International Payment 2022 Chapter 1-SV

November 4, 2022 Foreign Trade University, HCM city campus
INTERNATIONAL PAYMENT
1
PART ONE: FOREIGN EXCHANGE RATE- OBJECTIVES
November 4, 2022
➢ Foreign Exchange
➢ Exchange Rate
Exchange Rate Quotation
Foreign Trade University, HCM city campus

➢
➢ Cross Exchange Rate
➢ Determinants of Exchange Rate Fluctuations
➢ Types of Foreign Exchange Rates
➢ Methods of Exchange Rate Adjustment
➢ Foreign Exchange Market
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I. FOREIGN EXCHANGE
November 4, 2022
 Foreign Exchange (FX) includes all payment means that are
used in international settlements.(financial assets)

 The FX comprises:
• Foreign currencies
• Financial instruments denominated in foreign currencies
• Standard Gold
• The domestic currency held by non-residents
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ORDINANCE ON FOREIGN EXCHANGE CONTROL
ARTICLE 4
November 4, 2022
 1. Foreign exchanges comprises:
 (a) Currencies of other nations or the common European currency and
other common currencies used in international and regional payments

(hereinafter referred to as foreign currency);
 (b) Foreign currency payment instruments, cheques, credit cards, bills
of exchange, promissory notes and other payment instruments;
 (c) All types of valuable papers denominated in foreign currencies
including Government bonds, corporate bonds, term bonds, shares and
other valuable papers;
 (d) Gold belonging to the foreign exchange reserves of the State, gold
in overseas’ accounts of residents, and gold in the form of bullion,
bars, granules and plate which is brought into or taken out of the
territory of Vietnam;
 (dd) The currency of the Socialist Republic of Vietnam in cases where
it is remitted into or out of the territory of Vietnam or used as an 4
instrument for international payments.
II. FOREIGN EXCHANGE RATE: DEFINITION
November 4, 2022
 Exchange rate is conversion price for exchange one currency for
another (Dictionary of Banking Terms, Barrons)
 Rate of Exchange or Exchange Rate is price at which one

currency is exchanged for another (Dictionary of Banking and
Finance, Peter Collin)
 The Exchange Rate is simply the price of one currency in terms
of another (Keith Pibean, International Finance)
 Exchange Rate is the price of one country’s currency in units of
another currency or commodity (typically gold or silver) (David
K. Eiteman, Multinational Business Finance)
 The price of one currency in terms of another is called the
exchange rate (Federic S. Minskin, The Economics of Money,
Banking and Financial Markets) 5
FOREIGN EXCHANGE RATE (CONT.)
November 4, 2022
 The nature of exchange rate is the correlation of purchasing
power between currencies and is price in which currencies can
exchange of the others. (Financing Academy, International

Finance)
 Exchange Rate of VND is price of one unit of foreign currency
in units of VND (Law of the State Bank of Vietnam, 2010)
 Exchange Rate of the price of one unit of foreign currency in
terms of units in domestic currency, i.e foreign currency is
commodity currency and domestic currency in terms currency. In
other words, exchange rate is the number of units of domestic
currency in terms of one unit of foreign currency
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THE HISTORY OF EXCHANGE RATE
November 4, 2022
 The Classical Gold Standard
 The Collapse of the Gold Standard

 The Bretton Woods System
 Our Current Floating-Rate System
 What is the choice of Exchange Rate System?
7
GOLD STANDARD AND ITS RULES
November 4, 2022
 From ancient time to modern time, international trade operated
on the basis of “Commodity Standard”, among commodity,
metal was the main commodity, they were casted into bullions

which functioned as a medium of exchange and were circulated
in the economy.
8
THE CLASSICAL GOLD STANDARD
November 4, 2022
 A government would define a unit of its currency unit as worth
such-and-such an amount of gold. It would stand ready to buy or
sell its currency for gold at that price at anytime, in any amount.
Such a currency was convertible, for it could be converted into

gold freely (and gold could be converted into it freely).
 The currency’s price in terms of gold was its parity (the fixed
exchange rate system- the gold standard- gold parity)
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November 4, 2022
 At the post-WWII parities of the Bretton Woods “gold
exchange” standard:

 the US dollar (1/35 of a troy ounce of gold)
 The British pound sterling (1/15.58333 ounce of gold)
 Thus the exchange rate of the dollar for the pound was £1 =
$2.40
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THE COLLAPSE OF THE GOLD STANDARD
November 4, 2022
 The international gold standard was suspended when WWI
began in 1914.

 It took more than half a decade to full restore the gold standard.
But the revived gold standard did not produce prosperity.
Instead, in less than half a decade the Great Depression began,
and the restored gold standard broke apart
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THE BRETTON WOOD SYSTEM
November 4, 2022
 In ordinary times, exchange rates should be fixed: Fixed exchange rates
encourage international trade by making the prices of goods made in a
foreign country predictable, and so have powerful advantages.

 In extraordinary times: whenever a country find itself in recession with
a significantly overvalued currency that discouraged its exports, or
found itself suffering from inflation because an undervalued currency
raised the prices of imports and stimulated export demand- exchange
rates should be changed. Such “fundamental disequilibrium” could and
should be corrected by revaluating or devaluating the currency.
 An institution was needed- the International Monetary Fund (IMF)- to
watch over the international financial system.
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OUR CURRENT FLOATING-RATE SYSTEM
November 4, 2022
 Since the early 1970s the exchange rates at which the currencies
of the major industrial powers trade against each other have been
“floating” rates. The exchange rate is fixed by the government,

but fluctuates according to the balance of demand and supply on
that day in the foreign exchange market.
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SOME CONCEPTS
November 4, 2022
 Domestic (internal) purchasing power is the quantity of goods
bought by one unit of domestic currency in the domestic market.

 Domestic purchasing power changes through times and depends
on the inflation rate of domestic currency
 If the inflation rate is positive (+), the currency depreciates
compared to goods.
 If the inflation rate is negative (-), the currency appreciates
compared to goods.
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SOME CONCEPTS
November 4, 2022
 International (external) purchasing power is the quantity of
goods bought in the international market when one unit of
domestic currency is converted to foreign currency.

 International purchasing power changes through times and
depends on the exchange rate and inflation rate abroad.
 Because the goods prices change slowly and inconsiderably
while the exchange rates fluctuate rapidly and significantly, we
suppose goods prices are unchanged in the research period.
 Thus, the international purchasing power of one currency
increases when exchange rate falls and vice versa, international
purchasing power decreases when exchange rate rises.
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November 4, 2022
 In fact, when comparing the purchasing power parity between
two currencies, we do not compare the purchasing power of each
separate commodity; instead, we compare the purchasing power

of a similar basket of standard goods in domestic and
international market.
 Purchasing Power Parity is the rate of exchange between two
currencies at which the quantities of goods bought in each
market are the same when a unit of domestic currency is
converted to foreign currency and vice versa.
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ECONOMIC THEORIES OF EXCHANGE RATE DETERMINATION
 Exchange rates in the long run:
November 4, 2022
➢ The law of one price: in competitive markets free of
transportation costs and barriers to trade (such as tariffs),
identical products sold in different countries must sell for the

same price when their prices is expressed in terms of the same
currency
➢ The theory of purchasing power parity (PPP): if the law of one
price were true for all goods and services, the purchasing power
parity (PPP) exchange rate could be found from any individual
set of prices.
▪ By comparing the prices of identical products in different
currencies, it would be possible to determine the ‘real” or PPP
exchange rate that would exists if markets were efficient.
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November 4, 2022
 Exchange rates in the long run: The price of a “basket of goods”
should be roughly equivalent in each country. Exchange rates will
adjust to reflect changing price levels.

 P$: the U.S dollar price a basket of particular goods and P¥:the price
of the same basket of goods in Japanese yen. The PPP theory predicts
that the dollar/ yen exchange rate should be equivalent to:
E$/¥ = P$/ P¥
• Example: The exchange rate will change if relative prices change.
Imagine there is no price inflation in the U.S, while prices in Japan are
increasing by 10% a year. More precisely, by the end of the year:
E$/¥ = P$/ (P¥ + 10% P¥)
 Shortcomings of the theory of PPP
 Assumes all goods are identical in both countries
 Trade barriers and transportation costs are low
 Many goods and services are not traded across borders 18
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EMPIRICAL STATISTICS: PPP VS. EXCHANGE RATE
III. FOREIGN EXCHANGE RATE: QUOTATION
November 4, 2022
 Eg: USD1 = VND16800 ; GBP1 = USD1.9437
 Commodity Currency

 Quote/Terms Currency
Currency Code:
Currency IOS code Symbol

US dollar USD $
Euro EUR €
Japan Yen JPY ¥
Great Britain Pound GBP £
Vietnam Dong VND đ
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RATE QUOTATION
November 4, 2022
Foreign Exchange Rate In Vietnam In London
1 USD1 = VND16800 GBP1 = USD1.9437
2 1USD = 16800VND 1GBP = 1.9437USD

3 USD/VND16800 GBP/USD1.9437
4 16800VND/USD 1.9437USD/GBP
5 VND16800/USD USD1.9437/GBP
 Direct quotation: Exchange rate is the price of one unit of

foreign currency in terms of units of domestic currency
 Indirect quotation: Exchange rate is the price of one unit of
domestic currency in terms of units of foreign currency:GBP,
AUD, NZD, EUR and SDR
 The US follows both direct and indirect quotations; USD is 22
terms currency in the relation to the group of the five currencies.

FOREIGN EXCHANGE RATE: POINT
November 4, 2022
 A point always refers to one unit of the last digit of a
conventional quotation.

 Examples:
 1 USD = 1.3650 CHF ® 1 point: 0.0001 CHF
 1 GBP = 2.0005 USD ® 1 point: 0.0001 USD
 1 USD = 117.35 JPY ® 1 point: 0.01 JPY
 1 USD = 16,210 VND ®1 point: 1 VND
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FOREIGN EXCHANGE RATE: BID, ASK AND SPREAD
November 4, 2022
 Bid Rate is the rate at which the quoting bank is willing to buy
the commodity currency.

 Offer/Ask Rate is the rate at which the quoting bank is willing to
sell the commodity currency.
 Spread is the difference between the bid rate and the offer rate.
 For examples:
 In full writing: USD/VND = 15,010 – 15,020
 In abbreviation: USD/VND = 15,010/20
 In Practice: USD/VND = 10/20
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FOREIGN EXCHANGE RATE: SPREAD DEPENDS ON:
November 4, 2022
 The amount of currencies dealt
 The size or reputation of financial centre

 The volatility of currencies
 The frequency of currency in transactions
 Spread varies according to the different foreign exchange assets:

paper notes, cheques, promissory notes, credit cards, bank
transfers, etc.
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IV. FOREIGN EXCHANGE RATE: CROSS RATES
November 4, 2022
 Cross rate is the rate of two currencies derived from the third
one (or medium currency)

 Cross Exchange Rate is defined as an exchange rate between
two currencies, neither of which is the USD; in other words, the
exchange rate of two currencies which is derived from their rates
against USD is called cross rate, where USD plays the role as
the intermediate currency
 Example:
 USD/VND = 20,015- 20,025
 USD/ CNY = 6,1515 – 6,1525
 CNY/VND = ? Bid- Offer/ASK Rate 27

FOREIGN EXCHANGE RATE: CROSS RATE CACULATIONS
November 4, 2022
Example 1:
 USD/JPY = 117.90/94
 USD/CHF = 1.2567/72

 ASKc JPY/CHF = BIDbJPY/CHF = BIDb USD/CHF : ASKb
USD/JPY = 1.2567 : 117.94 = 0.010655

 BIDc JPY/ CHF = ASKb JPY/ CHF= ASKb USD/ CHF : BIDb
USD/ JPY = 1.2572 : 117.90 = 0.010663

Cho A/B; A/C
B/C = A/C : A/B
ASKc= BIDb = BIDb : ASKb
BIDc = ASKb =ASKb : BIDb
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November 4, 2022
 Example 2:
 EUR/ USD = 1.2645/48
 GBP/USD = 1.8793/98

 ASKcEUR/GBP= BIDbEUR/GBP= BIDbEUR/USD:
ASKb GBP/USD = 1.2645 : 1.8798 = 0.6726779

 BIDcEUR/GBP = ASKb EUR/GBP = ASKb EUR/USD : BIDb
GBP/USD = 1.2648 : 1.8793 = 0.6730165
Cho A/C; B/C

A/B = A/C : B/C
BIDc = ASKN = ASKN :BIDN
ASKc = BIDb = BIDb :ASKb 29
November 4, 2022
 Example 3:
EUR/USD = 1.2645/48
USD/CAD = 1.195/98

 BIDc EUR/ CAD = ASKb EUR/ CAD =ASKb EUR/USD ×
ASKb USD/CAD = 1.2648 × 1.1198 = 1.416323

 ASKc EUR/ CAD = BIDb EUR/ CAD = BIDb EUR/USD ×
BIDb USD/CAD = 1.2645 × 1.1195 = 1.415607
Cho A/B; B/C

A/C = A/B × B/C
BIDc = ASKb = ASKb× ASKb
ASKc = BIDb = BIDb × BIDb 30
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EXCHANGE RATES IN THE SHORT RUN
November 4, 2022
 An exchange rate is the price of domestic assets in
terms of foreign assets
 Using the theory of asset demand—the most important
factor affecting the demand for domestic (dollar) assets
and foreign (euro) assets is the expected return on these
assets relative to each other
Foreign Trade University, HCM city campus 17-33

INTEREST PARITY CONDITION
November 4, 2022
Ee
− Et
i =i −D F t +1
Et
 Capital mobility with similar risk and liquidity 
the assets are perfect substitutes
 The domestic interest rate equals the foreign
interest rate minus the expected appreciation of the domestic
currency
 Expected returns are the same on both domestic and foreign assets
 An equilibrium condition

DEMAND AND SUPPLY
FOR DOMESTIC ASSETS
November 4, 2022
 Demand
 Relative expected return
 At lower current values of the dollar (everything else equal), the quantity
demanded of dollar assets is higher
 Supply
 The amount of bank deposits, bonds, and equities in the U.S.
 Vertical supply curve

November 4, 2022 17-36 Trade University, HCM city campus
Foreign
Foreign
Foreign
Foreign
40
Foreign
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FOREIGN EXCHANGE RATE: FURTHER READING
November 4, 2022
 Investor Psychology and Bandwagon effects

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VI. EXCHANGE RATE CLASSIFICATIONS
November 4, 2022
 Spot rate
 Derivative rates

 Opening rate
 Closing rate
 Transfer rate
 Bank note rate
 Telegraphic transfer
 Mail rate
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EXCHANGE RATE CLASSIFICATIONS
November 4, 2022
 Official rate
 Black market rate

 Fixed rate
 Freely floating rate
 Managed Floating rate
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EXCHANGE RATE CLASSIFICATIONS
November 4, 2022
 Norminal exchange rate (NER)
 Real exchange rate (RER)

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VII. METHODS OF EXCHANGE RATE ADJUSTMENT
November 4, 2022
 Changes in Interest Rates: When domestic interes t rates rise due to
an expected increase in inflation, the domestic currency depreciates .

 Changes in the Money Supply: A higher domestic money supply
causes the domestic currency to depreciate
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Foreign Trade University,
November 4, 2022 17-48
HCM city campus
TOOLS OF EXCHANGE RATE POLICY
November 4, 2022
 Direct tools: devaluation, revaluation, the Central Bank
operations in the foreign exchange markets, surrender, restrictive
regulation

 Indirect tools: rediscount rate, tariff, quotas, price subsidies,
Required reserve adjustment on foreign currencies.
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November 4, 2022
 Devaluation: In the fixed exchange rate regime, a devaluation of
a currency refers to a drop in domestic currency’s value in
comparison with foreign currencies (made by the government).

The signal of devaluation is that exchange rate adjusted to
increase compared to that the government committed to
maintain. Exchange rate rises, leading to a decrease in domestic
currency’s value; therefore, it is called devaluation.
 Why does the government have to devalue domestic currency?
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November 4, 2022
 Revaluation: In the fixed exchange rate regime, a revaluation is
the activity of the government to increase the domestic
currency’s value in comparison with foreign currencies. The

signal of revaluation is exchange rate adjusted to decrease
compared to that the government makes a commitment to
maintain. Exchange rate falls, leading to a rise in the value of
domestic currency; therefore, it is called ‘revaluation”.
 Why does the government have to revalue domestic currency?
51
November 4, 2022
 The Central Bank operations on the foreign exchange markets
are related to maintain fixed exchange rate (in the fixed
exchange rate regime) or affect exchange rate fluctuate in the

positive manner for the economy (in the managed floating
exchange rate regime).
 To make an intervention, the Central Bank is required to have a
specific amount of official foreign exchange reserves.
52
November 4, 2022
 Surrender (Remittance): The government sets regulations to
force legal individuals and entities who have foreign exchange
income to sell a specific part of their income in a specific period

to those are allowed to participate in foreign exchange trading.
53
November 4, 2022
 Restrictive regulation: A measure that regulates who are permitted
to buy foreign currencies, the purposes of foreign currency used,
the quantity of purchasable foreign currencies, and the time to

purchase foreign currencies
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November 4, 2022
 Rediscount rate: Holding other things constant, when the Central
Bank raises rediscount rate, the average interest in the market
would be impacted to rise as an consequence. An increase in the

market interest will attract more foreign currency inflows,
leading to domestic currency appreciation.
 By contrast, a fall in discount rate would cause opposite effects
55
November 4, 2022
 Tariff: The high level of tariff is one of contributors to penalize
import which in turn brings about a decrease in the demand for
foreign currency. As a result, domestic currency is appreciated.

 Conversely, the low level of tariff will pose opposite effects
56
November 4, 2022
 Quotas: Like the hign level of tariff, quotas put the same effect
on exchange rate and penalize import. Removing quotas will
increase import, consequently affecting exchange rate like the

low level tarriff.
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November 4, 2022
 Price subsidies: Through the price system, the government can
subsidize strategic exports or exports in the first period of
production. Exports subsidies will encourage the quantitu of

exports and increase the supply of foreign currency, leading to
the domestic currency revaluation.
 The government also can compensate price of essential imports
that could encourage imports. As a result, this could lead to
domestic currency’s value decreased.
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November 4, 2022
 Required reserve adjustment on foreign currencies: When there is a
shortage of foreign currency in the foreign exchange market, the
Central Bank can increase the required reserve ratio on foreign

currency deposits of commercial banks, which helps increase the
cost of using foreign currency capital.
 To gain profits, commercial banks are forced to lower interest rate
of foreign currency deposits; therefore, holding foreign currency
becomes less attractive than holding domestic currency, which
motivates foreign currency owners to sell foreign currency in
exchange for domestic currency. This leads to an increase in the
supply of foreign currency in the foreign exchange market
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November 4, 2022
 Money is not, properly speaking, one of the subjects of
commerce; but only the instrument which men have agreed upon
to facilitate the exchange of one commodity for another. It is

none of the wheels of trade: It is the oil which renders the
motion of the wheels more smooth and easy. (David Hume, Of
Money (1752))
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VII. FOREIGN EXCHANGE MARKET
November 4, 2022
 The foreign exchange refers the organizational setting within which
individuals, businesses, governments, and banks buy and sell foreign
currencies and other debt instruments.

 The foreign-exchange market is by far the largest and most liquid
market in the world.
 Unlike stock or commodity exchanges, the foreign-exchange market
is not an organized structure. It has no centralized meeting place and
no formal requirements for participation. Foreign-exchange dealers
are in constant telephone and computer contact, the market is very
competitive; in effect, it functions no differently than if it were a
centralized market.
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 The foreign exchange market is a round-the-clock operation
THE FUNCTIONS OF THE FOREIGN EXCHANGE MARKET
November 4, 2022
 The first is to convert the currency of one country into the currency
of another.

 The second is to provide some insurance against foreign exchange
risk, by which we mean the adverse consequences of unpredictable
changes in exchange rates.
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TYPES OF FOREIGN EXCHANGE TRANSACTIONS
SPOT TRANSACTION
November 4, 2022
 A spot transaction is an outright purchase and sale of foreign currency
for cash settlement not more than two business days after the date the
transaction is recorded as a spot deal.

 The 2-day period is known as immediate delivery. By convention, the
settlement date is the second business day after the date on which the
transaction is agreed to by the two traders. The 2-day period provides
sample time for the two parties to confirm the agreement and arrange the
clearing and necessary debiting and crediting of bank accounts in
various international locations.
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WHAT IS A DERIVATIVE?
November 4, 2022
 A derivative is an instrument whose value depends on, or is
derived from, the value of another asset.

 Examples: futures, forwards, swaps, options, …
66
WHY DERIVATIVES ARE IMPORTANT
November 4, 2022
 Derivatives play a key role in transferring risks in the economy
 The underlying assets include stocks, currencies, interest rates,
commodities, debt instruments, electricity, insurance payouts, the
weather, etc
 Many financial transactions have embedded derivatives
 The real options approach to assessing capital investment decisions

has become widely accepted

67
HOW DERIVATIVES ARE TRADED
November 4, 2022
 On exchanges such as the Chicago Board Options Exchange
 In the over-the-counter (OTC) market where traders working for
banks, fund managers and corporate treasurers contact each
other directly

68
69
SIZE OF OTC AND EXCHANGE-TRADED MARKETS
November 4, 2022
(FIGURE 1.1, PAGE 3)
70
Source: Bank for International Settlements. Chart shows total principal amounts for OTC
market and value of underlying assets for exchange market

November 4, 2022
HOW DERIVATIVES ARE USED
 To hedge risks
 To speculate (take a view on the future direction of the
market)
 To lock in an arbitrage profit
 To change the nature of a liability
 To change the nature of an investment without incurring

the costs of selling one portfolio and buying another

71
FORWARD EXCHANGE CONTRACT
November 4, 2022
 A forward exchange contract is entered into between a bank and a
customer, the bank fixes the rate of exchange at which a foreign
currency will be bought or sold.

 The exchange rate may fluctuate during and at the time of maturity
but it will not have any affect on the forward contract agreed
between the bank and the customer. Through forward exchange
contracts both the importer and exporter know the exact amount of
their payables and receivable in foreign currency thereby covering
against fluctuation of any exchange rates during the period.
 Forward exchange contract is a legal contract to receive or deliver
foreign currency at the agreed date
72
November 4, 2022
 Forward rates apply to transactions for completion at an agreed future date
beyond two working days. The Forward Exchange rates can be “Fixed
Forward Rate” or “Option Forward Rate”.

 FIXED FORWARD EXCHANGE RATES is for receipt or delivery of a
foreign currency at a fixed date some time in the future i.e. after one month,
three month or six months etc.
 OPTION FORWARD EXCHANGE RATES is for the receipt or delivery of
a foreign currency sometime in the future between two agreed dates.
 For example an importer has to pay for goods in foreign currency and
wishes to enter into a three months forward contract with one month’s
option. Here the customer has the option to buy the foreign currency any
time during the third month. In this case the two dates in the future are after
the end of the second month and before the end of the third month from the
date of the forward contract 73
74
FORWARD TRANSACTION
November 4, 2022
 In many cases, a business or financial institution knows it will be
receiving or paying an amount of foreign currency on a specific date
in the future.

 For example, in August a U.S. importer may arrange for a special
Christmas-season shipment of Japanese radios to arrive in October.
The agreement with the Japanese manufacturer may call for payment
in yen on October 20. To guard against the possibility of the yen's
becoming more expensive in terms of the dollar, the importer might
contract with a bank to buy yen at a stipulated price, but not actually
receive them until October 20 when they are needed.
 When the contract matures, the U.S. importer pays for the yen with a
known amount of dollars. This is known as a forward transaction 75
FORWARD TRANSACTION
November 4, 2022
 Forward transactions differ from spot transactions in that their
maturity date is more than two business days in the future. A
forward-exchange contract's maturity date can be a few months

or even years in the future.
 The exchange rate is fixed when the contract is initially made.
No money necessarily changes hands until the transaction
actually takes place, although dealers may require some
customers to provide collateral in advance.
76
FOREIGN EXCHANGE QUOTES FOR GBP, MAY 24,
2010 (SEE PAGE 5)
November 4, 2022
Bid Offer
77
Spot 1.4407 1.4411
1-month forward 1.4408 1.4413
3-month forward 1.4410 1.4415

Forei
6-month forward 1.4416 1.4422 gn
Trade
Unive
rsity,
HCM
city
camp
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SWAP RATE
SWAP RATE
November 4, 2022
 SWAP RATE= Rs. K (Iv- Iu)/ (1+ Iu.K)
 Swap rate > 0 : Premium

 Swap rate < 0 : Discount
80
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HOW THE FORWARD EXCHANGE
RATE IS CALCULATED
RATE IS CALCULATED
November 4, 2022
RATE IS CALCULATED
82
November 4, 2022
FORWARD PRICE
 The forward price for a contract is the delivery price that
would be applicable to the contract if were negotiated today
(i.e., it is the delivery price that would make the contract
worth exactly zero)
 The forward price may be different for contracts of different
maturities (as shown by the table)

83
EXAMPLE (PAGE 5)
November 4, 2022
 On May 24, 2010 the treasurer of a corporation enters into a long
forward contract to buy £1 million in six months at an exchange
rate of 1.4422
 This obligates the corporation to pay $1,442,200 for £1 million
on November 24, 2010
 What are the possible outcomes?

84
applicable exchange rates in advance.
FUTURES CONTRACTS (PAGE
The futuresed 7) the forward market
from
November 4, 2022
in
that only a limited number of leading
 Agreement to buy or sell an asset for a certain price at a certain
currencies are
time
traded; moreover, trading takes place in
 Similar to forward contract
standardized
 Whereas a forward
contract contract
amounts and inis atraded OTC, a futures contract is
specific
tradedgeographic
on an exchange
location. Table 11.3 on page 348
summarizes the
major differences between the forward
market and
the futures market.

85
STANDARDISED CONTRACT
November 4, 2022
 Contract size / Trading unit
 Price quote

 Minimum price fluctuation
 Daily price limit
 Trading hours
 Delivery month / Settlement month / Contract month
 Delivery date / Settlement date
 Last day of trading
86
EXAMPLE: FUTURE CONTRACT SIZE
November 4, 2022
Currency transacted at IMM (CME) Contract size
Pound Sterling GBP 62,500
Japanese Yen JPY 12,500,000

Swiss Franc CHF 125,000
Canadian Dollar CAD 100,000
Australian Dollar AUD 100,000
Mexican Peso MXN 500,000
Euro EUR 125,000
(Source : www.cme.com)
87
EXAMPLE: FUTURE CONTRACT FOR EUR AT IMM
November 4, 2022
Contract size / Trading unit EUR 125,000
Price quote USD against EUR

Minimum price fluctuation 0.0001 USD (= USD 12.50 /contract)
Daily price limit unlimited
Trading hours 7:20 am - 2:00 pm. Last day of trading:

7:20am - 9:16 am
Delivery month / Settlement month / 3, 6, 9 & 12
Contract month
Delivery date / Settlement date two working days before the third 88
Wednesday of delivery month
Last day of trading T he third Wednesday of delivery month
INITIAL MARGIN AND MAINTENANCE MARGIN
November 4, 2022
Currency Initial margin Maintenance margin
AUD 2,025 1,500
GBP 1,890 1,400

CAD 1,755 1,300
EUR 3,240 2,400
JPY 2,700 2,000
CHF 2,565 1,900
MXN 1,875 1,500
(Source : www.cme.com, dated on 20/08/2008)
89
EXAMPLE
November 4, 2022
 On Monday (Oct 6th), buy a future contract of EUR, which will
deliver in December.

 Initial price USD 1.4568/EUR
 Contract size: EUR 125,000
 Value of the contract USD 182,100
 Intial margin USD 3,240 and maintenance margin USD 2,400
 You maintain the long position until you sell the contract at the
price of 1.4590 USD per EUR
90
FUTURE: MARKED TO MARKET- DAILY SETTLEMENT
(FROM OCT THE 6TH TO OCT THE 15TH)
November 4, 2022
Date Exchange Contract Marked to Margin Margin
rate value market + deposit account
- withdraw

6 – Oct 1.4550 181,875 (225) 3,240 3,015
7 – Oct 1.4528 181,600 (275) 2,740
8 - Oct 1.4492 181,150 (450) 2,290
9– Oct 1.4476 181,575 (200) 950 3,040
10 – Oct 1.4528 182,225 650 3,690
13 – Oct 1.4574 182,925 575 (450) 3,815
14 – Oct 1.4598 182,450 300 (575) 3,540
15 – Oct 1.4590 182,375 (100) (3,440)
91
FUTURES CONTRACTS
November 4, 2022
 Trading in foreign exchange can also be done in the futures
market. In this market, contracting parties agree to future
exchanges of currencies and set applicable exchange rates in

advance.
 The futures market is distinguished from the forward market in
that only a limited number of leading currencies are traded;
moreover, trading takes place in standardized contract amounts
and in a specific geographiclocation.
92
FUTURES CONTRACTS
November 4, 2022
Forward Contract Future Contract
Issuer Commercial bank Futures Exchange
Trading "Over the counter" On the IMM's market floor

Contract size Tailored to the needs of the Standardized in round lots
exporter/importer/investor;
no set size
Date of delivery Negotiable Only on particular dates
Contract costs Based on the bid/offer spread Brokerage fees for sell and buy
orders
Settlement On expiration date only, at Profits or losses paid daily at close
prearranged price of trading
93
EXCHANGES TRADING FUTURES
November 4, 2022
 CME Group (formerly Chicago Mercantile Exchange and
Chicago Board of Trade)
 NYSE Euronext
 BM&F (Sao Paulo, Brazil)
 TIFFE (Tokyo)
 and many more (see list at end of book)

94
CURRENCY SWAP
November 4, 2022
 A currency swap is the conversion of one currency to another
currency at one point in time, with an agreement to reconvert it
back to the original currency at a specified time in the future.

The rates of both exchanges are agreed to in advance.
 Swaps provide an efficient mechanism through which banks can
meet their foreignexchange needs over a period of time. Banks
are able to use a currency for a period in exchange for another
currency that is not needed during that time.
95
November 4, 2022
CURRENCY SWAP
 For example, Chase Manhattan Bank may have excess balances of
dollars but needs pounds to meet the requirements of its corporate
clients.

 At the same time, Royal Bank of Scotland may have excess balances
of pounds and insufficient amounts of dollars.
 The banks could negotiate a swap agreement in which Chase
Manhattan Bank agrees to exchange dollars for pounds today and
pounds for dollars in the future. The key aspect is that the two banks
arrange the swap as a single transaction in which they agree to pay
and receive stipulated amounts of currencies at specified rates.
96
CURRENCY SWAP
November 4, 2022
 Spot – Forward Swap
 Forward – Forward Swap

97
98
SPOT – FORWARD SWAP
99
FORWARD – FORWARD SWAP
CASE STUDY
November 4, 2022
 At present, on September the 1st , company A has VND in its
bank account but it needs 1,000,000 USD to pay for imported
machines. Simultaneously in 3 months, the company will receive

1,000,000 USD from its importer but will needs VND to
compensate for their domestic expenditure.
 What is the solution for the company A’s situation?
 Assumption:
 Spot: 16,480 – 16,496
 3m Swap / Forward: 120 – 145
100
OPTIONS
November 4, 2022
 An option is simply an agreement between a holder (buyer) and a
writer (seller) that gives the holder the right, but not the obligation, to
buy or sell financial instruments at any time through a specified date.

 Although the holder is not obligated to buy or sell currency, the
writer is obligated to fulfill a transaction. Having a throwaway
feature, options are a unique type of financial contract in that you
only use the contract if you want to.
 By contrast, forward contracts obligate a person to carry out a
transaction at a specified price, even if the market has changed and
the person would rather not .
101
FOREIGN-CURRENCY OPTIONS
November 4, 2022
 Foreign-currency options provide an options holder the right to
buy or sell a fixed amount of foreign currency at a prearranged
price, within a few days or a couple of years.

 The options holder can choose the exchange rate she wants to
guarantee, as well as the length of the contract.
 Foreign-currency options have been used by companies seeking
to hedge against exchange-rate risk as well as by speculators in
foreign currencies.
102
FOREIGN-CURRENCY OPTIONS
November 4, 2022
 There are two types of foreign currency options. A call option gives
the holder the right to buy foreign currency at a specified price,
whereas a put option gives the holder the right to sell foreign
currency at a specified price.

 The price at which the option can be exercised (that is, the price at
which the foreign currency is bought or sold)is calledthe strike
price.The holder of a foreign currency option has the right to
exercise the contract but may choose not to do so if it turns out to
be unprofitable.
 The writer of the options contract (for example, Bank of America,
Citibank, Merrill Lynch International Bank) must deliver the
foreign currency if called on by a call-holder or must buy foreign
currency if it is put to them by a put-holder.
 For this obligation, the writer of the options contract receives a 103
premium, or fee (the option price).
OPTIONS
November 4, 2022
 A call option is an option to buy a certain asset by a certain date
for a certain price (the strike price)

 A put option is an option to sell a certain asset by a certain date
for a certain price (the strike price)
104
AMERICAN VS EUROPEAN OPTIONS
November 4, 2022
 An American option can be exercised at any time during its life
 A European option can be exercised only at maturity

105
OPTIONS VS FUTURES/FORWARDS
November 4, 2022
 A futures/forward contract gives the holder the obligation to buy
or sell at a certain price
 An option gives the holder the right to buy or sell at a certain
price

106
TYPES OF TRADERS
November 4, 2022
 Hedgers
 Speculators
 Arbitrageurs

107
November 4, 2022
HEDGING EXAMPLES (PAGES 10-12)
 A US company will pay £10 million for imports from Britain in 3
months and decides to hedge using a long position in a forward
contract
 An investor owns 1,000 Microsoft shares currently worth $28
per share. A two-month put with a strike price of $27.50 costs $1.
The investor decides to hedge by buying 10 contracts

108
VALUE OF MICROSOFT SHARES WITH AND WITHOUT
HEDGING (FIG 1.4, PAGE 12)
November 4, 2022
40,000 Value of Holding ($)
35,000
No Hedging
30,000 Hedging
25,000
Stock Price ($)

20,000
20 25 30 35 40

109
SPECULATION EXAMPLE
November 4, 2022
 An investor with $2,000 to invest feels that a stock price will
increase over the next 2 months. The current stock price is $20
and the price of a 2-month call option with a strike of 22.50 is
$1
 What are the alternative strategies?

110
ARBITRAGE EXAMPLE
November 4, 2022
 A stock price is quoted as £100 in London and $140 in New
York
 The current exchange rate is 1.4300
 What is the arbitrage opportunity?

111
DANGERS
November 4, 2022
 Traders can switch from being hedgers to speculators or from
being arbitrageurs to speculators
 It is important to set up controls to ensure that trades are using
derivatives in for their intended purpose
 Soc Gen (see Business Snapshot 1.3 on page 17) is an example
of what can go wrong

112
HEDGE FUNDS (SEE BUSINESS SNAPSHOT 1.2, PAGE 11)
November 4, 2022
 Hedge funds are not subject to the same rules as mutual funds
and cannot offer their securities publicly.
 Mutual funds must
 disclose investment policies,
 makes shares redeemable at any time,
 limit use of leverage
 take no short positions.
 Hedge funds are not subject to these constraints.
 Hedge funds use complex trading strategies are big users of
derivatives for hedging, speculation and arbitrage

113

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November 4, 2022 Foreign Trade University, HCM city campus

Foreign Trade University, HCM city campus

Foreign Trade University, HCM city campus

• Financial instruments denominated in foreign currencies

• The domestic currency held by non-residents

Foreign Trade University, HCM city campus

Foreign Trade University, HCM city campus

Foreign Trade University, HCM city campus

Foreign Trade University, HCM city campus

 Our Current Floating-Rate System

 What is the choice of Exchange Rate System?

Foreign Trade University, HCM city campus

Foreign Trade University, HCM city campus

Foreign Trade University, HCM city campus

 The British pound sterling (1/15.58333 ounce of gold)

Foreign Trade University, HCM city campus

Foreign Trade University, HCM city campus

Foreign Trade University, HCM city campus

Foreign Trade University, HCM city campus

Foreign Trade University, HCM city campus

Foreign Trade University, HCM city campus

Foreign Trade University, HCM city campus

Foreign Trade University, HCM city campus

Foreign Trade University, HCM city campus

Currency IOS code Symbol

Foreign Trade University, HCM city campus

 Direct quotation: Exchange rate is the price of one unit of

terms currency in the relation to the group of the five currencies.

Foreign Trade University, HCM city campus

 1 USD = 1.3650 CHF ® 1 point: 0.0001 CHF

 1 GBP = 2.0005 USD ® 1 point: 0.0001 USD

 1 USD = 117.35 JPY ® 1 point: 0.01 JPY

 1 USD = 16,210 VND ®1 point: 1 VND

Foreign Trade University, HCM city campus

 In full writing: USD/VND = 15,010 – 15,020

 In abbreviation: USD/VND = 15,010/20

 In Practice: USD/VND = 10/20

Foreign Trade University, HCM city campus

 The frequency of currency in transactions

 Spread varies according to the different foreign exchange assets:

Foreign Trade University, HCM city campus

 USD/VND = 20,015- 20,025

 USD/ CNY = 6,1515 – 6,1525

 CNY/VND = ? Bid- Offer/ASK Rate 27

Foreign Trade University, HCM city campus

USD/JPY = 1.2567 : 117.94 = 0.010655

USD/ JPY = 1.2572 : 117.90 = 0.010663

Foreign Trade University, HCM city campus

ASKb GBP/USD = 1.2645 : 1.8798 = 0.6726779

GBP/USD = 1.2648 : 1.8793 = 0.6730165

Cho A/C; B/C

Foreign Trade University, HCM city campus

ASKb USD/CAD = 1.2648 × 1.1198 = 1.416323

BIDb USD/CAD = 1.2645 × 1.1195 = 1.415607

Cho A/B; B/C

Foreign Trade University, HCM city campus 17-33

Foreign Trade University, HCM city campus 17-34

Foreign Trade University, HCM city campus 17-35

Foreign Trade University, HCM city campus