Series of lectures from Brian Butler, given during fall 2008 session at Thunderbird Global MBA, Miami campus: This lecture 01: learn to read FX and interest rate tables & how to make arbitrage decisions to maximize profits or minimize costs

1. Contact Information: Brian David Butler Miami Campus Facilitator International Economics & Trade (Prof. Grosse) Email: [email_address] Cell: 786-457-0984 Blog: http://blog.globotrends.com/ Wiki: http://kookyplan.pbwiki.com/brianbutler Connect professionally: http://www.linkedin.com/in/briandbutler http://www.linkedin.com/e/gis/69362 Connect personally: http://www.facebook.com/people/Brian_Butler/293500110

2. Global MBA International Finance & International Trade GM6212 1 st session. September 13, 2008 Topics to cover today: Foreign exchange terminology Exchange rate arbitrage Interest arbitrage Session #1. Exchange Market Transactions – Arbitrage Goal: learn to read FX and interest rate tables & how to make arbitrage decisions to maximize profits or minimize costs

3. The investment rates quoted herein are on a 350-day coupon yield basis. Source: Financial Times , September 3, 2008 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 = 1/4 th International Money Market Rates (Bid Side) United States dollar England sterling Europe euro Switzerland franc Japan yen 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

4. 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 States dollar England sterling Europe euro Switzerland franc Japan yen Eurocurrency Rate LIBOR 12 months 3.21438 5.99750 5.32313 3.16667 1.15438

5. 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 States dollar England sterling Europe euro Switzerland franc Japan yen Eurocurrency Rate LIBOR 12 months 3.21438 5.99750 5.32313 3.16667 1.15438

6. Market Exch Rates as of: Sept 2, 2008 CDN depreciate UK sterling depreciate Euro depreciate Swiss F appreciate JPN yen appreciate Foreign Currency Exchange Rates (Bid) Canada dollar UK* sterling Europe* euro Switzerland franc Japan yen 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

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

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

9. 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)?

10. 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.

11. 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

12. Interest Arbitrage (another type of arbitrage example) Assume JP Morgan Chase in NYC on Sept 2 nd 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 States dollar England sterling Europe euro Switzerland franc Japan yen Eurocurrency Rate LIBOR 12 months 3.21438 5.99750 5.32313 3.16667 1.15438 Foreign Currency Exchange Rates (Bid) Canada dollar UK* sterling Europe* euro Switzerland franc Japan yen 12 months outright 1.0642 1.7493 1.4283 1.1043 106.453

13. 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

14. Currency Futures Open High Low Settle Change High Low Open Interest .9212 JAPAN YEN (CME)—12.5 million yen; $.00 per yen Sept .9200 .9299 .9164 .0010 179,278 Dec .9250 .9345 .9214 .9260 -.0010 23,866 BRITISH POUND (CME)—62,500 pounds; $ per pound Sept 1.8169 1.8170 1.7765 1.7806 -.0350 113,955 Dec 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 151,887 Dec 1.4560 1.4639 1.4389 1.4436 -.0127 7,901 MEXICAN PESO (CME)—MXN 500,000; $ per 10MXN Sept .97000 .97175 .95975 .96250 .0078 88,075 Dec .94925 .95725 .94750 .94975 .0073 18,769 (Sept 2, 2008) Note: Yen quoted in dollars per 100 yen (add 2 zeros)

15. 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?

16. 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? Answer: Buy in forward, sell in future Why?: Future Dec = .009260 = 107.99136 Forward 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?

17. 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?

18. 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? Answer: Buy in futures, sell in forward Why?: Future Dec = 1.4436 Forward 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?

19. 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…