own

types of currency

convertible currencies: aka hard currencies, freely tradable (dollar, pound, euro, canada dollar, swiss franc, yen, swedish krona) inconvertible currencies: aka soft currency, not freely tradable bc foreigners iether dont want to hold them or because the govt places limitations on their purchase and sale (cuban peso, north korean won)

cost of a purchase

cost in dollars = total yen bought x (one dollar/bid amt of yen)

PPP exchange rate

cost of big mac in Japan in yen/ cost of big mac in america in dollars

eurocurrency

currency deposited in a country other than the country it was issued ex. eurodollars

arbitrage

helps foreign markets reach equilibrium involves the riskless buying of assets in one market and immediately selling the assets in another market to profit from price discrepancy 2 kinds: arbitrage of goods and arbitrage of money

Purchasing power parity

if there is free trade, exchange rate adjusted prices of a good should be the same in 2 countries in the long run

arbitrage of goods

if there is free trade, exchange rate adjusted prices of a good should be the same in 2 countries in the long run PPP and law of one price eventually the prices in the 2 markets will equal. until then, arbitrageurs will exploit the disequilibrium until the exchange rates/prices adjust to be equal

law of one price

if you buy a good from one market and sell in another where price is different in both markets, evenutally this activity will cause the prices in the 2 markets to converge

cross rate

implied exchange rate calculated thru use of 3rd currency (normally the dollar) 3 point arbitrage

correspondent relationship

in early days of international business, most major banks linked internationally via this correspondent relationship where one bank acts as another's agent in another country

nominal interest rate calculation

real interest rate + expected rate of inflation if inflation is increasing, nominal rate will be higher

amt received from sale

sale in dollars = total yen sold x (one dollar / ask amt of yen)

dumping

sells exports in foreign market below their market price we have tarriffs against china for this

subsidiary banks

separately incorporated

decrease in riskiness

shift the entire demand curve up and shift the entire supply curve back

full employment rate

should be like 5.5 -6% current is like 5.9%

Liechtenstein

small Alpine country in Europe considered offshore location super small most banks owned by royal family, offer low cost eurocurrency loans, political stabilitiy, favorable regulations LGT banking group located here! whistleblower from this bank bc hiding assets from tax authorities, off shore tax evasion

vehicle currency

something like the dollar of euro that you could use to convert indirectly into another random currency

mrs watanabes

sophisticated japanese housewives carry trade super popular with them in 1980s

swap transaction

spot against forward swap forward transaction that currency is bought/sold at the same exact time, but deliver of the currency is made at different times. this allows company to use one currency to fund obligations that are in another currency without risk of fluctuation in the exchange rate you can expect to receive 3 months from now = the amt of yen transaction today/ the amt of yen in 3 months from now= $$ in 3 months from now

covered interest arbitrage

type of money arbitrage- protects you from exchange rate risk, affects spot market, forward market, and loanable fund market opporutnities that exist when interest rates do not fully account for the foward permium or discount on currency most important kind!!!! if interest rate in NYC is 8% and in London its 12%, the investors expect the pound to depreciate by 4% against the dollar in the coming year. investors can convert dollars into pounds and invest at 12% while covering the risk that the pound may depreciate by more than 4% by buying a forward contract to sell pounds and buy dollars at less than 4% premium on the dollar can earn more by investing in london than by investing in NYC eveutally willl increase forward premium on dollar until no opportunity exists - eventually the difference in interest rates will be exactly equal to the forward premium/disct on the dollar

carry trade

type of uncovered interest arbitrage investors borrow money at low interest rates in one coutnry and convert that country's currency to another country's currency, to ear the difference between the interest rate in the 2nd country and the interest rate in first country popular with mrs watanabes- japanese housewives

if price/exchange rate of dollars is LOWER than the equillibrium price, there is an ____ of dollars and dollars should ___ in the future

undersupply of dollars appreciate in future

supply of foreign exchange

upward sloping, we will provide more foreign exchange at a higher price derived supply bc based on desire of ppl in particular country whose currency we are looking at to buy foreign goods and services

transaction currency

us dollar is main one aka 87% of all foreign exchange transactions use the dollar

market clearing price

where supply = demand

Klebler

whistelblower on Leichtenstein's huge bank called LGT Banking- they were hiding assets in order to avoid taxes even tho a whistleblower- he tried to blackmail the head of state, and sold documents of the bank for profit to germany and other coutnreis

2 parts of the foreign exchange market

wholesale market and retail market wholesale- ppl who can buy currency at super low low prices that others cant (like walmart of currency buyers aka like insurance companies, corporate treasurers, hedge funds, pension funds) retail- individual customers who buy and sell small amts of currency, pay a premium over the wholesale price