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FXMarkets Part2

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81 views21 pages

FXMarkets Part2

Uploaded by

treiptreu
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Introduction to FX Markets

Phan Vũ Ngọc Lan

CROSS RATE

1
Cross Rate

A cross rate is the exchange rate between two


currencies when neither are official currencies of
the country in which the quote is given

Cross Rates

• Cross rates helps in the determination of exchange rate


between two countries with help of one mutual country.

2
Direct quote

• It state how much units of local currency is needed


to purchase a unit of foreign currency

Indirect quote

• AN indirect quote represent how much units of


foreign currency is required to purchase/sell one
unit of local currency.

• Indirect Quote = 1/ Direct quote

3
Exercise 1

Country $ Euro Pound Peso Yen C$


Canada 1.3689 -
Japan 109.48 -
Mexico 11.3921 -
United 0.5460 -
Kingdom
Euro 0.8222 -
United States -

4
Cross Rate

• USD/VND= 22.1305 - 15
• VND/USD = ??

• => X/Y =a–b => Y/X = ?

• X/Y = a- b => Y/X = 1/b – 1/a

• Market inform

– X/Y = a - b
– X/Z = c - d
– -> Calculation cross rate Y/Z , Z/Y

– Y/Z= c/b – d/a

– >> Z/Y= a/d – b/c

10

5
Spot Market Quotations (cont.)

• Calculating cross-rates (cont.)

– Example 3: Crossing two direct FX quotations:

USD/EUR0.7650–55
USD/JPY105.40–50

To determine the EUR/JPY cross-rate:

11

Spot Market Quotations (cont.)

• Calculating cross-rates (cont.)

– Example 4: Crossing a direct and indirect FX quotation:

USD/JPY 105.40–50
GBP/USD 1.9170–75

To determine the GBP/JPY cross-rate:

12

6
Spot Market Quotations (cont.)
• Calculating cross-rates (cont.)

– Example 5: Crossing two indirect FX quotations:

AUD/USD0.7862–69
GBP/USD1.9170–75

To determine the AUD/GBP cross-rate:

13

Exercise 2

14

7
How we can profit from FX market

• Principle trade : buy low ; sell high


• A/B = x/y
• A/B = z/t
• -Condition : y <z or x>t

15

Example

• At London : USD/VND = 22,120 – 25


• At NewYork: USD/ VND=22,128 – 30
• => Question: Do we earn profit ?

16

8
ARBITRAGE

17

Arbitrage

• In practice we often see temporary deviations from


law of one price. Mostly, these are so small that
transaction costs wipe out the potential gains.
• However, in some short lasting occasions they reach
to levels that traders can make arbitrage profits.
• These deviations fade away quickly, as traders buy
in the low price environment and sell in high price
environment.

18

9
Geographic Arbitrage

USD Quotes in CHF


London Tokyo

CHF 1.7140/60 CHF1.7165/70

Buy USD in London @1.7160 Sell USD in Tokyo @1.7165

CHF5000 gain for every USD10m

19

Arbitrage Profit

• Buy 10m USD at 1.7160


• Pay 17,160,000 CHF
• Sell 10m USD at 1.7165
• Receive CHF17,165,000
• Net gain at 2T is CHF 5,000

20

10
Cross Rates and Triangular Arbitrage

• In FX markets most of the quotations are against


USD.
• For instance when Citibank asks UBS its Swiss
Franc rate, that rate is quoted against USD unless
otherwise stated.
• Since bulk of dealings are done against the USD,
the "market rate" for any currency at any moment is
best reflected in its exchange rate against USD.

21

Exercise 3 Triangular Arbitrage

Cross-Rates: Three Quotes:


• Citibank Quote: $0.9045/€
• Barclays Quote $1.4443/£
• Dresdner Quote €1.6200/£

22

11
Exercise 3 Triangular Arbitrage

• a/ Calculate Cross Rate € against £ (available


worldwide): ($1.4443/£)/($/0.9045/€)= € ?/£
• Direct Rate of € against £: € 1.6200/£ (available in
UK and Eurozone)
• b/ Compare Cross rate & direct rate: Can we benefit
from this discrepancy?
– Yes! Buy GBP with Euro through cross rate and sell it at
direct rate!!
– Show your detailed transaction steps and calculations!

23

Exercise 3 Triangular Arbitrage: Transaction chain

• Start with EURO. Sell EUR1,000,000 at 0.9045, get


USD 904,500
• Sell USD904,500 @1/1.4443, get GBP626,255
• Sell GBP626,255 @1.6200, get €1,014,533
• Net Profit: €14,533 per 1m € recycled!

24

12
Triangular Arbitrage

Citibank
End with €1,014,533 Start with EUR1,000,000

(1) Sell EUR1,000,000 to


Citibank Bank at $0.9045
Receive $904,500

Dresdner Bank Barclays Bank

(3) Sell GBP626,255 at EUR1.62 get €1,014,533 (2) Sell $904,500 to Barclays
at $1.4443/£ get £626,255

25

Exercise 4 Triangular Arbitrage

New York

$1.060/ €

London Hong Kong

$1.5500/ £ € 1.5000/ £

26

13
Exercise 4 Triangular Arbitrage

• a/ Calculate Cross rate EUR against GBP: EUR


?/GBP
• EUR1.500/GBP-Direct Rate
• b/ Can we benefit from this discrepancy?
– Yes! Buy GBP with Euro through cross rate and sell it at
direct rate!!
– Show your detailed transaction steps and calculations!

27

Triangular Arbitrage

New York
Net Profit:EUR25,806
USD/EUR 1.060
1-Buy USD 1,060,000@ 1.06
3-Sell GBP683,871 @1.50 (USD1.060=1 Euro)
(Sell Euro 1,000,000 )
Get EUR 1,025,806
HK London

EUR/GBP1.5000 USD/GBP1.5500

2-Sell USD 1,060,000 @1.55


Receive GBP683,871

28

14
Transaction Chain

• Start with EURO


• Pay EURO get USD in NY
• Sell USD get GBP in London
• Sell GBP get EUR in HK
• (EUR-final)-(EUR-start)=Arbitrage Gain

29

Transaction Chain

• Pay 1,000,000 EUR to get USD 1,060,000


• Sell USD @ 1.5500/GBP get GBP683,871
• Sell GBP 683,871 @1.5000 get EURO EUR
1,025,806
• Net Profit=EUR 25,806

30

15
Calculating Cross Rates With Bid and Ask Rates

• In the textbook, cross rate examples are not


considering bid/ask rates.
• When bid and ask rates are involved cross rate
calculations are a bit more complicated.
• I attempted to develop an algorithm, and if you use
it, it should work, but it is best to practice it to get
comfortable with it.
• If we learn this we can also go through a more
realistic “Triangular Arbitrage” example.

31

Algorithm
• Can you get the cross rate by dividing one currency pair into the
other one? If “no” proceed to the next bullet point. If yes, then:
– Cross Bid Rate=Bid of the nominator pair/Offer of the
denominator pair
– Cross Offer Rate= Offer of the nominator pair/Bid of the
denominator pair
• Can you get the cross rate by multiplying one currency pair with the
other? If yes then
– Cross Bid Rate=Bid of the First Pair x Bid of the Second Pair
– Cross Offer Rate=Offer of the first pair x Offer of the second
pair
• End.
32

16
Example: CAD/JPY Cross Rate
• Use the following USD based quotes to calculate CAD/JPY Cross Rate:
– USD/JPY 105.50-106.10
– USD/CAD 1.2840-1.2850
• Solution: To get CAD/JPY rate we need to divide USD/JPY rate to
USD/CAD rate. In other words CAD/JPY= (USD/JPY)/(USD/CAD)
• If we check the algorithm the answer to first statement in the algorithm is
“YES”. Then follow the rule.
– Bid Rate of CAD/JPY is= Bid of the nominator (USD/JPY) / Offer of
the denominator (USD/CAD)= 105.50/1.2850=82.10
– Offer Rate= Offer of the nominator (USD/JPY) / Bid of the
denominator (USD/CAD)=106.10/1.2840=82.63
• Cross Rate: CAD/JPY 82.10-82.63
33

An intuitive explanation

• Bid side of the CAD/JPY implies that we deliver


CAD to the dealer and dealer pays us JPY. In other
words, we buy JPY with CAD.
• To purchase JPY with CAD, first we need to
convert CAD into USD.
– It takes CAD1.2850 to purchase 1 USD.
– If we deliver 1 USD to the dealer we get JPY 105.50
– In other words for every 1.2850 CAD we receive 105.50
JPY or for each CAD we get 105.5/1.2850=JPY 82.10

34

17
Offer Side

• The offer side of the CAD/JPY implies that we pay


JPY to get CAD. In other words we buy the base
currency.
• We pay JPY106.10 to get 1 USD
• We pay 1 USD and get CAD 1.2480
• For each (106.10/1.2480)=82.63 JPY we get 1
CAD.

35

Example-2
• Given the following rates, calculate EUR/CAD Cross rate:
– EUR/USD 1.2310-1.2315
– USD/CAD 1.2840-1.2850

• Calculate EUR/CAD Cross Rate:


• (EUR/USD) x (USD/CAD)=EUR/CAD or our answer to
first statement is “NO”. Our answer to second statement is
“YES”. Follow the rule stated in 2:
– Cross-Bid Rate= Bid x Bid= 1.2310 x 1.2840=1.5806
– Cross-Offer Rate= Offer x Offer=1.2315 x 1.2850=1.5825

• Hence EUR/CAD 1.806-1.5825



36

18
Exercise 5: A more realistic Triangular Arbitrage
• Assume that following rates appear in your screen:
– EUR/USD 1.3520 -1.3525
– USD/TRY 1.5890-1.5940
– EUR/TRY 2.1390-2.1433

• a/ Calculate the bid & ask cross rates EUR/TRY


• b/ Can you see an arbitrage opportunity here? How?
• c/ Show the steps and details calculations in the
arbitrage

37

Cross Rate and Arbitrage Check


• The cross rate: EUR/TRY
– We can calculate the cross rate EUR/TRY from USD
based quoted:
– (EUR/USD )x( USD/TRY)=EUR/TRY
– In this case since the cross rate is obtained through
multiplication we should multiply bid of the first rate
with bid of the second rate (and offer to offer to calculate
the offer rate of the cross:
– Bid Rate=1.3520 x 1.5890=2.1483
– Offer Rate=1.3535 x 1.5940=2.1559

38

19
– Bid Rate=1.3520 x 1.5890=2.1483
– Offer Rate=1.3535 x 1.5940=2.1559

• As these rate diverge from the direct rate of


– EUR/TRY 2.1390 -2.1433

• One can purchase the EUR directly at 2.1433, and


sell indirectly at 2.1483.
• The steps in the arbitrage will be shown in the next
slide:

39

• Use TRY100m to purchase EUR spot:


• TRY100,000,000 /2.1433=EUR46,657,024
• Buy USD at 1.3520
• EUR46,657,024 x 1.3520=$63,080,297
• Sell USD at 1.5890 against TRY
• =$63,080,297x1.5890=TRY100,234,591
• Arbitrage Profit: TRY 234,591
• The dollar equivalent is $147,634

40

20
THE END

41

21

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