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FINS3616
International Business Finance
Note: These notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS3616
International Business Finance for Term 3,2023. Reproduction, distribution and re-use of these notes outside the scope of the course, in any
way, shape or form is strictly prohibited.
Note: These notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS3616 International
Business Finance for Term 3,2023. Reproduction, distributio d r -us of thes n tes outsid the cop f t e course, in any way, shape or form
is strictly prohibited.
Note: These notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS3616 International
Business Finance for Term 3,2023. Reproduction, distribution and re-use of these notes outside the scope of the course, in any way, shape or
form is strictly prohibited.
The Foreign Exchange (FX) Market
Note: These notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS3616 International
Business Finance for Term 3,2023. Reproduction, distribution and re-use of these notes outside the scope of the course, in any way, shape or
form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or individual,
however defined, if these notes are used in valuations or providing investment advice for private or commercial purposes.
The Foreign Exchange Market
- The foreign exchange market is the de-centralised space where all currencies are
traded.
- The FX market facilitates the purchasing power denominated in one currency to be
obtained. For example, an individual sells USD for Chinese Renminbi, that individual
is selling USD-denominated purchasing power and buying Renminbi-denominated
purchasing power.
- Approximately 95% of currency transactions are channeled through the interbank
market. The interbank market is normally referred to as the FX market. Approximately
20 banks dominate the interbank market.
- Trading is done via the Society for Worldwide Interbank Financial Telecommunications
(SWIFT). Swift links 11,000 banks and institutions in more than 200 countries.
- The wholesale market is where the major banks trade – Operates from major financial
cities: e.g. London, New York, Tokyo, 24 hours/day.
Note: These notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS3616 International
Business Finance for Term 3,2023. Reproduction, distribution and re-use of these notes outside the scope of the course, in any way, shape or
form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or individual,
however defined, if these notes are used in valuations or providing investment advice for private or commercial purposes.
The Size of the Foreign Exchange Market
Source: BIS, Savills, Sifma and others. Please email me if you’d like the exact source links.
Note: These notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS3616 International
Business Finance for Term 3,2023. Reproduction, distribution and re-use of these notes outside the scope of the course, in any way, shape or
form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or individual,
however defined, if these notes are used in valuations or providing investment advice for private or commercial purposes.
Contracts Traded on the Foreign Exchange Market
Contracts traded on the FX market are:
- Spot contracts: Currencies traded for immediate delivery. Immediate delivery
officially means the currencies are traded literally within two business days following
the concluding of the transaction.
- Forward contracts and futures: Buying or selling currencies for future delivery.
- Swap contracts: a combination of a spot contract and forward contract.
- Derivatives: contracts that derive value from changes in the underlying asset’s value.
Note: These notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS3616 International
Business Finance for Term 3,2023. Reproduction, distribution and re-use of these notes outside the scope of the course, in any way, shape or
form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or individual,
however defined, if these notes are used in valuations or providing investment advice for private or commercial purposes.
Foreign Exchange Rate Quotations
- When the trading of currencies involves the USD, quotations can be on:
- There are two ways in which foreign currency exchange rates are quoted:
American Terms
Number of USD per unit
of foreign currency.
For example: the AUD
rate in American terms:
USD 0.75/AUD.
European Terms
Number of foreign
currency units per USD.
For example:
AUD1.333/USD.
Direct Quote
Direct AUD quote in
Australia is the number of
AUD per USD
Indirect Quote
Indirect AUD quote in
Australia is the number of
USD per AUD.
Note: These notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS3616 International
Business Finance for Term 3,2023. Reproduction, distribution and re-use of these notes outside the scope of the course, in any way, shape or
form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or individual,
however defined, if these notes are used in valuations or providing investment advice for private or commercial purposes.
Participants in the FX Market
- Foreign exchange dealers
oMajor commercial and investment banks
oMarket makers: actively dealing in foreign exchange for their own accounts.
- Foreign exchange brokers:
o Intermediaries: match supplier and demander banks
oReceive commission on trades.
- Other participants:
oMultinational corporations
oCentral banks
oPrivate individuals
Note: These notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS3616 International
Business Finance for Term 3,2023. Reproduction, distribution and re-use of these notes outside the scope of the course, in any way, shape or
form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or individual,
however defined, if these notes are used in valuations or providing investment advice for private or commercial purposes.
Bid Exchange Rate and Ask Exchange Rate
- In practice there is no such thing as “the exchange rate”.
- When market participants buy and sell one currency for another, they will see a bid
exchange rate and an ask exchange rate. For example:
- The bid rate is the ______ that the market maker is willing to pay for the ______
currency.
- The ask rate is the ________ that the market maker is willing to pay for the ______
currency.
- The reciprocal of the AUD bid rate is _____________________.
- The reciprocal of the AUD ask rate is _____________________.
Bid Ask
Spot Rate USD0.768/AUD USD0.774/AUD
Note: These notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS3616 International
Business Finance for Term 3,2023. Reproduction, distribution and re-use of these notes outside the scope of the course, in any way, shape or
form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or individual,
however defined, if these notes are used in valuations or providing investment advice for private or commercial purposes.
Bid Rate and Ask Rate
- The magnitude of the bid-ask spread depends on:
o currency’s market size,
o volatility of currency values, and
omarket uncertainty
- What is the implication of market uncertainty? Forward spreads > Spot spreads.
Why do we have bid exchange rates and ask exchange rates for currencies?
Note: These notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS3616 International
Business Finance for Term 3,2023. Reproduction, distribution and re-use of these notes outside the scope of the course, in any way, shape or
form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or individual,
however defined, if these notes are used in valuations or providing investment advice for private or commercial purposes.
Bid-Ask Exchange Rate Spread – Example 1
- Suppose we have the following spot exchange rates between the GBP and the USD:
USD1.2022−31/GBP
- The bid spot rate will be: USD1.2022/GBP.
- The ask spot rate will be: USD1.2031/GBP.
- The percentage spread is expressed (in the course textbook) as:
=
−
× 100
- In the example above, the bid-ask spread will be:
=
1.2031/GBP − 1.2022/GBP
1.2031/GBP
× 100 = 0.075%
Note: These notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS3616 International
Business Finance for Term 3,2023. Reproduction, distribution and re-use of these notes outside the scope of the course, in any way, shape or
form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or individual,
however defined, if these notes are used in valuations or providing investment advice for private or commercial purposes.
Cross Exchange Rate – Example 1
- The cross exchange rate is also known as the ‘cross currency triangulation’. The cross
exchange rate arises from the fact that most currencies are not traded against one
another in the interbank market. In other words, it relates to foreign currency
exchanges not involving the USD.
- Another way of seeing this is the exchange rate between two currencies is based on
the exchange rate between each of these two currencies and a third currency, usually
the USD.
- For example: USD1.53/EUR and USD0.96/CHF. What is the CHF/EUR exchange
rate?
=
1
0.96
×
1.53
1.04167
×
1.53
=
1.59375
Note: These notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS3616 International
Business Finance for Term 3,2023. Reproduction, distribution and re-use of these notes outside the scope of the course, in any way, shape or
form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or individual,
however defined, if these notes are used in valuations or providing investment advice for private or commercial purposes.
Cross Exchange Rate – Example 2
- You are at the foreign exchange market in New York, where the spot rates for the
Renminbi (RMB) and AUD are quoted at RMB8.522/USD and AUD1.371/USD,
respectively. What is the RMB/AUD spot rate?
Note: These notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS3616 International
Business Finance for Term 3,2023. Reproduction, distribution and re-use of these notes outside the scope of the course, in any way, shape or
form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or individual,
however defined, if these notes are used in valuations or providing investment advice for private or commercial purposes.
Triangular Arbitrage
- Triangular currency arbitrage profiting from exchange rate inconsistencies or
mispricing across money markets involving three currencies.
- In equilibrium, we must have:
/ = / × /
/ × / × / = 1
- If the product of the 3 exchange rate quotations is ≠ 1, then the law of one price
(LOOP) is not satisfied and profit can be made through arbitrage.
Note: These notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS3616 International
Business Finance for Term 3,2023. Reproduction, distribution and re-use of these notes outside the scope of the course, in any way, shape or
form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or individual,
however defined, if these notes are used in valuations or providing investment advice for private or commercial purposes.
Triangular Arbitrage – Example 1
- Suppose you observe the exchange rates for AUD, USD, and CNY:
1.282/
4.03/
0.21/
- Can we make a riskless profit from these quotations? We need to first establish
whether the law of one price (LOOP) holds.
1.282/ × 4.03/ × 0.21/ = 1.085 > 1
Strategy to exploit the disparity:
1. Sell 1 USD for 1.282 AUD
2. Then sell 1.282 AUD for 5.16646 CNY ( = 1.282 x 4.03)
3. sell 5.16646 CNY for 1.085 USD ( = 5.16646 x 0.21)
You have earned 1.085 USD – 1 USD = 0.085USD.
Note: These notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS3616 International
Business Finance for Term 3,2023. Reproduction, distribution and re-use of these notes outside the scope of the course, in any way, shape or
form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or individual,
however defined, if these notes are used in valuations or providing investment advice for private or commercial purposes.
Triangular Arbitrage – Example 2 (For You)
- Suppose you observe the exchange rates for JPY, EUR, and THB:
138.06/
0.26/
38.84/
- Can we make a riskless profit from these quotations? We need to first establish
whether the law of one price (LOOP) holds.
What do you obtain if
you take the
reciprocal of the
product of the three
prices?
Note: These notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS3616 International
Business Finance for Term 3,2023. Reproduction, distribution and re-use of these notes outside the scope of the course, in any way, shape or
form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or individual,
however defined, if these notes are used in valuations or providing investment advice for private or commercial purposes.
Triangular Arbitrage – Stylised Visual
Shapiro textbook page 270. 10th Edition
Note: These notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS3616 International
Business Finance for Term 3,2023. Reproduction, distribution and re-use of these notes outside the scope of the course, in any way, shape or
form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or individual,
however defined, if these notes are used in valuations or providing investment advice for private or commercial purposes.
Triangular Arbitrage with Bid-Ask Rates – Example 1
- What is the arbitrage opportunity?
Direction 1 around the “triangle”:
- Sell GBP and buy USD at
- Sell USD and buy MYR at
- Sell MYR and buy GBP at
Bid Rate Ask Rate
USD1.60/GBP USD1.61/GBP
USD0.200/MYR USD0.201/MYR
MYR8.10/GBP MYR8.20/GBP
- Thus, the return obtained is:
GBP
USDMYR
Note: These notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS3616 International
Business Finance for Term 3,2023. Reproduction, distribution and re-use of these notes outside the scope of the course, in any way, shape or
form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or individual,
however defined, if these notes are used in valuations or providing investment advice for private or commercial purposes.
Triangular Arbitrage with Bid-Ask Rates – Example 1
- What is the arbitrage opportunity?
Direction 2 around the “triangle”:
- Sell GBP and buy MYR at
- Sell MYR and buy USD at
- Sell USD and buy GBP at
Bid Rate Ask Rate
USD1.60/GBP USD1.61/GBP
USD0.200/MYR USD0.201/MYR
MYR8.10/GBP MYR8.20/GBP
- Thus, the return obtained is:
GBP
USDMYR
Note: These notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS3616 International
Business Finance for Term 3,2023. Reproduction, distribution and re-use of these notes outside the scope of the course, in any way, shape or
form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or individual,
however defined, if these notes are used in valuations or providing investment advice for private or commercial purposes.
Triangular Arbitrage with Bid-Ask Rates – Example 1
- What does the comparison of the implied bid and ask rates to the quoted bid and ask
rates (for a selected currency pair) reveal?
Bid Rate Ask Rate
USD1.60/GBP USD1.61/GBP
USD0.200/MYR USD0.201/MYR
MYR8.10/GBP MYR8.20/GBP
Note: These notes are property of the author (Mohamad Mourad). They are for the exclusive use of students enrolled in FINS3616 International
Business Finance for Term 3,2023. Reproduction, distribution and re-use of these notes outside the scope of the course, in any way, shape or
form is strictly prohibited. The author and UNSW bear no responsibility for any loss, injury or claims made by any party, entity or individual,
however defined, if these notes are used in valuations or providing investment advice for private or commercial purposes.
Triangular Arbitrage with Bid-Ask Rates – Example 2
- The following table contains the spot rates for selected currencies. Determine whether
a riskless arbitrage opportunity exists. If one does exist, then what is the profit made?
- You are to show calculations for both ways around the triangle and also the implied
spread approach.
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