International Finance

# International Finance

## International Finance

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##### Presentation Transcript

1. International Finance Exchange Rates Bill Reese

2. Learning Objectives • In this unit we will learn: • How to interpret direct and indirect exchange rates • How to determine cross-rates • How rates are quoted • How to calculate the bid-ask spread

3. Basic Terms • Spot Rate • The price of a currency in terms of another currency for a trade today • Forward Rate • Price agreed upon today for a trade to be executed at a specified future date (30, 60, 90, 180 or 360 days)

4. Basic Terms • Direct quote • American quote • Domestic currency/foreign currency • Dollars needed to buy one unit of foreign currency • \$/€

5. Basic Terms • Indirect quote • European quote • Foreign currency/domestic currency • Units of foreign currency needed to buy one dollar • €/\$

6. Quotes • Currency is a commodity • Bananas • \$0.5/pound = 2 lbs. for a dollar • Price of dollar = €.813 • Price of a euro = \$1.23

7. Quotes • Currency in denominator is the one being priced • .813 €/\$ • 1.23 \$/€

8. Quotes • You have dollars and want euros \$ → € • Selling dollars • Buying euros • You have euros and want dollars € → \$ • Selling euros • Buying dollars

9. Quotes • You have \$5.00. How many euros is it worth if XR is 1.23 \$/€? • Multiply or divide? • Direct quote: \$5 x 1.23 \$/€ • Note that \$ won’t cancel out • Must invert • Indirect quote or divide

10. Quotes • \$5 ÷ 1.23 \$/€ = \$5 x 1/1.23 €/\$ = \$5 x .813 €/\$ = €4.065

11. Quotes • Suppose you have €30 and want dollars? • €30 x 1.23 \$/€ = \$36.90 • Note how €s cancel out in numerator and denominator

12. Cross Rates • Cross exchange rate • One foreign currency per unit of another foreign currency 1.23 \$/€ and 1.81 \$/£ • Cross-rate between euro and pound

13. Cross Rates • Multiply to cancel out \$ 1.23 \$/€ x 1.81 \$/£ Can’t do it – must divide or invert 1.23 \$/€ ÷ 1.81 \$/£ = 1.23 \$/€ x 1/1.81 \$/£ = 0.68 £/€

14. Cross Rates • If you want €/£ • Take reciprocal • 1/0.68 £/€ = 1.47 €/£

15. Bid and Ask • There are two XRs • Bid: price dealer will pay you for your currency • Rate if you want to sell • Ask: price dealer will sell you units of a currency for • Rate if you want to buy • Ask > Bid

16. Bid and Ask • Indirect quotes • Ask: 1.29 SF/\$ • Bid: 1.28 SF/\$ • Direct quotes • Ask: .78125 \$/SF • Bid: .7752 \$/SF • Bid in \$ = Ask in SF • Bid in SF = Ask in \$

17. Bid and Ask • Example • Ask: .0091 \$/¥ • Bid: .0090 \$/¥ • \$150 to convert to yen • Buy yen at price of .0091 \$/¥ • Or sell dollars at price of 1/.0091 ¥/\$ • \$150 ÷ .0091 \$/¥ = ¥16,483.5

18. Bid and Ask • Change your mind – convert back • Sell yen at price of .0090 \$/¥ • Or buy dollars at price of 1/.0090 ¥/\$ • ¥16,483.5 x .0090 \$/¥ = \$148.35

19. Bid and Ask • \$150 → \$148.35 • Lost \$1.65 • Lost 1.1% of \$150 you started with • Bid-Ask Spread Spread = Ask – Bid Ask = (.0091 - .0090)/.0091 = 1.1%

20. Bid and Ask • Spread • Transaction cost for round-trip transaction • Decreases with greater amounts of currency • Increases with less frequently traded currency