A-4-2-Lecture in International Finance (1).ppt

Lecture in International
Finance
Chinese University of Technology
Foued Ayari, PhD

About Dr Ayari
• Assistant Professor of Finance in New York
• President & CEO of Bullquest LLC, a financial training
company.
• Partner at Goldstone Property Group Inc
• Author of a recently published book:
“Credit Risk Modeling: An Empirical Analysis on
Pricing, Procyclicality and Dependence
• Author of a forthcoming book published with Wiley &
Sons,
“Understanding Credit Derivatives: Strategies &
New Market Developments”.

Outline
• The FX market
• Currency Forwards
• Eurobond Market
• Eurocurrency Market
• Currency Swaps
• Strategies in FX

Foreign Exchange Markets
• BACKGROUND
• Foreign Exchange markets come under Global Markets
Division within Banks. It features are as follows:
– OTC market
– Major international banks
– Spot market and forward market
– London is the largest centre
• 7/24 Market with daily Turnover of more than $3,200 Billions
(BIS, 2007)
• All currencies are primarily valued against the USD dollar:
– USD 1 = JPY 112.26 (in this quote, the most common type, the
USD is the base currency)
– EUR 1 = USD 1.2594 (in this quote the USD is the variable
currency)

Correspondent Banking
Relationships
• International commercial banks
communicate with one another with:
– SWIFT: The Society for Worldwide Interbank
Financial Telecommunications.
– CHIPS: Clearing House Interbank Payments
System
– ECHO Exchange Clearing House Limited, the
first global clearinghouse for settling interbank
FX transactions.

Spot Market Participants and
Trading
• FX MARKET STRUCTURE
• The foreign exchange spot markets are QUOTE DRIVEN
markets with international banks as the wholesale participants.
This market is also known as the FX inter-bank market.
• International banks act as MARKET MAKERS. They make
each other two-way prices on demand:
– The bank MAKING the quote bids for the BASE currency on the
left and offers (ask) it on the right. e.g:
• GBP 1 = USD 1.8850 (Bid), GBP 1 = USD 1.8860 (Ask)
Becomes:
• 1.8850/60
or even
• 50/60

The Foreign Exchange Market
• TYPES OF EXCHANGE MARKETS AND CONVENTIONS
• Exchange markets
FX Market
Spot Market
Deals for delivery T +
2
Forward Market
Deals for delivery up
to 12 months later
than T + 2
FX Swaps Market
Deals with one spot
component and one
forward component

Spot & Forward
• A spot contract is a binding commitment for an exchange of funds,
with normal settlement and delivery of bank balances following in
two business days (one day in the case of North American
currencies).
• A forward contract, or outright forward, is an agreement made today
for an obligatory exchange of funds at some specified time in the
future (typically 1,2,3,6,12 months).
• Forward contracts typically involve a bank and a corporate
counterparty and are used by corporations to manage their
exposures to foreign exchange risk.
• An FX swap (not to be confused with a cross currency swap) is a
contract that simultaneously agrees to buy (sell) an amount of
currency at an agreed rate and to resell (repurchase) the same
amount of currency for a later value date to (from) the same
counterparty, also at an agreed rate.
• Non Deliverable Forwards

How Factors Can Affect Exchange Rates

Forwards
• Spot Rates
• Spot is the term used for standard settlement in the FX markets. The spot date is two business
days after the trade date: T+2.
– Spot rates are quoted as two way prices between the banks that populate the FX markets:
Source: Bloomberg

The Spot Market
• Spot Rate Quotations
• The Bid-Ask Spread
• Spot FX trading
• Cross Rates

Spot Rate Quotations
• Direct quotation
– the U.S. dollar equivalent
– e.g. “a Japanese Yen is worth about a penny”
• Indirect Quotation
– the price of a U.S. dollar in the foreign
currency
– e.g. “you get 100 yen to the dollar”

Country
USD equiv
Friday
USD equiv
Thursday
Currency per
USD Friday
Currency per
USD Thursday
Argentina (Peso) 0.3309 0.3292 3.0221 3.0377
Australia (Dollar) 0.7830 0.7836 1.2771 1.2762
Brazil (Real) 0.3735 0.3791 2.6774 2.6378
Britain (Pound) 1.9077 1.9135 0.5242 0.5226
1 Month Forward 1.9044 1.9101 0.5251 0.5235
3 Months
Forward 1.8983 1.9038 0.5268 0.5253
6 Months
Forward 1.8904 1.8959 0.5290 0.5275
Canada (Dollar) 0.8037 0.8068 1.2442 1.2395
1 Month Forward 0.8037 0.8069 1.2442 1.2393
3 Months
Forward 0.8043 0.8074 1.2433 1.2385
6 Months
Forward 0.8057 0.8088 1.2412 1.2364

The direct quote for
British pound is:
£1 = $1.9077
Country
USD equiv
Friday
USD equiv
Thursday
Currency per
USD Friday
Currency per
USD Thursday
Argentina (Peso) 0.3309 0.3292 3.0221 3.0377
Brazil (Real) 0.3735 0.3791 2.6774 2.6378
Britain (Pound) 1.9077 1.9135 0.5242 0.5226
1 Month Forward 1.9044 1.9101 0.5251 0.5235
3 Months
Forward 1.8983 1.9038 0.5268 0.5253
6 Months
Forward 1.8904 1.8959 0.5290 0.5275
Canada (Dollar) 0.8037 0.8068 1.2442 1.2395
1 Month Forward 0.8037 0.8069 1.2442 1.2393
3 Months
Forward 0.8043 0.8074 1.2433 1.2385
6 Months

The indirect quote
for British pound
is:
£.5242 = $1
Country
USD equiv
Friday
USD equiv
Thursday
Currency per
USD Friday
Currency per
USD Thursday
Argentina (Peso) 0.3309 0.3292 3.0221 3.0377
Brazil (Real) 0.3735 0.3791 2.6774 2.6378
Britain (Pound) 1.9077 1.9135 0.5242 0.5226
1 Month Forward 1.9044 1.9101 0.5251 0.5235
3 Months
Forward 1.8983 1.9038 0.5268 0.5253
6 Months
Forward 1.8904 1.8959 0.5290 0.5275
Canada (Dollar) 0.8037 0.8068 1.2442 1.2395
1 Month Forward 0.8037 0.8069 1.2442 1.2393
3 Months
Forward 0.8043 0.8074 1.2433 1.2385
6 Months

Note that the
direct quote is the
reciprocal of the
indirect quote:
5242
.
1
9077
.
1 =
Country
USD equiv
Friday
USD equiv
Thursday
Currency per
USD Friday
Currency per
USD Thursday
Argentina (Peso) 0.3309 0.3292 3.0221 3.0377
Brazil (Real) 0.3735 0.3791 2.6774 2.6378
Britain (Pound) 1.9077 1.9135 0.5242 0.5226
1 Month Forward 1.9044 1.9101 0.5251 0.5235
3 Months
Forward 1.8983 1.9038 0.5268 0.5253
6 Months
Forward 1.8904 1.8959 0.5290 0.5275
Canada (Dollar) 0.8037 0.8068 1.2442 1.2395
1 Month Forward 0.8037 0.8069 1.2442 1.2393
3 Months
Forward 0.8043 0.8074 1.2433 1.2385
6 Months

The Bid-Ask Spread
• The bid price is the price a dealer is willing
to pay you for something.
• The ask price is the amount the dealer
wants you to pay for the thing.
• The bid-ask spread is the difference
between the bid and ask prices.

The Bid-Ask Spread
• A dealer could offer
– bid price of $1.25 per €
– ask price of $1.26 per €
– While there are a variety of ways to quote that,
• The bid-ask spread represents the
dealer’s expected profit.

The Bid-Ask Spread
• A dealer would likely quote these prices as 72-
77.
• It is presumed that anyone trading $10m
already knows the “big figure”.
Bid Ask
1.9072
.5242
S($/£)
S(£/$)
1.9077
.5243
big figure small figure

Spot FX trading
• In the interbank market, the standard size
trade is about U.S. $10 million.
• A bank trading room is a noisy, active
place.
• The stakes are high.
• The “long term” is about 10 minutes.

Cross Rates
• Suppose that S($/€) = 1.50
– i.e. $1.50 = €1.00
• and that S(¥/€) = 50
– i.e. €1.00 = ¥50
• What must the $/¥ cross rate be?
$1.50
¥50
=
$1.50 €1.00
€1.00 ¥50
×
$1.00 = ¥33.33
$0.0300 = ¥1

Triangular Arbitrage
$
£
¥
Credit Lyonnais
S(£/$)=1.50
Credit Agricole
S(¥/£)=85
Barclays
S(¥/$)=120
Suppose we observe
these banks posting
these exchange rates.
First calculate any implied
cross rate to see if an
arbitrage exists.
£1.00
¥80
=
£1.50 $1.00
$1.00 ¥120
×

$
Credit Lyonnais
S(£/$)=1.50
Credit Agricole
S(¥/£)=85
Barclays
S(¥/$)=120
As easy as 1 – 2 – 3:
1. Sell our $ for £,
2. Sell our £ for ¥,
3. Sell those ¥ for $.
¥ £
1
2
3
$

Sell $100,000 for £ at S(£/$) = 1.50
receive £150,000
Sell our £150,000 for ¥ at S(¥/£) = 85
receive ¥12,750,000
Sell ¥12,750,000 for $ at S(¥/$) = 120
receive $106,250
profit per round trip = $106,250 – $100,000 = $6,250

$
Credit Lyonnais
S(£/$)=1.50
Credit Agricole
S(¥/£)=85
Barclays
S(¥/$)=120
Here we have to go “clockwise” to
make money—but it doesn’t
matter where we start.
¥ £
1
2 3
$
If we went “counter clockwise” we would be the source of arbitrage profits, not the
recipient!

• As a quick spot method for triangular arbitrage, write the three rates out with
a different denominator in each:
– 1.3285 CHF / USD
– 0.00851 USD / JPY
– 88.20 JPY / CHF
• If there is parity:
– If this is greater, or less than, 1 an arbitrage opportunity exists.
– An answer < 1 means that one of the component rates (fractions) is too low. An
answer > 1 mean that one of the rates is too high.
– If the total is less than one, assume that any of the fractions is too low, e.g. CHF/USD.
This would imply that CHF is too low (overvalued vs USD) or USD is too high
(undervalued vs CHF); this tells us to either buy the undervalued or sell the
overvalued currency.
1
=


CHF
JPY
JPY
USD
USD
CHF

The Forward Market
• A forward contract is an agreement to buy
or sell an asset in the future at prices
agreed upon today.

Forward Rate Quotations
• The forward market for FX involves
agreements to buy and sell foreign
currencies in the future at prices agreed
upon today.
• Bank quotes for 1, 3, 6, 9, and 12 month
maturities are readily available for forward
contracts.
• Non Deliverable Forwards

• Consider the example from above:
for British pounds, the spot rate is
$1.9077 = £1.00
While the 180-day forward rate is
$1.8904 = £1.00
• What’s up with that?

Clearly the market
participants
expect that the
pound will be
worth less in
dollars in six
months.
Country
USD
equiv
Friday
USD equiv
Thursday
Currency per
USD Friday
Currency per
USD Thursday
Argentina
(Peso) 0.3309 0.3292 3.0221 3.0377
Australia
(Dollar) 0.7830 0.7836 1.2771 1.2762
Brazil (Real) 0.3735 0.3791 2.6774 2.6378
Britain
(Pound) 1.9077 1.9135 0.5242 0.5226
1 Month
Forward 1.9044 1.9101 0.5251 0.5235
3 Months
Forward 1.8983 1.9038 0.5268 0.5253
6 Months
Forward 1.8904 1.8959 0.5290 0.5275
Canada
(Dollar) 0.8037 0.8068 1.2442 1.2395
1 Month
Forward 0.8037 0.8069 1.2442 1.2393
3 Months
Forward 0.8043 0.8074 1.2433 1.2385
6 Months
Forward 0.8057 0.8088 1.2412 1.2364

• Consider the (dollar) holding period return of
a dollar-based investor who buys £1 million
at the spot and sells them forward:
$HPR=
gain
pain
$1,890,400 – $1,907,700
$1,907,700
=
–$17,300
$1,907,700
=
$HPR = –0.0091
Annualized dollar HPR = –1.81% = –0.91% × 2

Forward Premium
• The interest rate differential implied by
forward premium or discount.
• For example, suppose the € is appreciating
from S($/€) = 1.25 to F180($/€) = 1.30
• The 180-day forward premium is given by:
= 0.08
1.30 – 1.25
1.25
× 2
=
f180,€v$
F180($/€) – S($/€)
S($/€)
= ×
360
180

Long and Short Forward
Positions
• If you have agreed to sell anything (spot or
forward), you are “short”.
• If you have agreed to buy anything
(forward or spot), you are “long”.
• If you have agreed to sell FX forward, you
are short.
• If you have agreed to buy FX forward, you
are long.

Payoff Profiles
0
S180($/¥)
F180($/¥) = .009524
Short position
loss
profit If you agree to sell anything in the future at a set
price and the spot price later falls then you gain.
If you agree to sell anything in the future at a set
price and the spot price later rises then you lose.

Payoff Profiles
loss
0 S180(¥/$)
F180(¥/$) = 105
-F180(¥/$)
profit
Whether the payoff
profile slopes up or down
depends upon whether
you use the direct or
indirect quote:
F180(¥/$) = 105 or
F180($/¥) = .009524.
short position

Payoff Profiles
loss
0
S180(¥/$)
F180(¥/$) = 105
-F180(¥/$)
When the short entered into this forward
contract, he agreed to sell ¥ in 180 days at
F180(¥/$) = 105
profit
short position

Payoff Profiles
loss
0
S180(¥/$)
F180(¥/$) = 105
-F180(¥/$)
120
If, in 180 days, S180(¥/$) = 120, the short will make
a profit by buying ¥ at S180(¥/$) = 120 and
delivering ¥ at F180(¥/$) = 105.
15¥
profit
short position

Payoff Profiles
loss
0
S180(¥/$)
F180(¥/$) = 105
Long position
-F180(¥/$)
F180(¥/$) short position
profit Since this is a zero-sum game, the long position
payoff is the opposite of the short.

Payoff Profiles
loss
0
S180(¥/$)
F180(¥/$) = 105
Long position
-F180(¥/$)
profit
The long in this forward contract agreed to BUY
¥ in 180 days at F180(¥/$) = 105
If, in 180 days, S180(¥/$) = 120, the long will
lose by having to buy ¥ at S180(¥/$) = 120
and delivering ¥ at F180(¥/$) = 105.
120
–15¥

Interest Rate Parity Defined
• IRP is an arbitrage condition.
• If IRP did not hold, then it would be
possible for an astute trader to make
unlimited amounts of money exploiting the
arbitrage opportunity.
• Since we don’t typically observe persistent
arbitrage conditions, we can safely
assume that IRP holds.

Interest Rate Parity Carefully
Defined
Consider alternative one year investments for $100,000:
1. Invest in the U.S. at i$. Future value = $100,000 × (1
+ i$)
2. Trade your $ for £ at the spot rate, invest
$100,000/S$/£ in Britain at i£ while eliminating any
exchange rate risk by selling the future value of the
British investment forward. S$/£
F$/£
Future value = $100,000(1 + i£)×
S$/£
F$/£
(1 + i£) × = (1 + i$)
Since these investments have the same risk, they must have the same future value
(otherwise an arbitrage would exist)

IRP
Invest those
pounds at i£
$1,000
S$/£
$1,000
Future Value =
Step 3: repatriate
future value to the
U.S.A.
Since both of these investments have the same risk, they must have the same future value—
otherwise an arbitrage would exist
Alternative 1:
invest $1,000 at i$
$1,000×(1 + i$)
Alternative 2:
Send your $ on
a round trip to
Britain
Step 2:
$1,000
S$/£
 (1+ i£) × F$/£
$1,000
S$/£
 (1+ i£)
=
IRP

• The scale of the project is unimportant
(1 + i$)
F$/£
S$/£
× (1+ i£)
=
$1,000×(1 + i$)
$1,000
S$/£
 (1+ i£) × F$/£
=

Formally,
IRP is sometimes approximated as
i$ – i¥ ≈
S
F – S
1 + i$
1 + i¥ S$/¥
F$/¥
=

Forward Premium
• It’s just the interest rate differential implied
by forward premium or discount.
• For example, suppose the € is appreciating
from S($/€) = 1.25 to F180($/€) = 1.30
• The forward premium is given by:
F180($/€) – S($/€)
S($/€)
×
360
180
f180,€v$ = =
$1.30 – $1.25
$1.25
× 2 = 0.08

Interest Rate Parity Carefully
Defined
• Depending upon how you quote the
exchange rate ($ per ¥ or ¥ per $) we have:
1 + i$
1 + i¥
S¥/$
F¥/$
=
1 + i$
1 + i¥ S$/¥
F$/¥
=
or
…so be a bit careful about that

IRP and Covered Interest
Arbitrage
If IRP failed to hold, an arbitrage would exist.
It’s easiest to see this in the form of an
example.
Consider the following set of foreign and
domestic interest rates and spot and
forward exchange rates.
Spot exchange rate S($/£) = $1.25/£
360-day forward rate F360($/£) = $1.20/£
U.S. discount rate i$ = 7.10%
British discount rate i£ = 11.56%

IRP and Covered Interest
Arbitrage
A trader with $1,000 could invest in the U.S. at 7.1%, in
one year his investment will be worth
$1,071 = $1,000  (1+ i$) = $1,000  (1,071)
Alternatively, this trader could
1. Exchange $1,000 for £800 at the prevailing spot
rate,
2. Invest £800 for one year at i£ = 11,56%; earn
£892,48.
3. Translate £892,48 back into dollars at the forward
rate F360($/£) = $1,20/£, the £892,48 will be exactly
$1,071.

Arbitrage I
Invest £800 at
i£ = 11.56%
$1,000
£800
£800 = $1,000×
$1.25
£1
In one year £800
will be worth
£892.48 =
£800 (1+ i£)
$1,071 = £892.48 ×
£1
F£(360)
Step 3: repatriate
to the U.S.A. at
F360($/£) = $1.20/£
Alternative 1:
invest $1,000
at 7.1%
FV = $1,071
Alternative 2:
buy pounds
Step 2:
£892.48
$1,071

Interest Rate Parity
& Exchange Rate Determination
According to IRP only one 360-day forward
rate,
F360($/£), can exist. It must be the case that
F360($/£) = $1.20/£
Why?
If F360($/£)  $1.20/£, an astute trader could
make money with one of the following
strategies:

Arbitrage Strategy I
If F360($/£) > $1.20/£
i. Borrow $1,000 at t = 0 at i$ = 7.1%.
ii. Exchange $1,000 for £800 at the
prevailing spot rate, (note that £800 =
$1,000÷$1.25/£) invest £800 at 11.56% (i£)
for one year to achieve £892.48
iii. Translate £892.48 back into dollars, if
F360($/£) > $1.20/£, then £892.48 will be
more than enough to repay your debt of
$1,071.

Arbitrage I
Invest £800 at
i£ = 11.56%
$1,000
£800
£800 = $1,000×
$1.25
£1
In one year £800
will be worth
£892.48 =
£800 (1+ i£)
$1,071 < £892.48 ×
£1
F£(360)
Step 4: repatriate
to the U.S.A.
If F£(360) > $1.20/£ , £892.48 will be more than enough to
repay your dollar obligation of $1,071. The excess is your profit.
Step 1:
borrow $1,000
Step 2:
buy pounds
Step 3:
Step 5: Repay
your dollar loan
with $1,071.
£892.48
More
than $1,071

Arbitrage Strategy II
If F360($/£) < $1.20/£
i. Borrow £800 at t = 0 at i£= 11.56% .
ii. Exchange £800 for $1,000 at the
prevailing spot rate, invest $1,000 at 7.1%
for one year to achieve $1,071.
iii. Translate $1,071 back into pounds, if
F360($/£) < $1.20/£, then $1,071 will be
more than enough to repay your debt of
£892.48.

Arbitrage II
$1,000
£800
$1,000 = £800×
£1
$1.25
In one year $1,000
will be worth $1,071 > £892.48 ×
£1
F£(360)
Step 4:
repatriate to
the U.K.
If F£(360) < $1.20/£ , $1,071 will be more than enough to repay
your dollar obligation of £892.48. Keep the rest as profit.
Step 1:
borrow £800
Step 2:
buy dollars
Invest $1,000
at i$
Step 3:
Step 5: Repay
your pound
loan with
£892.48 .
$1,071
More
than
£892.48

IRP and Hedging Currency Risk
You are a U.S. importer of British woolens and have just
ordered next year’s inventory. Payment of £100M is due in
one year.
IRP implies that there are two ways that you fix the cash outflow to a
certain U.S. dollar amount:
a) Put yourself in a position that delivers £100M in one year—a long
forward contract on the pound.
You will pay (£100M)(1.2/£) = $120M in one year.
b) Form a forward market hedge as shown below.
Spot exchange rate S($/£) = $1.25/£
360-day forward rate F360($/£) = $1.20/£
U.S. discount rate i$ = 7.10%
British discount rate i£ = 11.56%

IRP and a Forward Market
Hedge
To form a forward market hedge:
Borrow $112.05 million in the U.S. (in one year
you will owe $120 million).
Translate $112.05 million into pounds at the
spot rate S($/£) = $1.25/£ to receive £89.64
million.
Invest £89.64 million in the UK at i£ = 11.56%
for one year.
In one year your investment will be worth £100
million—exactly enough to pay your supplier.

Forward Market Hedge
Where do the numbers come from? We owe our
supplier £100 million in one year—so we know that
we need to have an investment with a future value of
£100 million. Since i£ = 11.56% we need to invest
£89.64 million at the start of the year.
How many dollars will it take to acquire £89.64 million at the start of the year if S($/£) =
$1.25/£?
£89.64 =
£100
1.1156
$112.05 = £89.64 ×
$1.00
£1.25

Is the Forward Rate a good
predictor of future spot?
• FORWARD RATES AS PREDICTORS OF
FUTURE SPOT RATES
• 12 month forward rates from
November ’05 to May ’06…

• …and the spot rate 12 month’s later

Purchasing Power Parity and
Exchange Rate Determination
• The exchange rate between two currencies
should equal the ratio of the countries’ price
levels:
S($/£) =
P£
P$
S($/£) =
P£
P$
£150
$300
= = $2/£
 For example, if an ounce of gold costs $300 in
the U.S. and £150 in the U.K., then the price of
one pound in terms of dollars should be:

• Suppose the spot exchange rate is $1.25 =
€1.00
• If the inflation rate in the U.S. is expected to be
3% in the next year and 5% in the euro zone,
• Then the expected exchange rate in one year
should be $1.25×(1.03) = €1.00×(1.05)
F($/€) = $1.25×(1.03)
€1.00×(1.05)
$1.23
€1.00
=

• The euro will trade at a 1.90% discount in the forward
market:
$1.25
€1.00
=
F($/€)
S($/€)
$1.25×(1.03)
€1.00×(1.05) 1.03
1.05
1 + $
1 + €
= =
Relative PPP states that the rate of change in the
exchange rate is equal to differences in the rates of
inflation—roughly 2%

Purchasing Power Parity
and Interest Rate Parity
• Notice that our two big equations today
equal each other:
=
=
F($/€)
S($/€)
1 + $
1 + €
PPP
1 + i€
1 + i$
=
F($/€)
S($/€)
IRP

Expected Rate of Change in
Exchange Rate as Inflation
Differential
• We could also
reformulate our
equations as inflation or
interest rate differentials:
=
F($/€) – S($/€)
S($/€)
1 + $
1 + €
– 1 =
1 + $
1 + €
–
1 + €
1 + €
=
F($/€)
S($/€)
1 + $
1 + €
=
F($/€) – S($/€)
S($/€)
$ – €
1 + €
E(e) = ≈ $ – €

Expected Rate of Change in
Exchange Rate as Interest Rate
Differential
=
F($/€) – S($/€)
S($/€)
i$ – i€
1 + i€
E(e) = ≈ i$ – i€

Quick and Dirty Short Cut
• Given the difficulty in measuring expected
inflation, managers often use
≈ i$ – i€
$ – €

Currency Strategies
• Momentum trading seeks to take advance of
market trends, purchasing currencies with the
best recent performance and selling the weakest
performers.
• Mean reversion strategies in are some ways
the opposite of momentum strategies. It is based
on the idea that currencies are prone to move too
far too fast and then are reversed in part or in full.
• Carry trades seek to take advantage of interest
rate differentials, selling low yielding currencies
and buying higher yielding currencies.

Currency Swaps
• In a plain vanilla cross-currency swap transaction, one party
typically holds one currency and desires a different currency.
• Each party will then pay interest on the currency it receives in the
swap and the interest payment can be made at either a fixed or a
floating rate.
• Contrary to the Interest Rate Swap there is an actual exchange of
cash flow at initiation
• Frequent bond issuers often issue bonds in currencies demanded by
investors.

Cross-Currency Swaps
Positions
• Party A holds €
• Party B holds $
• 4 Possibilities:
– A pays fixed rate on $ received and B pays fixed rate
on € received.
– A pays floating rate on $ received and B pays fixed
rate on € received.
– A pays fixed rate on $ received and B pays floating
– A pays floating rate on $ received and B pays floating

Example of a Currency Swap
• Below are cash flows for £10m 4 year swap 5% fixed for fixed £ / $:
• US Interest Rates: 10% UK Interest Rates 8% Party A holds £10m
• From the perspective of A
Pays
£10m
Contrary to
IRS there is
exchange of
cash flows at
initiation and
termination
Receive $20m Receive £0.8m
Pay
$2m
Receive
£0.8m
Pay
$2m
Receive
£0.8m
Pay
$2m
Receive
£10.8m
Pay
$22m
Termination
date

Other Instruments in International
Finance
• EUROCURRENCY MARKETS
• EUROBOND MARKETS

A-4-2-Lecture in International Finance (1).ppt

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