IBUS 302: International Finance

1. IBUS 302: International Finance Topic 3-FX Quotations Lawrence Schrenk, Instructor .

2. Learning Objectives • Explain the structure and mechanisms of the FX market. • Explain the spot market. • Convert FX rates between American and European terms.▪

3. An Additional Resources • The Basics of Foreign Trade and Exchange (NY Fed) • Yahoo! Currency Converter • Abbreviations List (supplements)

4. The Spot Market

5. FX Rates • Foreign Exchange (FX or Forex) • How much one currency is worth in terms of another? • Transfer of purchasing power • FX rates are volatile and uncertain • Foreign Exchange Risk is • The possibility that the value of an investment, cash flow, return might change due to changes in exchange rates for currencies.

6. Current FX Rates 1.7769 dollars are worth one pound. NOTE: Yen quotations are to 6 places, not 4.

7. Currency Abbreviations • Every currency has a three letter abbreviation • Since ‘dollar’, ‘franc’ and ‘pound’ ambiguous • Abbreviations List (supplements) AUD Australian Dollar (AU$) CAD Canadian Dollar (C$) CHF Swiss Franc (CHF) EUR Euro (€) GBP British Pound (£) HKD Hong Kong Dollar (HK$) JPY Japanese Yen (¥) USD United States Dollar ($)

8. FX Notation I–Technical • S(j/k) price of one unit of k in terms of j • Or the number of j needed to buy 1 k. • S($/¥) is 1yen in terms of dollars • Or the number of dollars to buy 1 yen. NOTE: In this notation either symbols (¥) or abbreviations (JPY) can be used, e.g., S(¥/$) = S(JPY/USD)

9. FX Notation II S($/AU$) = S($ / AU$) ←Number of these to buy 1 of these→

10. FX Notation II • S($/AU$) = .8363 means... • You need to pay 0. 8363 USD for AU$ 1. • Spot rate for Australian dollars is $0. 8363 • An Australian dollar is worth $0. 8363. • AU$ 1 = $0.8363.

11. ‘Yours’ versus ‘Theirs’ • Spot Rate: The immediate rate • Direct Quotation: From ‘your’ currency • If an American works for a firm in Germany, ‘your’ currency is the euro. • Indirect Quotation: From ‘their’ currency • If an American works for a firm in Germany, ‘their’ currencies are the yen, American dollar, Kuwaiti dollar, etc. • What about an American working for a German firm in Japan? ▪

12. American Terms • FX Quotation in American Terms • Non-dollar currency priced in US dollars • S($/___) = number of US dollars to buy 1 ___. • In American terms, $ is before the ‘/’. • S($/C$) = number of US dollars to buy 1 Canadian dollar • S($/C$) = $0.9422 (September 2008)

13. European Terms • FX Quotation in European Terms • US dollars priced in a non-dollar currency • S(__/$) = number of ___ to buy 1 US dollar • In European terms, $ is after the ‘/’. • S(C$/$) = number of Canadian dollars to buy 1 US dollar • S(C$/$) = C$1.0613 (September 2008) NOTE: The non-dollar currency need not be ‘European’.

14. Reading the FX Table I European Terms American Terms Cross Rates ▪

15. Reading the FX Table II European Terms It takes 108.3650 yen to buy one dollar. ▪ European Terms: How many non-dollar units does it take to buy one dollar?

16. Reading the FX Table III American Terms It takes $1.4457 to buy one euro. ▪ American Terms: How many dollars does it take to buy one non-dollar unit?

17. Reading the FX Table IV Cross Rates It takes C$1.8859 to buy one pound. ▪ Cross Rates: How many non-dollar units does it take to buy a different non-dollar unit?

18. Reading the FX Table V Cross Rates: How many non-dollar units in the row does it take to buy a non-dollar unit in the column? ▪

19. Appreciation/Depreciation I • When there is more demand for the pound, • Pound appreciates relative to the U.S. dollar • S($/£) exchange rate increases • More dollars to buy one pound. • When there is less demand for the pound, • Pound depreciates relative to the U.S. dollar, • S($/£) exchange rate decreases • Less dollars to buy one pound. ▪

20. Appreciation/Depreciation II • If S($/£) = 1.80 • You need to spend more than $1 for a pound. • IMPORTANT: This does not mean the pound is ‘stronger’ or more in demand than the dollar. • ‘Stronger’/’more in demand’ refers to change over time • If yesterday S($/£) = 1.80, and now S($/£) = 1.70, • The dollar has become ‘stronger’ or more in demand relative to the pound, • Because it takes fewer dollars to buy one pound.

21. Appreciation/Depreciation III • Remember supply and demand curves • Dollar Demand and Supply of Pounds ▪ • Supply of Pounds • Demand forPounds • What Happened?▪

22. Converting between American and European Terms I • American and European terms are inverses (or reciprocals), i.e., • If you convert $1.74 • From dollars to pounds, • Then pounds to dollars • You still have $1.74

23. Converting between American and European Terms II • American Terms • S($/CHF) = 0.9049 ($0.9049 buys 1 Swiss franc) • European Terms • How many Swiss francs to buy 1 US dollar? • ‘Reverse’ for European →American Terms ▪

24. Converting between American and European Terms: Examples • European → American • American → European

25. What if... • S(£/$) = 0.5628 • S($/£) = 1.855

26. General Rules of Thumb • Most currencies are worth less than the USD • If the FX rate between the US Dollar and another currency is less than 1, the rate is probably in... • American Terms, i.e., S($/Non-Dollar) • Exceptions • GBP (£) and EUR (€) • A few other minor currencies • It takes a lot of yen to buy anything