International Finance 2012 Non-official SWOT VAC Revision Lecture

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					   International Finance
2012 Non-official SWOT VAC
      Revision Lecture
          ~ Vu da Vinci ~
  Download the slides/contact me at
  my website: www.vullionaire.com
  Understanding exchange rates
Eg: JPY/AUD 75-77
• Bid-ask
• Term/Commodity
• Home/Foreign (Direct)
• Foreign/Home (Indirect)
        Converting currencies
Eg: JPY/AUD 75-77
• Sell JPY 10,000 for AUD. How much do you
  receive?
• Sell AUD 10,000 for JPY. How much do you
  receive?
• How much does it cost in AUD to buy
  JPY10,000 ?
• How much does it cost in JPY to buy
  AUD10,000 ?
          Some theory topics
• Pegged exchange system.
  – How do central banks/monetary authorities peg a
    currency? Using foreign exchange reserves
  – Asymmetrical payoffs. Eg: Apple products in HK vs
    Australia
           Some theory topics
• Impossible trinity
  – Use of monetary policy oriented toward
    domestic goals
  – Exchange rate stability
  – Full financial integration (free capital
    mobility)
                Some theory topics
• Asian financial crises (1997)
    What happened in 1997?
    – Various weaknesses in the economies of the East Asian
      countries were becoming apparent.
        • It became clear that these currencies were overvalued.

    – July 2nd, 1997, Thailand devalued the baht.
    – This triggered a selloff of other currencies in the region, and
      speculators (eg global macro hedge funds) got in on the act.
    – Pegged exchange rate systems (where there are no capital
      controls) are highly vulnerable to speculative attack.
    – This is because there’s an asymmetric payoff to speculators -
      money can be made with relatively little risk.

(Source: Elaine’s lecture notes Week 3)
                     Some theory topics
• Eurozone crisis
• Maastricht treaty, December 1991: plan to replace
  European currencies with the euro.
• Convergence criteria:
     –   Inflation no more than 1.5% above average 3 lowest;
     –   Long-term interest rates no more than 2% above average 3 lowest;
     –   Fiscal deficit no more than 3% of GDP;
     –   Government debt no more than 60% of GDP.
•   In the early-to-mid 2000s, monetary policy in Europe was too ‘tight’ for Germany, and too
    ‘loose’ for boom countries like Ireland and Spain.
      – Spain and Ireland were growing fast; Germany was growing very slowly.



(Source: Elaine’s lecture notes Week 3)
          Some theory topics
1.Capital markets and lending to Eurozone
  governments – did they assume they
  would be bailed out in a crisis?
2.The perspective of the borrower – if a
  government knows that it will be bailed out,
  why stop the debt binge party?
           Some theory topics
• International Fisher Effect: a higher interest
  rate will cause the currency to depreciate
  (eventually)
• Short term: rarely holds. Long term, yes.
• Eg: Midsem test, last question.
                CIA vs Carry Trade (UIA)
CIA:
       – Borrow the undervalued currency (not necessarily one with lower
         interest rate)
       – Invest in the other currency
       – at the same time enter into a forward contract to sell the other
         currency in the future to receive the first currency
       – Pay back debt & earn a risk-free profit.
       – Only do CIA if IRP is violated today.
Carry trade/UIA
       –   Pure speculating
       –   Borrow the lower interest rate currency (JPY)
       –   Invest in another higher interest rate currency
       –   Convert the returns back to the first currency in the future & pay debt,
           hoping to earn a profit
         Calculating changes
Today: JPY/AUD 75
Next year: JPY/AUD 80

Change in AUD: (80-75)/75
Change in JPY: (75-80)/80
     Forward premium/discount
S= JPY/AUD 75
F= JPY/AUD 80

Just do the same thing. If it’s positive, the
currency is selling at a forward premium.
Otherwise, forward discount.
     Forwards, Futures, Options
Forwards vs Futures

F=S (1+iT)/(1+iC)
         Forwards, Futures, Options
•   Example: Assume 2-year interest rates in Australia and the US are 5% and
    7% respectively, the spot exchange rate is USD/AUD0.6200.
•   (This exchange rate is direct if we are in the US; so the domestic interest
    rate is the US one).
•   The two-year forward rate should be:




                     F = .6453
     BREAKKKK TIME!!!
Download slides/contact me at
   www.vullionaire.com




    Dream big. It doesn’t cost you anything!
           Currency Option Pricing
CALL vs PUT ?

Black-Scholes model:
•   Example. We are in the US. Calculate the value of an 8 month European
    call option on the Aussie with an exercise price of USD/AUD0.50. The
    current exchange rate is USD/AUD0.52, the volatility of the exchange rate
    is 12%, rh = 4% and rf = 8%.
•   What is the option’s value?
•   What is its intrinsic value and what is its time value?




                                                                                1
                                                                                7
                                d1 = .17712  .18


                                 d2 = .079  .08

N(d1) = 0.5714
N(d2) = 0.5319




                 It costs 2.27 US cents per Aussie to buy the call
   C = .0227     option.
                                                                     1
                                                                     8
                   Hedging
• Forward
• Money Market Hedge:
  – Export Receivables vs Import Payables
• Options
• Which method is the best???
• Example: Week 10 Tutorial.
               Questions?
• Download the slides/contact me at
            www.vullionaire.com

				
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