foreign investment

1. THE FOREIGN
EXCHANGE MARKET
Cross rate – Option contract

2. Cross Rates
■ Cross rates helps in the determination of exchange rate betwwen two
countries with help of one mutual country.

3. Direct quote
■ It state how much units of local currency is needed to purchase a unit of foreign
currency

4. Indirect quote
■ AN indirect quote represent how much units of foreign currency is required to
purchase/sell one unit of local currency.
■ Indirect Quote = 1/ Direct quote

5. Excercise
Country $ Euro Pound Peso Yen C$
Canada 1.3689 -
Japan 109.48 -
Mexico 11.3921 -
United
Kingdom
0.5460 -
Euro 0.8222 -
United
States
-

7. ■ USD/VND= 22.1305 - 15
■ VND/USD = ??
■ => X/Y =a–b =>Y/X = ?
■ Dealers buyY by X -> Dealers offer price a ( we sellY)
■ Dealers sellY by X => we offer price b (We buyY)
■ X/Y = a- b =>Y/X = 1/b – 1/a

8. ■ Market inform
– X/Y = a/b
– X/Z = c/d
– -> Calculation cross rateY/Z , Z/Y
– Y/Z= c/b – d/a
– >> Z/Y= a/d – b/c

9. 15-9
Spot MarketQuotations (cont.)
■ Calculating cross-rates (cont.)
– Example 3: Crossing two direct FX quotations:
USD/EUR0.7650–55
USD/JPY105.40–50
To determine the EUR/JPY cross-rate:

10. 15-10
Spot MarketQuotations (cont.)
■ Calculating cross-rates (cont.)
– Example 4: Crossing a direct and indirect FX quotation:
USD/JPY 105.40–50
GBP/USD 1.9170–75
To determine the GBP/JPY cross-rate:
1.9170 x 105.40 = 202.05
1.9175 x 105.50 = 202.30
GBP/JPY 202.05–30

11. 15-11
Spot MarketQuotations (cont.)
■ Calculating cross-rates (cont.)
– Example 5: Crossing two indirect FX quotations:
AUD/USD0.7862–69
GBP/USD1.9170–75
To determine the AUD/GBP cross-rate:
0.7862/1.9175 = 0.4100
0.7869/1.9170 = 0.4105
AUD/GBP 0.4100–05

13. How we can profit from FX market
■ Principle trade : buy low ; sell high
■ A/B = x/y
■ A/B = z/t
■ -Condition : y <z or x>t

14. Example
■ At London : USD/VND = 22,120 – 25
■ At NewYork: USD/VND=22,128 – 30
■ => Question: Do we earn profit ?

15. OPTION CONTRACT

16. Options
■ With options, one pays money to have a choice in the future
■ Essence of options is not that I buy the ability to vacillate, or to exercise
free will.The choice one makes actually depends only on the underlying
asset price
■ Options are truncated claims on assets

17. Terms of Options Contract
■ Exercise date
■ Exercise price
■ Definition of underlying and number of shares
■ Strike price
■ Premium

18. Derivatives product
Options
Forward
Future
Swaps

19. DERIVATIVES
Types of
Derivatives Markets
Over-the-Counter
derivatives
(OTC)
Exchange traded
derivatives

20. • A contract to buy or sell an asset at a specified time in
the future for a price established today
• A forward contract involves a buyer and a seller.
• In general, neither party of a forward contract pays any
money at start.
FUTURES – forward contracts

21. OPTIONS
■ This is an instrument that gives investors choice
of whether or not exercise their option by
buying of selling the underlying asset linked to
the option

22. REASON FOR DERVIVATIESTRADING
LEVERAGE: -> using of small capital in order to obtain bigger returns.
SPECULATE -> OBTAIN HUGE PROFIT when the underlying asset moves in the
way expected by investor
HEDGING -> preserve the capital and minimize risk

23. Ternminology
■ Strike price – exercise price : will be unchanged to until the option expires
■ Option premium: the fee/ price of option contract
■ Underwriter: the party sells call option – sell put option
■ Pay off : the returns from buying the call option is called pay-off

24. BasicTerminology
■ Every option has three different price elements
– The strike or exercise price is the exchange rate at which the
foreign currency can be purchased or sold
– The premium, the cost, price or value of the option itself paid
at time option is purchased
– The underlying or actual spot rate in the market
■ There are two types of options
– American options may be exercised at any time during the
life of the option
– European options may not be exercised until the specified
maturity date

25. OPTIONS
Call option – Right to buy
(but not an obligation)
Put option – Right to sell
(but not an obligation)
DERIVATIVES
 Main types of Options Contract

26. Company Logo

27. Calls and Puts
CALL BUYER
Right to buy
Expects FC ↑
CALL WRITER
Obligation to sell
Expects FC ↓
PUT BUYER
Right to sell
Expects FC ↓
PUT WRITER
Obligation to buy
Expects FC ↑

28. Call option value = max [ 0,V –X]
V: underlying asset price
X: strike price
Profit for buying call option = max [ 0,V –X] – call option premium

29. ■ You bought one call option of MAS share at RM2 with an
exercise price is RM10.
■ A) Find out the value of the call option and then calculate the
pay –off and the profit if MAS share price in the future is (i)
RM15; (ii) RM10; (iii) RM5
■ B/What is the MAS share price if the buyer of call option
wants to break even?

31. There are four types of participants in
options markets:
1. Buyers of calls
2. Seller of calls
3. Buyer of puts
4. Seller of puts

32. Company Logo

33. Simple Example
■ ABC has Euro 10m payment due in 128 days.
■ Buys Call options to limit its cost of Euro payment!
■ Strike Price: $1.31 per Euro
■ Premium: $0.016 per Euro

34. ■ If spot is >1.31, call option will be exercised!
– Cost=Strike x Underlying Amt + Premium
– Cost= 1.31 x (10,000,000)+160,000
– =$13,260,000
– Or unit cost 1.31+0.016=1.3260

35. Spot<1.31
■ If Spot < 1.31, call will not be exercised.We will buy Euro 10m at spot:
■ Cost=Spot Rate x 10,000,000+Premium
■ =or per unit =Spot Rate+0.016

36. Simple Example
■ ABC has Euro 10m receivable (asset) due in 128 days.
■ Buys Put options to protect $ value of its Euro receivables (assets)!
■ Strike Price: $1.31 per Euro
■ Premium: $0.0385 per Euro

37. Effective Receipt of Euros
■ Exercise the option if Spot<1.31
■ Get : (Strike-Premium)per Euro sold
■ =1.31-0.0386=1.2714
■ Do not exercises if spot >1.31
■ Get: (Spot-0.0386)

38. ■ You purchase a call option on pounds for a premium of $.03 per unit,
with an exercise price of $1.64; the option will not be exercised until the
expiration date, if at all. If the spot rate on the expiration date is $1.65,
What is your net profit per unit ?

39. ■ A U.S. corporation has purchased currency put options to hedge a 100,000Canadian
dollar (C$) receivable.The premium is $.01 and the exercise price of the option is $.75.
If the spot rate at the time of maturity is $.85, what is the net amount received by the
corporation if it acts rationally?

40. ■ A U.S. corporation has purchased currency call options to
hedge a 70,000 pound (£) payable.The premium is $0.02 and
the exercise price of the option is $0.50. If the spot rate at the
time of maturity is $0.65, what is the total amount paid by the
corporation if it acts rationally?