FINC3011 Tutorial 1 B&H Chapter 2 Questions 1, 2, 3, 4, 5, 6 & 9 1. What is an exchange rate? Answer: An exchange rate is the relative price of two currencies, like the U.S. dollar price of the euro, the Thai baht price of the Malaysian ringgit, or the Mexican peso price of the Canadian dollar.
2. What is the structure of the foreign exchange market? Is it like the New York Stock Exchange? Answer: The interbank foreign exchange market is a very large, diverse, over-the-counter market, not a physical trading place where buyers and sellers gather to agree on a price to exchange currencies. Traders, who are employees of financial institutions in the major financial cities around the world, deal with each other primarily over the phone or via computer, with written or formal electronic confirmations of transactions occurring only later.
3. What is a spot exchange rate contract? When does delivery occur on a spot ...view middle of the document...
First, for exchanges between the U.S. dollar and the Canadian dollar or the Mexican peso, the rule is 1 business day. Second, if the transaction involves the dollar and the first of the 2 days is a holiday in the United States but not in the other settlement center, the first day is counted as a business day for settlement purposes. Third, Fridays are not part of the business week in most Middle Eastern countries, although Saturdays and Sundays are. Hence, non– Middle Eastern currencies settle on Fridays, and Middle Eastern currencies settle on Saturdays.
4. What was the Japanese yen spot price of the U.S. dollar on December 21, 2010? Answer: Examining Exhibit 2.5 for December 21, 2010 we find that the Japanese yen spot price of the U.S. dollar was ¥84.12/$.
5. What was the U.S. dollar spot price of the Swiss franc on December 21, 2010? Answer: Examining Exhibit 2.5 for December 21, 2010, we find that the U.S. dollar spot price of the Swiss franc was $1.0289/CHF.
6. How large are the bid–ask spreads in the interbank spot market? What is their purpose? Answer: The purpose of the bid-ask spread is to allow traders to profit by buying a currency at a low bid price and selling that currency at a higher ask price. Bid–ask spreads in the spot foreign exchange market are quite small, often only two or three basis points. For example, a yen–dollar trader might quote a bid price of yen per dollar at which she is willing to buy dollars in exchange for yen of, say, ¥83.74/$. The trader would then quote a higher ask price at which she is willing to sell dollars for yen, say, at an exchange rate of ¥83.76/$. This percentage bid-ask spread is
¥83.76/$ - ¥83.74/$ ×100 = 0.02% ( ¥83.76/$ + ¥83.74/$ ) / 2
What is an appreciation of the dollar relative to the pound? What happens to the dollar price of the pound in this situation? Answer: An appreciation of the dollar relative to the pound means that it takes fewer dollars to buy a pound, so the dollar price of the pound falls. This situation is also described as the dollar is stronger in the foreign exchange market, the pound has depreciated versus the dollar, and the pound is weaker in the foreign exchange market.