Currency Exchange Rates

1 usd = 7 yen
1USD = 6 yen
Price/Base; BDT/USD = 85/1. 87/1, 83/1
• Asset (USD)
– BDT/USD = 87/1
– Importer, frm USA>>>>87>>>>>90: 1000 USD; 1000*3 = 3000
extra payment
– Exporter (RMG), you sell in USA, income in
USD.,,,,,,87>>>>>>>85; earned 1>>>>87>>>>>85
– For Importer:
• To hedge risk of USD appreciating
• Forward 88/1….he’s assuming that will become more than or equal
90
• This contract is a derived contract from the original asset.
ASEET>>Contract
• Price/Base
– Price currency is the commodity
– Base currency is what we will use to buy these comodities
– Also, remember an exchange is always expressed through BASE
• Relation: you will need to use 1 unit of USD to buy 87 units of BDT
• Bdt/usd….87/1…….90/1
• 87/1………..84/1
• 1/1
– Next month BDT/USD = 85/1
– When will the value be same = BDT/USD = 1/1
– Any exchange is always expresed through the base currency.
 Introduction
• Measured by daily turnover, the foreign exchange (FX) market—the market in
which currencies are traded against each other—is by far the world’s largest
market. Current estimates put daily turnover at approximately USD4 trillion
for 2010. This is about 10 to 15 times larger than daily turnover in global
fixed-income markets and about 50 times larger than global turnover in
equities. Moreover, volumes in FX turnover continue to grow: Some predict
that daily FX turnover will reach USD10 trillion by 2020 as market
participation spreads and deepens.
• Daily Global stock market transaction is currently 200 billion
• The FX market is also a truly global market that operates 24 hours a day, each
business day. It involves market participants from every time zone connected
through electronic communications networks that link players as large as
multibillion-dollar investment funds and as small as individuals trading for
their own account—all brought together in real time. International trade
would be impossible without the trade in currencies that facilitates it, and so
too would cross-border capital flows that connect all financial markets
globally through the FX market.
• These factors make foreign exchange a key market for investors and market participants
to understand. The world economy is increasingly transnational in nature, with both
production processes and trade flows often determined more by global factors than by
domestic considerations. Likewise, investment portfolio performance increasingly
reflects global determinants because pricing in financial markets responds to the array
of investment opportunities available worldwide, not just locally. All of these factors
funnel through, and are reflected in, the foreign exchange market. As investors shed
their “home bias” and invest in foreign markets, the exchange rate—the price at which
foreign-currency-denominated investments are valued in terms of the domestic
currency—becomes an increasingly important determinant of portfolio performance.

• Even investors adhering to a purely “domestic” portfolio mandate are increasingly

affected by what happens in the foreign exchange market. Given the globalization of the
world economy, most large companies depend heavily on their foreign operations (for
example, by some estimates about 40 percent of S&P 500 Index earnings are from
outside the United States). Almost all companies are exposed to some degree of foreign
competition, and the pricing for domestic assets—equities, bonds, real estate, and
others—will also depend on demand from foreign investors. All of these various
influences on investment performance reflect developments in the foreign exchange
market.
 Participants in FOREX market
• Foreign exchange market participants consist of two broad
categories: the buy side and the sell side. The sell side consists of
large FX trading banks like Citigroup and the buy side consists of
clients who use these banks to undertake transactions. The buy
side includes:
• Corporate Accounts: Corporations perform transactions during
cross-border purchase or sales of goods and services through FX
markets. As a result, this facilitates cross-border investments.
• Real Money Accounts: These are investments controlled by
mutual funds, insurance companies or pension funds among
other institutional investors. These accounts are restricted in
their use of financial derivatives.
• Government: Most sectors of the government have to
perform foreign transactions. For example, the security
sector might purchase military equipment from
abroad.

• Central Banks: Central banks might intervene in the

foreign exchange market so as to influence either the
level or trend of the domestic exchange rate. This is
most often the case for net exporting countries
wanting to keep their currency at relatively low levels
to keep their prices competitive on the global markets.
• Main purpose of creating a derivative is:
– If you predict risk in the future then you might want to get into
some contracts with other entities that will help you minimize
your prpedicted risk. These contracts are derived, hence the
name derivatives.
– Example: I am an imprter (based in BD). I import goods from
USA, using USD; BDT/USD = 87>>>>>>>90….1000usd : 3000loss
– 88 USD seal:
– Arbitrage opportunities
– RMG he exports goods to EU and USA and he earnsin
USD.::::::::::bdt/usd = 87>>>>>>>>90
 The FOREX Market
• Exchange Rates:
– Base Currency (denominator)
– Price Currency (numerator)
– P/B
– Always consider base as your commodity. And always consider price as the unit you are spending
to buy 1 unit of base. Base currency is always always expressed in 1 unit.
– BDT/USD = 85/1
– Now we always express everything in-terms of base
• According to the CFA convention, the currency indicated as the denominator is
the base currency and the numerator is the price currency (in other
conventions, known as the price currency). The base currency has 1 unit. The
base currency represents how much of the price currency is needed for you to
get one unit of the base currency. In other words, price currency as numerator
represents, how many units of price currency you’ll get by one unit of base
currency.
• Example: USD/EUR = 1.33; here, EUR is base currency and USD is price currency.
For 1 unit of EUR one will get 1.333 units of USD in the market today.
 Changes in exchange rate:
• 2020 Spot(bdt/usd) = 85/1
• 2021 Spot(bdt/usd) = 87/1
• USD change = appreciated from last year
– What percent? (new-old)/old = (87-85)/85 = +2.35%
– BDT change = depreciate
– What percent? -2.35% (WRONG)
– I’m wrong because I calculated the change in BDT, keeping BDT as price
and USD a base
– Always remember, any changes has to be calculated from the
perspective of BASE CURRENCY. In order to calculate the change in BDT,
I need to bring BDT to base then calculate change
• 2020 Spot(USD/BDT) = 1/85 =0.0117
• 2021 Spot(USD/BDT) = 1/87 = 0.0114
• Change in BDT = (0.0114 – 0.0117)/0.0117 = -2.5%
• S(P/B) * Price(B)/Price(P) = Real Exchange Rate
Spot (INR/USD) = 70; Spot (PKR/USD) = 100
Mr. Jon is an American, and he can buy a burger at 5 USD
If He takes 5 USD India then he’ll get = 5*70 = 350 INR; In India each
burger is sold at 100 INR;
With 5USD or 350 INR Jon will be able to buy 3.5 units of burgers in
India; real exchange (INR/USD) =3.5
If He takes 5 USD PAK then he’ll get = 5*100 = 500 PKR; In PAK each
burger is sold at 250 PKR;
With 5USD or 500 PKR Jon will be able to buy 2 units of burgers in
PAK; real exchange (PKR/USD) =2
Real Exchange Rate = S(P/B) * Price(B)/Price(P) =
Real Exchange (INR/USD) = 70 * 5/100 = 3.5
Real Exchange (PKR/USD) = 100 * 5/250 = 2
 Direct/Indirect Quote
• In Bangladesh, if BDT is numerator and foreign
currency is denominator then it’s a direct
quote. BDT/USD = 84
• Indirect quote USD/BDT = 0.012
– In USA this will direct in USA
• Never use increase or decrease while
describing currency movement
Example
• All else equal, an increase in the nominal AUD/HKD exchange rate will
lead to an increase in the AUD-denominated value of your foreign
investment (True/False)
• All else equal, an increase in the nominal AUD/HKD exchange rate
means your relative purchasing power for your Hong Kong trips will
increase (based on paying for your trip from the income from your HKD
–denominated bonds)(True/False)=false
• All else equal, an increase in the nominal AUD/HKD exchange rate
means your relative purchasing power for your Hong Kong trips will
increase (based on paying for your trip from the income from AUD
currency)(True/False) = false

• All else equal, an increase in the Australian inflation rate will lead to an
increase in the real exchange rate (AUD/HKD). A higher real exchange
rate means that the relative purchasing power HKD income is higher if
you spend in Australia (True/False)
 Rough
• Nominal (BDT/USD) = 85>84,83,82
• 100, in BD 8600
• Real (AUD/HKD) = S (AUD/HKD) * Price
(HKD)/Price (AUD) = if denomintor goes up
then answer will go down.
• All else equal, a decrease in the nominal exchange rate
(AUD/HKD) will decrease the real exchange rate (AUD/HKD) and
increase the relative purchasing power of your AUD-
denominated income from HKD invest. What about the power
of AUD as a currency?
Suppose, exchange rate AUD/HKD goes up by 5%, price level in
Australia goes up by 2% and price level Hong Kong increase by 5%:
– Based on the advisor’s scenario and assuming that the HKD value of
the HKD bonds remained unchanged , the nominal AUD value of the
client’s HKD investment would? They want to know whether the
amount you’ll get from the HKD investment in AUD will go up or down?
– Based on the advisor’s scenario, the change in the relative purchasing
power of the client’s HKD bond income in Australia is closest to?
• SPOT (AUD/HKD) = high or low = 10 , 12
• SPOT (BDT?USD) = 85, 86, 87if exchnage rate
goes up it means price currency has weakened

She’s scared that exchange rate might go down.

B/U = 85>>>>>>>82, 83.84.80,81, 86, 87, 88,90
After a year at a trading point, he’ll buy USD at 84
Sales =100 USD; in BD, 8500 >>>>>8400
 Solution to forward problem
• Spot (AUD/HKD) = 0.1429/1
• Investment in HK @7%
• She’s afraid that HKD might depreciate a lot. If that happens she’ll loose money. Hence, she got into a
forward contract, to buy AUD at a fixed rate in the future.
• Forward (AUD/HKD) = 0.1402
• Even if HKD for some reason actually becomes stronger, the lady will have to buy @ forward rate.
• Let’s say the AUS lady has 100 AUD to invest in HK. How many HKD can she buy with 100 AUD:
100/0.1429 = 700 HKD
• She invested this 700 HKD in a bond @7%; therefore in 1 year what will be her total return: 700
(1+0.07)^1 = 749HKD
• ).1429??NO NO;; now as she went to forwared contract she has to exchnage HKD with that forward
rate; 749*0.1402 = 105 AUD
• Now she’ll convert the 749 HKD to AUD = 749 * 0.1402 = 105 AUD
• Investmet return in AUD = (105-100)/100 = 5% return
• Hypothetically, if she hadn’t gone for the forward contract and let’s say the spot @ year 1 remained the
same as now:
– 749*0.1429 = 107
– Return: (107 -100)/100 = 7%
1. To reduce exchange rate risk of HK investment, client should:
a) Sell AUD spot
b) Sell AUD forward
c) Sell HKD forward
2. Over a one-year horizon, the investment proposed by the investment advisor is
most likely:
a) Risk-free
b) Exposed to interest rate risk
c) Exposed to exchange rate risk
3. To set up the investment proposed by the advisor, the client would need to:
a) Sell AUD spot; sell a one year, HKD denominated bond; and buy AUD forward
b) Buy AUD spot; buy a one year, HKD denominated bond; and sell AUD forward
c) Sell AUD spot; buy a one year, HKD denominated bond; and buy AUD at forward rate
4. The return (in AUD) on the investment proposed by the investment advisor is
closest to:
a) 5%
b) 6%
c) 7%
• HEDGING VS Arbitrage VS Speculation

Hedge her risks: her objective was to reduce risk.

Home Insurance Plan: if the home is damaged you’ll get
reembursement.
– Corresponding insurance premium 7%
– If you want this 7% to recover, your house must catch fire.
– If you look at profit>>>>>you would want your house to be
on fire.
–
• Arbitrage:
– Taking quick buy and sell position in different markets if ncessary.
– Efficiency level goes down…..USA: 10>>>>>UK: 12
• Buy @10 in USA and sell @12 in UK
– You go in quick and go out quick
– Market has invisible hand>>>>>UK: 12>>>>10
– BD:5 >>> vs IND: 7<<<<<<<
• 100 *2 = 200
• 1,000,000*2 = 2,000,000
• Total APPLE outstanding 1 trillion apples: Market CAP 2 trillion USD>>>>>>INFLATION
• GDP 320 billion 80>>>>>>incerases price>>>>>.inlation
• HUGE Possbility inflation>>>>>> crypto
– DOGE meme>>>>>0.5
– Interest rate increase: save more money in banks
» High intererst >>>>loan cost high>>>>cost of doing business high>>>>capital is more expensive>>>>>
• Speculation:
– Buy low and sell high
 Appreciation and Depreciation
Example:
• BDT/USD = 84/1 (year 1)
• In year 2, BDT/USD = 87/1 (year 2)
• Looks like USD appreciated: 87 -84/84 = 3.57%
• However, if USD has appreciated, the BDT has depreciated. How
much? Not 3.57%
• We always express any movement based on the base currency.
Although BDT has depreciated, but in order for us to know how
much, we have t bring BDT to the base and then do the calculation.
• USD/BDT: Y1 = 0.0119; Y2= 1/87 = 0.0115
• Now let’s calculate = 0.0115 -0.0119/0.0119 = -3.36%
• Foreign exchange transactions for spot settlement see the most trade
volume in term of average daily turnover because the FX market is
primarily focused on settling international trade flows

• The most important FX market participants on the buy side are

corporations engaged international trade; on the sell side they are local
banks that service their local FX needs.
 Cross Exchange Rate
Let’s say, in both BD and India
BDT/USD and INR/USD
BDT/INR (there’s market exchange rate between BDT and INR).
However, you can also calculate a relative exchange rate (which
is not quoted in mkt.) by comparing the relative relation of both
BDT and INR with a common currency.
BDT/USD = 86; INR/USD = 70;
Spot BDT/INR = 1.15 (market)
What is cross exchnage rate of BDT/INR based on b/u and I/U:
BDT/USD = 86; INR/USD = 70 reverse : USD/INR = 1/70
BDT/USD * USD/INR = 86* 1/70 = BDT/INR = 1.23
 Practice
• What is the Spot
CHF/EUR?
• What is the Spot
GBP/EUR?
• Is the EUR expected
to appreciate or
depreciate against the
USD? By how much
• Which currency is
expected to be the
strongest?
 Solution
• USD/EUR =1.3960
• CHF/USD = 0.9585
• USD/GBP = 1.5850; inverse of spot = GBP/USD = 1/1.5850
• CHF/EUR
– USD/EUR * CHF/USD =CHF/EUR = 1.3960*0.9585 = 1.338066
• GBP/EUR = GBP/USD * USD/EUR = GBP/EUR =
– =*1/1.5850) *1.3960 = 0.88075

– USD<EUR; CHF >USD ; EUR vsCHF; EUR >CHF

– GBP>USD
– GBP vs EUR?
– GBP> EUR