Tiêu đề LM01 Currency Exchange Rates IFT Notes.pdf ✅

LM01 Currency Exchange Rates 2023 Level II Notes © IFT. All rights reserved 1 LM01 Currency Exchange Rates: Understanding Equilibrium Value 1. Introduction ...................................................................................................................................................... 3 2. Foreign Exchange Market Concepts ......................................................................................................... 3 3. Arbitrage Constraints on Spot Exchange Rate Quotes ...................................................................... 4 4. Forward Markets ............................................................................................................................................. 8 5. The Mark- to- Market Value of a Forward Contract........................................................................10 6. A Long- Term Framework for Exchange Rates .................................................................................14 6.1 International Parity Conditions .......................................................................................................14 7. Covered Interest Rate Parity, Uncovered Interest Rate Parity, & Forward Rate Parity ...14 7.1 Uncovered Interest Rate Parity .......................................................................................................15 7.2 Forward Rate Parity .............................................................................................................................15 8. Purchasing Power Parity ...........................................................................................................................18 9. The Fisher Effect, Real Interest Rate Parity and Tying the International Parity Conditions Together ...............................................................................................................................................................19 9.1 International Parity Conditions: Tying All the Pieces Together .........................................20 10. The Carry Trade .........................................................................................................................................22 11. The Impact of Balance of Payments Flows: Current Account Imbalances and the Determination of Exchange Rates ..............................................................................................................24 11.1 Current Account Imbalances and the Determination of Exchange Rates .....................24 12. Capital Flows and the Determination of Exchange Rates and Equity Market Trends and Exchange Rates ..................................................................................................................................................25 13. Monetary and Fiscal Policies .................................................................................................................28 13.1 The Mundell–Fleming Model .........................................................................................................29 13.2 Monetary Models of Exchange Rate Determination..............................................................30 13.3 The Portfolio Balance Approach ...................................................................................................32 14. Exchange Rate Management: Intervention and Controls ..........................................................34 15. Warning Signs of a Currency Crisis.....................................................................................................35 Summary ..............................................................................................................................................................38 This document should be read in conjunction with the corresponding reading in the 2023 Level II CFA® Program curriculum. Some of the graphs, charts, tables, examples, and figures are copyright 2022, CFA Institute. Reproduced and republished with permission from CFA Institute. All rights reserved. Required disclaimer: CFA Institute does not endorse, promote, or warrant the accuracy or quality of the products or services offered by IFT. CFA Institute, CFA®, and Chartered Financial Analyst® are trademarks owned by CFA Institute.
LM01 Currency Exchange Rates 2023 Level II Notes © IFT. All rights reserved 2 Version 1.0
LM01 Currency Exchange Rates 2023 Level II Notes © IFT. All rights reserved 3 1. Introduction Exchange rates usually follow a random walk, i.e., fluctuations from one day to the next are unpredictable. Therefore, forecasting exchange rate movements can be a difficult task. This reading focuses on tools one can use to understand exchange rates and their long-term equilibrium value. 2. Foreign Exchange Market Concepts An exchange rate is the price of the base currency expressed in terms of the price currency. For example, a USD/EUR rate of 1.3650 means the euro, the base currency, costs 1.3650 US dollars. Although different conventions can be used to express exchange rates, the curriculum (and exam questions) follows the Price Currency and Base Currency convention, “P/B”. Instructor’s Note: Remember ‘base’ in the ‘base’. Currency quotes in the foreign exchange market are two sided; each quote has both a bid price and an offer price. The bid price represents the price at which the dealer is willing to buy the currency and the offer price represents the price at which the dealer is willing to sell the currency. Hence, a USD/EUR exchange rate of 1.3646/1.3651 means that the dealer is willing to buy one euro for USD 1.3646 and sell one euro for USD 1.3651. The offer price is also referred to as the “ask” price. Instructor’s Note: Remember ‘b’ for ‘bid’ and ‘b’ for ‘buy’. Most currencies are quoted to four decimal places, and one 'pip' is equal to 0.0001. The bid- offer spread in our example is 1.3651 – 1.3646 = 0.0005 = 5 pips. Some currencies are quoted to two decimal places, here one pip = 0.01 (for example, Japanese Yen). The offer price is always higher than the bid price because the dealer seeks a compensation for providing foreign exchange to the market participants. The participant who receives the quote has the option (but not the obligation) to either sell the currency at the dealer’s bid price or buy the currency at the dealer’s offer price. Factors that Affect Bid-Offer Spread The size of the bid-offer spread that the dealer quotes to clients can vary depending on different factors. These factors are discussed below. Primary Factors 1. The currency pair involved: Liquidity in major currency pairs such as USD/EUR, JPY/USD, and USD/GBP is generally higher than that in less popular pairs. Therefore, major currency pairs have lower spreads. 2. The time of the day: The interbank market is most liquid when major trading centers are open. Hence, liquidity would be higher when London and New York, two of the largest
LM01 Currency Exchange Rates 2023 Level II Notes © IFT. All rights reserved 4 trading centers, are open at the same time. 3. Market volatility: If market volatility is high, market participants will charge a higher price for taking on risk, leading to high bid-offer spreads. Secondary Factors 1. The size of the transaction: The larger the transaction size, the wider the bid-offer spread. This is because the dealer is taking larger FX risk and seeks compensation in the form of wider spreads. 2. The relationship between the dealer and the client: Dealers often offer more than just foreign exchange related services to clients. In order to secure regular business from the client in foreign exchange as well as in other asset classes, the dealer may offer tight bid-offer spreads. 3. Client’s credit profile: If the client has poor credit history, the dealer may offer a wider bid-offer spread. 3. Arbitrage Constraints on Spot Exchange Rate Quotes There are two primary constraints on spot exchange rate quotes: 1. The dealer bid cannot be higher than the interbank offer: We shall call this scenario DBi G IO (dealer bid greater than interbank offer). If the dealer's bid quote is higher than the interbank offer quote, then market participants can buy in the interbank market and sell to the dealer to make a riskless profit. For example, if the JPY/USD quote by the dealer is 100.50/100.60 and in the interbank market the quote is 100.40/100.45, then the participant can buy the base currency (USD) at 100.45 in the interbank market and sell at 100.50 to the dealer to make an arbitrage profit of JPY 0.05 per USD. 2. The dealer offer cannot be lower than the interbank bid: We shall call this scenario DO L IB (dealer offer lower than interbank bid). If the dealer offer is less than the interbank bid, the market participant can buy from the dealer and sell in the interbank market. For example, if the JPY/USD quote by the dealer is 100.50/100.60 and in the interbank market the quote is 100.70/100.75, then the market participant can buy the base currency (USD) from the dealer at 100.60 and sell in the interbank market at 100.70 to make an arbitrage profit of JPY 0.10 per USD. Understanding Cross Rates Assume A, B and C are three different currencies. We are given a quote for A/B and B/C and we wish to obtain a quote for A/C. The implied A/C can be derived using the A/B and the B/C rates. This is demonstrated by the simple expression that: