Contact Information:

Brian David ButlerMiami Campus FacilitatorInternational Economics & Trade (Prof. Grosse)

Email: bdbutler@global.t-bird.eduCell: 786-457-0984Blog: http://blog.globotrends.com/ Wiki: http://kookyplan.pbwiki.com/brianbutler

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Global MBA International Finance & International Trade GM6212

1st session.September 13, 2008

Topics to cover today: 1.Foreign exchange terminology2.Exchange rate arbitrage3.Interest arbitrage

Session #1.Exchange Market Transactions – ArbitrageGoal: learn to read FX and interest rate tables & how to make arbitrage decisions to maximize profits or minimize costs

The investment rates quoted herein are on a 350-day coupon yield basis.

Source: Financial Times, September 3, 2008

International Money Market Rates (Bid Side)

United Statesdollar

Englandsterling

Europeeuro

Switzerlandfranc

Japanyen

Eurocurrency Rate

LIBOR overnight 2.17125 5.05563 4.3025 2.05 0.55

1 month 2.48563 5.38125 4.50813 2.25 0.69875

3 months 2.81313 5.74638 4.95188 2.74333 0.89375

6 months 3.11938 5.88750 5.15438 2.88167 0.97125

12 months 3.21438 5.99750 5.32313 3.16667 1.15438

Three-Month Treasury Bill Rate

1.68

Market Int Rates as of: Sept 2, 2008

Note: these are all ANNUAL rates. If you want the 3-month rate, you need to divide by 4. Example: the 3-month rate for US dollar is = 2.81313 / 4 = 0.07032 per quarter. Why divide by 4? Because 3months out of 12 = 1/4th

Question: Based on the following data (from FT.com),

If you were a US based bank, with US currency looking to invest money for 12 months…..where would you choose to deposit your money (to make the most return)?

International Money Market Rates (Bid Side)

United Statesdollar

Englandsterling

Europeeuro

Switzerlandfranc

Japanyen

Eurocurrency Rate

LIBOR 12 months 3.21438 5.99750 5.32313 3.16667 1.15438

Question: Based on the following data (from FT.com),

If you were a US based bank, with US currency looking to invest money for 12 months…..where would you choose to deposit your money (to make the most return)?

Answer: it DEPENDS not just on the interest rate, but also on the expected change in foreign exchange rate as well.

You might be temped to choose the England (sterling) option of 5.99% because it’s the highest…but that currency might be expected to lose value (depreciate) over the next year…wiping out the expected gains.

International Money Market Rates (Bid Side)

United Statesdollar

Englandsterling

Europeeuro

Switzerlandfranc

Japanyen

Eurocurrency Rate

LIBOR 12 months 3.21438 5.99750 5.32313 3.16667 1.15438

Foreign Currency Exchange Rates (Bid)

Canadadollar

UK*sterling

Europe*euro

Switzerlandfranc

Japanyen

Spot Rate— (Closing Foreign currency units per US dollar)

1.0625 1.7863 1.4522 1.1090 108.84

Forward Rate—Closing Rates

1 month outright

1.0630 1.7822 1.4498 1.1086 108.652

3 months outright

1.0636 1.7749 1.4454 1.1080 108.281

6 months outright

1.0639 1.7638 1.4391 1.1066 107.716

12 months outright

1.0642 1.7493 1.4283 1.1043 106.453

*(U.S. dollars per foreign currency unit)

Spot rates 0.9412 1.7863 1.4522 0.9017 0.00919

Market Exch Rates as of: Sept 2, 2008

CDN depreciate

UK sterling depreciate

Euro depreciate

Swiss F appreciate

JPN yen appreciate

Question: How to use this information to make $$? Interest arbitrage (2-way exchange arbitrage) example:

1.Assume CitiBank in NYC offers a spot exchange rate of SF 1.1103 per $US. How could you take advantage of that information, if you work in a corporate treasury or another bank?

Quote from London (table above): SF 1.1090 Quote from NYC bank (example) : SF 1.1103

What would you do?

Question: How to use this information to make $$? 2-way exchange arbitrage example:

1.Assume CitiBank in NYC offers a spot exchange rate of SF 1.1103 per $US. How could you take advantage of that information, if you work in a corporate treasury or another bank?

Quote from London (table above): SF 1.1090 Quote from NYC bank (example) : SF 1.1103

ANSWER:

Buy in NYC…where $1 USD buys more Swiss francs. Then sell in London (back to dollars).How it works:•Convert $10m USD to SF in NYC = SF 11,103,000•Then, convert back to USD in London = SF 11,103,000 / 1.1090 = $US 10,011,722 •Profit = $11,722•With NO risk….

2-way exchange arbitrage; example #2:

2. Assume CitiBank in NYC offers a spot exchange rate of 110 Yen per $US. How could you take advantage of that information, if you work in a corporate treasury or another bank?

Quote from London (table above): 108.84 yen Quote from NYC bank (example) : 110 yen / $USD

How would you use this information to make money? (with no risk)?

2-way exchange arbitrage; example #2:

2. Assume CitiBank in NYC offers a spot exchange rate of 110 Yen per $US. How could you take advantage of that information, if you work in a corporate treasury or another bank?

Quote from London (table above): 108.84 yen Quote from NYC bank (example) : 110 yen / $USD

ANSWER:

Buy in NYC…where $1 USD buys more yen. Then sell in London where Yen are more valuable…results in profit without risk.

Get volunteer for whiteboard….to show calculations for profit.

Why study ARBITRAGE?

•Many markets ….banks set the market for FX trading•There is no such thing as “THE” exchange rate.•There are many•Arbitrage is the mechanism that equalizes exchange rates across markets….•Its how FX rates are set

Interest Arbitrage (another type of arbitrage example)

3.Assume JP Morgan Chase in NYC on Sept 2nd 2008 offering to take interbank deposits of $1 million USD or ore at rate of 3.1425% per year on a one-yar deposit in dollars. Given the information on the FT page (table) representing interest rate from bank in London….what would you do?

Rate in London (table above): 3.21438%Rage in NYC bank (example) : 3.1425%

Obviously, you would pick the one with the higher % interest rate? London. But, how would you change your answer if … you consider putting your deposit in a foreign currency?

International Money Market Rates (Bid Side)

United Statesdollar

Englandsterling

Europeeuro

Switzerlandfranc

Japanyen

Eurocurrency Rate

LIBOR 12 months 3.21438 5.99750 5.32313 3.16667 1.15438Foreign Currency Exchange Rates (Bid)

Canadadollar

UK*sterling

Europe*euro

Switzerlandfranc

Japanyen

12 months outright

1.0642 1.7493 1.4283 1.1043 106.453

Facilitator Session #2.Exchange Market Transactions – Arbitrage, including FUTURES

Goal: learn to read the futures exchange rate quotes and to make arbitrage decisions to maximize profits or minimize borrowing costs

Currency Futures

Open High Low Settle Change High Low Open

Interest

.9212JAPAN YEN (CME)—12.5 million yen; $.00 per yen Sept .9200 .9299 .9164 .0010 179,278Dec .9250 .9345 .9214 .9260 -.0010 23,866

BRITISH POUND (CME)—62,500 pounds; $ per poundSept 1.8169 1.8170 1.7765 1.7806 -.0350 113,955Dec 1.8039 1.8039 1.7655 1.7693 -.0346 3,873

EURO/US DOLLAR (CME)—€125,000; $ per €Sept 1.4680 1.4712 1.4456 1.4504 -.0127 151,887Dec 1.4560 1.4639 1.4389 1.4436 -.0127 7,901

MEXICAN PESO (CME)—MXN 500,000; $ per 10MXNSept .97000 .97175 .95975 .96250 .0078 88,075Dec .94925 .95725 .94750 .94975 .0073 18,769

(Sept 2, 2008)

Note: Yen quoted in dollars per 100 yen (add 2 zeros)

Futures Example #1

Assuming you are starting with US dollars…how could you profit from arbitrage between the futures and the forward market in YEN?

Futures Example #1Assuming you are starting with US dollars…how could you profit from arbitrage between the futures and the forward market in YEN?

Answer: Buy in forward, sell in futureWhy?:

Future Dec = .009260 = 107.99136Forward 3 months = 108.281

Buy YEN (where Yen is cheap) at 108.28, then buy Dollars (where Yen is expensive) back at 107.99

If you have $10 million USD …how much money to you make? Is there any risk?

Futures Example #2

Assuming you are starting with US dollars…how could you profit from arbitrage between the futures and the forward market in Euros?

Do the same thing….

Who can get the right answer?

Futures Example #2Assuming you are starting with US dollars…how could you profit from arbitrage between the futures and the forward market in euros?

Answer: Buy in futures, sell in forwardWhy?:

Future Dec = 1.4436Forward 3 months = 1.4454

Buy Euros(where is cheap) at 1.4454, then buy Dollars (where Euro is expensive) back at 1.4436

If you have $10 million USD …how much money to you make? Is there any risk?

Final Question of the Day….

Without using arbitrage….

Is it a good idea to buy a futures contract for Mexican Pesos (or Euros) today, for a maturity in December?

Discuss…