Chapter 2 - Forex Rate [PDF]

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CONTENTS CHAPTER 2: EXCHANGE RATES AND FINANCIAL DERIVATIVES ON THE FOREIGN EXCHANGE MARKET

A. EXCHANGE RATES 2.1 Concepts 2.2 Bases for determining exchange rates 2.3 Methods of quotation 2.4 Some conventions in foreign exchange transactions 2.5 Common types of exchange rates 2.6 How to calculate currency cross rates 2.7 Factors influencing exchange rates 2.8 Main measures to regulate exchange rates 2

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KHOA THƯƠNG MẠI – ĐH TÀI CHÍNH MARKETING

CONTENTS

A. EXCHANGE RATES

B. SOME OPERATIONS ON THE FOREIGN EXCHANGE MARKET 2.9 Overview of foreign exchange market 2.10 Spots 2.11 Forwards 2.12 Options 2.13 Arbitrages 2.14 Futures 2.15 Swaps

2.1 Concepts ‘The price of a nation’s currency in terms of another currency’ [- Đinh Xuan Trinh, (2006), International Payment, Labour and Social Publishing House, page 47-48 - Intovespedia ]

E.g.: USD/EUR = 0.76 3

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A. EXCHANGE RATES

A. EXCHANGE RATES

2.1 Concepts (cont.) According to Law on the State Bank of Viet Nam : “Exchange rate of Vietnam dong shall be the price of a unit of foreign currency which is calculated by Vietnam currency unit»

Currency Code

Currency Name

Buy

Transfer

Sell

AUD

AUST.DOLLAR

15,503.28

15,596.86

15,862.08

CAD

CANADIAN DOLLAR

17,124.96

17,280.48

17,574.34

CHF

SWISS FRANCE

23,385.62

23,550.47

23,950.94

EUR

EURO

25,550.98

25,627.86

26,397.54

GBP

BRITISH POUND

27,734.16

27,929.67

28,178.28

HKD

HONGKONG DOLLAR

2,918.23

2,938.80

2,982.80

JPY

JAPANESE YEN

211.42

213.56

219.75

SGD

SINGAPORE DOLLAR

16,507.98

16,624.35

16,805.91

THB

THAI BAHT

737.76

737.76

768.53

USD

US DOLLAR

23,150.00

23,150.00

23,270.00

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Source: vcb.com.vn

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A. EXCHANGE RATES Currency Australian Dollar

1.788

Canadian Dollar

1.615

Chinese Yuan Euro

1.2 Bases for determining exchange rates 1.2.1 Before Dec 1971

8.5198 1.0905

Indian Rupee

86.9906

Japanese Yen

128.5659

Russian Ruble

Before 1944 Gold standard system

• 1 GBP = 7,880 gr gold • 1 USD =1,5047gr gold =>GBP/ USD = 7,9880/1.5047 = 5,3089 1GBP = 5,3089 USD

80.2976

South Korean Won

1470.0702 1.2114

US Dollar

https://www.bankofengland.co.uk

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A. EXCHANGE RATES

A. EXCHANGE RATES 2.2 Basis for determining exchange rates (cont.) 2.2.1 After Dec. 1971

1944- 1971 Bretton Woods system

- Nations pegged their currencies to the U.S. dollar based on gold content of these currencies and that of US currency - USD was begged to price of gold, fixed at $35 an ounce (1USD = 0.888671gr)

Fee-floating exchange rate

determined by the market through supply and demand (“self-correcting”)

E.g.:

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A. EXCHANGE RATES 2.2 Basis for determining exchange rates (cont.) 2.2.2 After Dec. 1971 Managed floating exchange rate

Floating rate + intervention of the Government

What exchange rate mechanism is Vietnam applying? 11

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• Article 13. Exchange rates 1.Exchange rates of Vietnam dong shall be determined on the basis of the foreign currency supply and demand in the state-regulated market. 2. The State Bank shall announce exchange rates and decide on the exchange rate regime and management mechanisms. Law on the State bank of Vietnam No. 46/2010/QH12) 12

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A. EXCHANGE RATES

A. EXCHANGE RATES

2.3 Methods of quotation 2.3.1 Direct quotation

2.3 Methods of quotation 2.3.2 Indirect quotation

1 foreign currency = X home currency

1 home currency = X foreign currency

E.g.: In Great Britain, the exchange rates are quoted as following:

E.g.: In Viet Nam:

1USD = 23,150 VND 1EUR = 27,723 VND

1 GBP = 28,274.54 VND 1 GBP = 1.3895 USD

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A. EXCHANGE RATES

https://www.xe.com/currencyconverter/

2.4 Some conventions in foreign exchange transactions 2.4.1 How to write exchange rates In accordance with ISO’s regulation: One country’s currency is written in 3 characters: + 2 first characters: country’s name + 3rd character: currency name E.g.: Currency name of the United State of Amercia: USD - The United State  US - Dollar  D http://www.xe.com/iso4217.php#Y

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A. EXCHANGE RATES

A. EXCHANGE RATES

2.4.1 Writing the rates (cont.) According to business practices: • Commodity currency  front • Terms currency  behind E.g: USD/VND = 23,150 or 1 USD = 23,150 VND

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https://www.dailyfx.com/forex-rates

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BID

BID rate : USD/ VND =23,150 ASK rate: USD/ VND = 23,270

(CALL)

ASK (PUT)

USD/VND = 23,150 - 23,270 Buy USD Sell USD

USD/ VND = 23,150 - 23,270 USD/ VND = 23,150 / 23,270 USD/ VND = 23,150 / 270

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KHOA THƯƠNG MẠI – ĐH TÀI CHÍNH MARKETING

A. EXCHANGE RATES • BID - Front rate - The rate that the bank buys the commodity currency

1.4.2 How to read exchange rates For the terms currency, we take the name of + the capital of industrialized country or + the city being a commercial center instead of the name of country’s currency E.g.: * US Dollar– Tokyo 84.27 means 1 USD = 84.27 JPY * US Dollar– Bangkok 30.58 means 1 USD = 30.58 THB

• ASK - Behind rate - The rate that the bank sells the commodity currency

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A. EXCHANGE RATES

2.4.3 Two-way quotation Inverse rate

2.4.2 How to read exchange rates

1 Rate B/A = ----------rate A/B

 Read: variable digits (or last digitss) E.g.: USD/SGD = 1.7642/50 Two first decimal digits  figure Two next decimal digits  point  Dollar – Singapore: one unit, seventy-six figure, forty-two point to fifty point

1 Rate A/B = ----------rate B/A

1 EUR/USD = ----------USD/EUR 23

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• GBP/USD = 1.5538 USD/GBP =

BID

1

GBP/USD = 1.5538 BUY GBP

1.5538

1

1

1.5544

1.5538

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CO. A sells GBP to get USD 25

1.5544 SELL GBP BUY USD CO. A sells USD to get GBP

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A. EXCHANGE RATES

A. EXCHANGE RATES

2.5 Types of common rates 2.5.1 Classifying under the Central Bank’s management Decision No. 2730/2015/ QD-NHNN On 31st Dec, 2015 (article 1 and 2)

-

SELL USD

• GBP/USD =1.5538 - 1.5544 • USD/GBP =

ASK

2.5.2 Classifying by Commercial Bank’s operations

• Ask rate (selling rate)

Central exchange rate

• Bid rate (buying rate)

SBV

• Cash rate

The average exchange rate on the inter-bank forex market

• Transferring rate 27

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A. EXCHANGE RATES

A. EXCHANGE RATES 2.6 Calculating the currency cross rate

2.5.3 Classifying by the transaction time

1. Currency cross rate between two commodity pairs

• Closing rates

2. Currency cross rate between two terms pairs

•Opening rates

3. Currency cross rate between one commodity currency and one terms currency 29

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A. EXCHANGE RATES

A. EXCHANGE RATES

1. Currency cross rate between two commodity pairs

General formula: We have: Rate

A/C = b1 – a1 B/C = b2 – a2

We have USD/ VND EUR/ VND

 Cross rate A/B =

 Calculate USD/ EUR?

* BID (A/B) =

A/C B/C

b1 a2

* ASK (A/B) =

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a1 b2

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A. EXCHANGE RATES

A. EXCHANGE RATES

1. Currency cross rate between two commodity pairs

2. Currency cross rate between two terms pairs

E.g.:

GBP/USD = 1.5682 – 1.5951 AUD/USD = 1.0522 – 1.0775 GBP/AUD = ? Answer: Formula 1.5682 = 1.4554 BID GBP/AUD = BIDA/B = ASK A/B =

b1

USD/ VND

1.0775

a2 a1

We have USD/ CNY

ASK GBP/AUD =

1.5951

 Calculate CNY/ VND? = 1.5160

1.0522

b2

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A. EXCHANGE RATES

A. EXCHANGE RATES Formula: We have :

A/B = BID A/B = ASK A/B =

E.g.1:

C/A = b1 – a1 C/B = b2 – a2 C/B C/A b2 a1 a2 35

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USD/JPY = 78.40 – 78.60 USD/VND = 20,800 – 20,860 JPY/VND = ? Answer: 20,800 BID JPY/VND = Formula: = 264.63 78.60 b2 BID A/B = a1 20,860 ASK JPY/VND = a2 = 266.07 ASK A/B = 78.40 b1 36

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A. EXCHANGE RATES

A. EXCHANGE RATES

E.g. 2: One Vietnamese importer has to pay a bill for one Swiss company in CHF. What exchange rate will the bank apply for the importer? The rates quoted on the market by this bank are as follows:

3. Currency cross rate between one commodity currency and one terms currency We have GBP/ USD USD/ VND  Calculate GBP/ VND?

USD/CHF = 0.9040 - 0.9267 USD/VND = 20,800 – 20,860 37

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A. EXCHANGE RATES

A. EXCHANGE RATES

3. Currency cross rate between one commodity currency and one terms currency

We have the rates A/C = b1 – a1 C/B = b2 – a2  Cross rate A/B = A/C x C/B With BID A/B = b1 x b2 With ASK A/B = a1 x a2

3. Currency cross rate between one commodity currency and one terms currency Formula BID A/B = b1 x b2 ASK A/B = a1 x a2

E.g.: GBP/USD = 1.5682 – 1.5951 USD/VND = 20,800 – 20,860  GBP/VND = ? Answer:

BID GBP/VND = GBP/USD x USD/VND = 1.5682 x 20,800 = 32,618.75 39

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ASK GBP/VND = 1.5951 x 20,860 = 33,274.54

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A. EXCHANGE RATES

A. EXCHANGE RATES

2.7 Factors influencing the foreign exchange rates

2.7 Factors influencing the foreign exchange rates Inflation

Inflation

Other factors

Inflation of B > A  the exchange rate

Regulatory intervention of State bank

Interest rate between domestic currency and foreign currency

Supply and demand of foreign currencies on the market KHOA THƯƠNG MẠI – ĐH TÀI CHÍNH MARKETING

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A B 42

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A. EXCHANGE RATES

A. EXCHANGE RATES

2.7 Factors influencing the foreign exchange rates (cont.)

2.7 Factors influencing the foreign exchange rates (cont.)

Interest rate between domestic currency and foreign currency

Domestic interest rate > foreign interest rate:  Foreign captital flows into the domestic capital market  Supply of forex , demand of forex  Forex rate

Supply and demand of foreign exchange on the market

depend on

-

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Supply of forex  exchange rate Demand of forex  exchange rate

Deficit / surplus balance of international payments Actual income Abnormal demand for foreign exchange

KHOA THƯƠNG MẠI – ĐH TÀI CHÍNH MARKETING

A. EXCHANGE RATES

A. EXCHANGE RATES

2.7 Factors influencing the foreign exchange rates (cont.)

2.7 Factors influencing the foreign exchange rates (cont.) Other factors

Regulatory intervention of Central bank

Buy foreign currency Limit the devaluation of foreign currency and the revaluation of home currency

Exchange equalization account

Prevent the revaluation of foreign currency, the devaluation of home Sell foreign currency

currency

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Economic events

Monetary policy

Psychology

Politics

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Calamity

Society

War

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A. EXCHANGE RATES

A. EXCHANGE RATES 2.8 Main measures to regulate exchange rates

2.8 Main measures to regulate exchange rates Significance of regulating exchange rates

Monetary measures

Incentivize export; control import

Hamonize the balance of supply and demand of foreign currency; stabilize macroeconomy; restrain inflation

Devaluation or revaluation 48

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A. EXCHANGE RATES

A. EXCHANGE RATES Change the interest rates

Monetary measures Interest rates

* Forex rate : ln.rate Market In.rate Short-term capital in the world would flow into the Forex rate country

OMO (Open market operations)

* Forex rate

: Interest rate 50

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KHOA THƯƠNG MẠI – ĐH TÀI CHÍNH MARKETING

A. EXCHANGE RATES

A. EXCHANGE RATES

Open-market policy

Impacts of OMOs:

An open market operation (OMO) is an activity by the State Bank to buy or sell short-term valuable papers with credit institutions.

* Forex rate  the State Bank sells valuable papers  the amount of money hold by the commercial banks goes down  forex rate * Forex rate rate

 the State Bank buys valuable papers  forex

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A. EXCHANGE RATES

A. EXCHANGE RATES Currency devaluation

Currency devaluation or revaluation

Currency devaluation

Definition: Devaluation means lowering the purchasing power of a country’s currency against foreign currencies, lower than its real purchasing power. E.g.:

Currency revaluation

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A. EXCHANGE RATES

A. EXCHANGE RATES

Currency devaluation

Currency revaluation Definition: Currency revaluation means improving the purchasing power of a country’s currency against foreign currencies, higher than its real purchasing power.

Impacts: * Export (Commodity) Import (capital) Import (Tourism)

Import (Commodity) Export (capital)

E.g.: 55

Impacts: contrast with currency devaluation

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A. EXCHANGE RATES

A. EXCHANGE RATES Questions

Currency revaluation 1.

Reasons to revaluate: 1. Due to other countries’ pressure. 2. Countries with “too hot” economy wish to do “cool” to avoid economic crisis. 3. Building its position in other countries. 1971: USD/JPY = 360 1996: USD/JPY =102

2. 3. 4.

1. Direct quotation and indirect quotation, commodity currency and terms currency, selling rate and buying rate. 2. Types of foreign exchange rates? 3. Formulas for cross rates? 4. Factors influencing foreign exchange rates and main measures to regulate exchange rates? 58

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KHOA THƯƠNG MẠI – ĐH TÀI CHÍNH MARKETING

A. EXCHANGE RATES 1 . GBP/USD = 1.5538/44 2 . USD/JPY = 93.45/67 3 . USD/VND = 20,080 /20,955 4 . USD/AUD = 1.1139/56

EXERCISE

5 . EUR/USD = 1.4395/1.4400 6. USD/SGD = 1.4023/34 7. USD/HKD = 7.7533/53 8. GBP/EUR = 1.4717/27 59

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Which rate does the bank apply in case customers

A. buy USD with GBP B. sell USD to get JPY C. sell EUR for USD D. buy EUR with GBP E. buy AUD with USD F. exchange USD for HKD G. buy SGD with USD H. buy GBP with USD i. sell USD for EUR 60

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B. FINANCIAL DERIVATIVES ON THE FOREIGN EXCHANGE MARKET

Exercise 1: Fill in the gaps with approriate cross rates: USD/VND EUR/USD GBP/USD USD / JPY USD/ CAD AUD/USD EUR/GBP JPY/VND EUR/VND GBP/AUD AUD/CAD GBP/VND EUR/JPY

bid 21120 1.1363 1.5538 118.95 1.2422 0.7851 ? ? ? ? ? ? ?

ask 21190 1.1366 1.5544 119 1.2426 0.7855 ? ? ? ? ? ? ?

Definition: Foreign exchange market is the international market in which participants are able to buy, sell, exchange and speculate on currencies.

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B. FINANCIAL DERIVATIVES ON THE FOREIGN EXCHANGE MARKET Features: -

- Promptness: with a 24-hour work schedule - Globalization without geography - Price determined on the supply-demand relationship - High volume - Transactions in freely convertible foreign currencies: USD, EUR, JPY, CHF, GBP …  63

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KHOA THƯƠNG MẠI – ĐH TÀI CHÍNH MARKETING

B. FINANCIAL DERIVATIVES ON THE FOREIGN EXCHANGE MARKET Functions: Helping customers to make international trade transactions The capital flows between countries The external value of the currency effectively. is determined in an objective way Insuring export proceeds, and import payments … Tools for the central bank to capture market information

Creating the conditions for integration 64 with int’l financial markets

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B. FINANCIAL DERIVATIVES ON THE FOREIGN EXCHANGE MARKET

B. FINANCIAL DERIVATIVES ON THE FOREIGN EXCHANGE MARKET

Types of foreign exchange markets:

Types of foreign exchange markets

In the process of formation and development

American – British Exchange Rate System

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European Exchange Rate System

According to the nature of market activity

Spot foreign exchange market

Deposit market 66

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B. FINANCIAL DERIVATIVES ON THE FOREIGN EXCHANGE MARKET Types of foreign exchange markets

B. FINANCIAL DERIVATIVES ON THE FOREIGN EXCHANGE MARKET Types of foreign exchange markets

According to business operations

Forward market

Spot market Options market

According to the scope of the market

International Monetary Market

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Regional Monetary Market

KHOA THƯƠNG MẠI – ĐH TÀI CHÍNH MARKETING

SPOTS Definition: Spot transaction: the purchase or sale of foreign currency that - the transfer is done immediately or not later than two working days after the agreement of sale .

SPOTS 69

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SPOTS

- transac on is made on the basis of the spot exchange rate (spot rate), that is, the exchange rate is determined and valid at the time of transaction. 70

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SPOTS

When to use a spot? Individuals, exporters, importers need to trade foreign currency at once

How to perform a spot transaction: When one Vietnamese importer wants to pay $1m to one American exporter 71

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SPOTS

SPOTS

Step 1. Currency transaction: verbal agreement with Import Bank, the importer specifies: a. Account to debit

(his acct)

Step 2. Bank sends importer contract note including: - amount of foreign currency - agreed exchange rate

b. Account to credit (exporter) 73

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- confirmation of Step 1. 74

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SPOTS

Step 3.

Settlement Correspondent bank in the U.S. transfers $US from nostro account to exporter’s. Value Date. Import bank debits importer’s account

• A bank quoted Spot exchange rate EUR / VND: 27,739 - 27,895 • Customer A wants to sell 90,000 EUR, how much (in VND) will he get? • Customer A wants to buy 90,000 EUR, how much (in VND) does he have to spend?

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SPOTS Strengths and weaknesses: * Strengths: transactions are provided for Exporters who have demand for selling foreign currency at once Importers who have demand for buying foreign currency at once.

FORWARDS

* Weaknesses: unable to provide transactions for the buyer or seller on demand with future transaction time. 77

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Forwards

Forwards

Definition of a Forward exchange contract

Purpose of a Forward:

An agreement between two parties to deliver a specified amount of currency against another currency at a specified future date and at a fixed exchange rate.

The act of reducing exchange rate risks

Hedging

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Forwards

Forwards Calculating the forward rate: 1+n.rB Fn= Fs x 1+n.rA

Calculating the forward rate :

Where Fn: the forward rate of currency A agaisnt B (A/B) Fs : the spot rate (A/B) n : the number of days/months/years in the forward contract rA: Interest rate of currency A (commodity currency) rB: Interest rate of currency B (terms currency)

Simple formula: Fn = Fs +Fs x n x (rB - rA)

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Forwards

Forwards

Calculating the forward rate:

Calculating the forward rate :

Forward Bid rate:

Fb = Sb +

Forward Ask rate:

Sb [DrB – LrA] n

Fa = Sa +

100 x 365

Sa [L rB – D rA] n 100 x 365

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On 4th April, customer X has contacted with ACB bank to sell 90,000 EUR under a 3-month forward contract. • Spot rate EUR / VND: 27,739 - 27,895 • Interest rate of EUR: deposit 1%, loan 4% /year • Interest rate of VND: deposit: 7% / year, loan 9% / year. Calculating VND amount this customer earns when the contract is due.

Calculate 3-month USD / VND, knowing that: spot rate USD / VND = 21,120 interest rate of USD: 2% and of VND: 8% / year

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Forwards

86

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Forwards

Exercise: One exporter wants to sell 2m JPY to take VND under a 3month forward contract with a bank. How much VND will the exporter receive after 3 months? We have the spot rate of USD/JPY = 78.40 – 78.60 USD/VND = 20,850 – 20,885 Interest rate of JPY : deposit 2%/year; lending 3%/year, of VND : deposit 7.5% ; lending 8.5%/year 87

KHOA THƯƠNG MẠI – ĐH TÀI CHÍNH MARKETING

Steps to perform a forward transaction:  Step 1: Bank collects necessary info. to determine the forward rate.  Step 2: the Bank offers the forward rate for the customer.  Step 3: If the Bank and the customer agree to do transaction  sign a forward contract.  Step 4: Transfer foreign currency on the mature date. 88

KHOA THƯƠNG MẠI – ĐH TÀI CHÍNH MARKETING

Forwards Strengths and weaknesses: * Strengths: - Satisfying the demand for trading foreign currencies that are transfered in the future. * Weaknesses: Compulsory transaction Unable to meet current demand 89

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OPTIONS 90

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Definition: Option holder/ buyer

Option writer/ seller Option contract

Option

OPTION

holder

CONTRACT

Holder The right, but not the obligation, to buy/ sell

A specific amount of foreign currency The obligation to sell/ buy

At a predetermined price and within a predetermined period of time.

Foreign currency Writer :EUR, USD, CHF, CAD, …

Premium (Price of an option contract)

Exercise or strike rate

Option writer

Spot rate

Maturity (duration of the contract)

91

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KHOA THƯƠNG MẠI – ĐH TÀI CHÍNH MARKETING

OPTIONS

OPTIONS

Types of Options

Option style

Put option

Call option

American option style

European option style

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KHOA THƯƠNG MẠI – ĐH TÀI CHÍNH MARKETING

OPTIONS

OPTIONS

When to use an option?:

Speculation

Hedge 95

KHOA THƯƠNG MẠI – ĐH TÀI CHÍNH MARKETING

Example of speculation: At present, the exchange rate of EUR/USD is 1.32001.3212. Customer A forecasts EUR to go up. He can buy 200,000 EUR as a speculation to get profits after 3 months if the price of EUR increases. However, 200,000 EUR is a big sum of money that is difficult to have.  What should Customer A do to perform his wish of speculation? 96



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OPTIONS

OPTIONS

 Customer A contacts Bank B to buy a call option contract with terms as follows: - Option writer: Bank B - Option holder: A - Option type: call option - Option style: American

* Issues needed to be taken in consideration of Customer A Break-even point (BEP): 1.3250 + 0.02 = 1.3450 At any time later, if:

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Exercise the contract

Future exchange rate

*

EUR > USD

1.3450 < BEP=1,3450

(1 EUR = 1,3350 1.3350 USD)

- Amount of foreign currency: 200,000 EUR - Exercise rate: 1.3250 - Maturity: 90 days - Premium: 0.02 USD for each EUR

KHOA THƯƠNG MẠI – ĐH TÀI CHÍNH MARKETING

Do not exercise the contract

Lose 2,000 USD Lose 4,000 USD =( – ) x (premium) 200,000

*

> BEP=1,3450 1.3450 Profit 6,000 USD =( (1 EUR =1,3750 1.3750 USD) )x200,000 EUR * < Ex.Rate = 1.3250 Lose 6.000 USD Lose 4,000 USD = (1.3150 – < 21/05/21 99 1 EUR = 1.3150 USD 1.3450) x 200,000 (premium) KHOA THƯƠNG MẠI – ĐH TÀI CHÍNH MARKETING USD 99

OPTIONS

For call option holder Condition

FX Rateb >

Call option

Note

Yes

Profit = FXRateb – BEP

FX Rateb < FX Ratect

No

BEP > FX Rateb≥ FX Ratect

Yes/ No

= FXRateb - FXRct – P : the difference between the market price and the call price in the contract and the premium.

FXRateb : Exchange rate on the market at expiration date FXRatect: Exchange rate in the contract 100 P : Premium. 21/05/21 100 BEP: Break-even point KHOA THƯƠNG MẠI – ĐH TÀI CHÍNH MARKETING

OPTIONS

Example of speculation (buy put option): At present, the FX rate of EUR/USD là 1.3200 – 1.3212. Customer A forecasts EUR to go down in the next 3 months Customer A contacts Bank B to buy a put option contract with terms as follows: - Option writer: Bank XNZ - Option holder: A - Option type: put option - Option style: American 101

KHOA THƯƠNG MẠI – ĐH TÀI CHÍNH MARKETING

- Amount of foreign currency: 200,000 EUR - Exercise rate: 1.3250 - Maturity: 90 days - Premium: 0.02 USD for each EUR Break-even point: 1.3250 – 0.02 = 1.3050 At any time later, if:

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Exercise the contract

Future exchange rate

EUR < USD

* > BEP=1.3050 1 EUR = 1.3150 USD

* < BEP=1.3050 1 EUR = 1.290 USD

EUR > USD 21/05/21

Do not exercise the contract

For put option holder Condition

FXRb < BEP

Lose 2,000 USD Lose 4,000 USD = (1.3050 – premium) 1.3150) x 200,000 Profit 3,000 USD = (1.30501.290)x200,000

Lose 6,000 USD Lose 4,000 USD = (1.3050 – 103 1.3350) x 200,000 (premium) 1 EUR = THƯƠNG 1.3350 USD KHOA MẠI – ĐH TÀI CHÍNH MARKETING

* > FXR = 1.3250

103

Profit = BEP - FXRb = FXRct – P - FXRb : the

No

BEP < FXRb≤ FXRct

Yes/ No

difference between the put price in the contract and the market price and the premium.

FXRb : Exchange rate on the market at expiration date FXRct: Exchange rate in the contract 104 P : Premium. 21/05/21 BEP: Break-even point

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* Steps to perform an option transaction

Customer with import contract

Customer with export contract

Buy OptionPut

Buy OptionCall 105

 Customer contacts the Bank  Customer and the bank reach agreement on option type, option style, exercise rate …  When customer wants to exercise the contract  send written request to the bank 106

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KHOA THƯƠNG MẠI – ĐH TÀI CHÍNH MARKETING

B. FINANCIAL DERIVATIVES ON THE FOREIGN EXCHANGE MARKET

OPTIONS It’s not obligatory to exercise the contract

1.

2.

can be used to hedge

3.

4.

-There

Yes

OPTIONS

Hedge

-Options

Note

FXRb > FXRct

OPTIONS

STRENGTHS

Put option

are investment opportunities with limited cost, and unlimited profit.  107

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Questions 1. What is a spot foreign exchange transaction? In what cases do customers use spot transaction? 2. Drawbacks of spot transaction? How to overcome these drawbacks? 3. What is a forward transaction? What are the benefits that the bank and customer have when they perform forward transactions? 4. Drawbacks of forward transaction? How to overcome these drawbacks? 108

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B. FINANCIAL DERIVATIVES ON THE FOREIGN EXCHANGE MARKET

B. FINANCIAL DERIVATIVES ON THE FOREIGN EXCHANGE MARKET

Exercises 1. Assume that there is some information on the market as follows: Foreign exchange rate: GBP/USD EUR/USD USD/JPY USD/CHF USD/VND

Bid 1.7245 1.3128 111.12 1.1184 16,068

Ask 1.7295 1.3188 111.92 1.1254 16,078

Call Option

Put Option

100,000 USD

100,000 USD

20,840

20,830

Duration

2 months

2 months

Option style

American

American

30 VND

6 months

3.25 3.35 3.38 3.00 3.45 7.20

4.25 4.35 4.48 4.10 4.25 9.60

3.45 3.55 3.48 3.10 3.50 7.80

4.45 4.55 4.58 4.20 4.15 10.20

3.65 3.75 3.68 3.20 3.60 8.40

20 VND 111

On 5th July, customer X wanted to buy one call option and customer Y wanted to buy one put option. a. Base on the above information, determine the option premium that customer X and Y have to pay. b. To what exchange rate can customer X and Y exercise the options? c. Assume that on 20th July, the exchange rate of USD/VND is 20,865, what can customer X and Y do with their options? 112

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KHOA THƯƠNG MẠI – ĐH TÀI CHÍNH MARKETING

• Company A wants to buy the call option with bank B for USD100,000; the exercise price : USD / EUR = 0.8125; The term: 3 months, the option premium: 0.0020 EUR for 1 USD. Option style: European. • On the maturity date, the spot rate on the market (FX rate) is as follows: - FX rate = 0.8150, Does the company exercise the contract? - FX rate = 0.8110, Does the company exercise the contract? - FX rate= 0.8135, Does the company exercise the contract?

• Company A wants to buy put options with the bank B for USD100,000; the exercise rate: USD / EUR = 0.8125; The term: 3 months, the option premium: 0.002 EUR for 1 USD. Option style: European. • At the maturity date, suppose the spot rate in the market (FX rate) is as follows: - FX rate = 0.8095, Does the company perform the contract? - FX rate = 0.8135, Does the company perform a contract? - FX rate = 0.8115, Does the company perform the contract?

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4.65 4.75 4.78 4.30 4.20 10.80

B. FINANCIAL DERIVATIVES ON THE FOREIGN EXCHANGE MARKET

transaction as follows:

Premium per each USD

3 months

KHOA THƯƠNG MẠI – ĐH TÀI CHÍNH MARKETING

2. ABC Bank provides information about Option

Exercise rate (USD/VND)

GBP EUR USD JPY CHF VND

1 month

Deposit Lending Deposit Lending Deposit Lending

110

B. FINANCIAL DERIVATIVES ON THE FOREIGN EXCHANGE MARKET

Value

Term

Basing on the above information, determine the selling and buying forward rates for all types of currency in 1-month, 3month and 6-month terms.

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Contract’s content

Interest rate (%/year):

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19

• Call option helps the customer to determine the ……he …… • Put option helps the customer to determine the ……he …… 1. Minimum equivalent amount 2. Maximum equivalent amount 3. Pays 4. Gets 115

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