Foreign Exchange in Practice

The New Environment, Third Edition

By: Steve Anthony

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Hardcover | 1 January 2003 | Edition Number 3

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Hardcover
408 Pages

Edition Type
Revised

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24.77 x 16.51 x 2.54

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Foreign Exchange in Practice , now in its 3rd edition, is the single reference to the forex market any financial practitioner needs to have. It explains the concepts involved in foreign exchange and their application to real-life situations. Numerous examples are given. The book was originally developed as a textbook for the Citibank Bourse Course, an intensive course available to clients and staff of Citibank to improve their mastery of these markets. Examples in this edition have been updated to reflect current rates and include the Euro rather than the former European national currencies. The 3rd edition contains a substantial amount of new content particularly with regard to financial mathematics, interest rate swaps, option pricing and applications of option derivatives and Value at Risk.

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Published: 1st January 2003

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Preface	p. xiii
Exchange Rates	p. 1
Commodity Currency and Terms Currency	p. 1
Reciprocal Rates	p. 2
Price Changes	p. 3
Price and Volume Quotations	p. 3
Cross Rates	p. 5
Chain Rule	p. 5
Points	p. 7
Calculating Exchange Profits and Losses	p. 8
Realized and Unrealized Profits and Losses	p. 8
History of Exchange Rate Determination	p. 9
Practice Problems	p. 11
Interest Rates	p. 12
Nominal and Effective Interest Rates	p. 12
Basis Points	p. 12
Day Count Conventions	p. 13
Simple Interest	p. 13
Variable Interest	p. 15
Compound Interest	p. 16
Semi-Annual Interest	p. 17
Floating Interest Rates	p. 18
Equivalent Interest Rates	p. 19
Index Algebra	p. 19
Logarithms	p. 20
Continuously Compounding Rates	p. 20
Forward Interest Rates	p. 22
Present Value	p. 24
Discount Factors	p. 25
Bonds	p. 25
Practice Problems	p. 27
Cash Flows and Value Dates	p. 29
Specifications of Cash Flows	p. 29
Positive and Negative Cash Flows	p. 29
T-Accounts	p. 29
Spot Value Dates	p. 31
Nostro Accounts	p. 32
Forward Value Dates	p. 32
Short Dates	p. 33
Net Cash Flow Position	p. 33
Net Exchange Position	p. 33
Distinction Between Net Exchange Position and Net Cash Flow Position	p. 35
Net Exchange Position Sheet	p. 38
Blotter	p. 38
NPV Method	p. 39
Practice Problems	p. 40
Yield Curves and Gapping in the Money Market	p. 41
The Yield Curve	p. 41
Reasons for the Normal Yield Curve	p. 42
Impact of Interest Rate Expectations	p. 43
Yield Curves in Practice	p. 45
Spreads for Credit and Liquidity Risk	p. 46
Yield Curve Movements	p. 47
Traditional Banking Strategy: Riding the Yield Curve	p. 48
Gapping in the Money Market: How to Profit from Expected Changes in Interest Rates	p. 49
Opening a Negative Gap	p. 50
Closing a Negative Gap	p. 51
Gapping with a Normal Yield Curve	p. 52
Opening a Positive Gap	p. 54
Closing a Positive Gap	p. 55
Break-Even Rates	p. 55
Early Closure of a Gap	p. 56
Extending a Gap	p. 57
Practice Problems	p. 58
Bid and Offer Rates	p. 61
Quoting Bank and Calling Bank	p. 61
Price Maker and Price Taker	p. 61
Bid and Offer Rates in the Money Market	p. 62
Bid and Offer Rates in the Foreign Exchange Market	p. 62
Bid Offer Spreads	p. 64
Brokers	p. 67
Electronic Dealing Systems	p. 67
Market Jargon	p. 68
Trending Rates	p. 68
Covering a Spot Exchange Position at Market Rates	p. 70
Covering a Spot Exchange Position at Own Rates: Jobbing	p. 70
Market Making	p. 71
Arbitrage	p. 72
Cross Rates	p. 72
Arbitraging Cross Rates	p. 74
Practice Problems	p. 75
Forward Exchange Rates	p. 78
Calculation of Forward Exchange Rates	p. 78
Calculation of Forward Margins	p. 80
Forward Discounts	p. 80
Forward Premiums	p. 81
Compensation Argument	p. 82
Forward Rate Formula	p. 82
Role of Price Expectations	p. 83
Bid and Offer Rates	p. 84
Forward Cross Rates	p. 88
Currency Futures	p. 89
Long-Term Foreign Exchange (LTFX)	p. 89
Zero Coupon Discount Factors	p. 90
NPV Accounting	p. 92
Short Dates	p. 95
Short Date Margins	p. 97
Practice Problems	p. 98
Applications of Forward Exchange	p. 101
Foreign Exchange Risk	p. 101
Hedging	p. 102
Partial Hedging	p. 104
Hedging Export Receivables	p. 105
Effective Exchange Rates	p. 108
Benefits and Costs of Premiums and Discounts	p. 108
Hedging Foreign Currency Borrowings	p. 109
Effective Cost of Hedged Foreign Currency Borrowings	p. 111
Break-Even Rates	p. 112
Cost of Hedging Foreign Currency Borrowings	p. 114
Effective Cost of Unhedged Foreign Currency Borrowings	p. 115
Unhedged Foreign Currency Investments	p. 117
Effective Yield on Hedged Foreign Currency Investments	p. 120
Effective Yield on Unhedged Foreign Currency Investments	p. 121
Par Forwards	p. 124
Practice Problems	p. 126
Swaps	p. 130
Types of Currency Swap	p. 131
Swap Rates	p. 131
Outright Forwards Rates	p. 131
Determining the Spot Rate in a Swap	p. 133
Pure Swaps and Engineered Swaps	p. 133
Short Dated Swaps	p. 135
Applications of Currency Swaps	p. 136
Covering Outright Forward Exchange Positions	p. 137
Rolling a Foreign Exchange Position	p. 140
Historic Rate Rollovers	p. 144
Early Take-Ups	p. 145
Simulated Foreign Currency Loans	p. 147
Simulated Foreign Currency Investments	p. 151
Covered Interest Arbitrage	p. 153
Central Bank Swaps	p. 156
Forward Rate Agreements (FRAs)	p. 157
Calculating the Settlement for an FRA	p. 157
Forward Yield Curves	p. 157
Interest Rate Swaps	p. 158
Pricing Interest Rate Swaps	p. 160
General Formula for Pricing Swaps	p. 162
Cross Currency Swaps	p. 164
Varying Market Conventions	p. 165
Practice Problems	p. 166
The FX Swaps Curve and Gapping in the Foreign Exchange Market	p. 169
The FX Swaps Curve	p. 169
Gapping in the Foreign Exchange Market: How to Profit from Expected Changes in Interest Rate Differentials	p. 173
Riding the Swaps Curve	p. 176
Cash Flow Implications of Spot Rate Changes	p. 177
Break-Even Swap Rate	p. 179
Practice Problem	p. 180
Currency Options - Pricing	p. 181
Calculating Option Premiums	p. 183
Profit Profiles: Naked Options	p. 184
Option Pricing	p. 192
Combinations and Probabilities	p. 194
Probability Distribution	p. 195
Relationship Between the Strike Price and Market Rate	p. 198
Time to Expiry	p. 199
Volatility	p. 201
Risk-Free Interest Rate	p. 206
Put-Call Parity	p. 206
Put-Call Arbitrage	p. 207
Reverse Binomial Method	p. 209
American Versus European Options	p. 210
Geometric Binomial Model	p. 210
Black-Scholes Model	p. 213
Interest Rate Differentials	p. 215
Currency Options	p. 215
Proof of Put-Call Parity	p. 215
Interpreting the Adapted Black-Scholes Formula	p. 217
Black's Model	p. 219
Practice Problems	p. 220
Applications of Currency Options	p. 222
Applications Using Options When There is an Underlying Exposure	p. 222
Effective Exchange Rate	p. 228
Foreign Currency Borrower	p. 229
Foreign Exchange Trader	p. 232
Foreign Currency Investor	p. 234
Varying the Strike Price	p. 236
Collars	p. 237
Zero Premium Collar	p. 237
Ill-Fitting Collar	p. 240
Debit Collar	p. 240
Credit Collar	p. 241
Participating Options	p. 242
Participating Collars	p. 244
Practice Problems	p. 245
Option Derivatives	p. 248
Digital Options	p. 248
Pricing an At-Expiry Digital	p. 249
Reverse Binomial Pricing Method	p. 250
Pricing One-Touch Digitals	p. 251
Closed Form Pricing Formula	p. 252
Applications of Digital Options	p. 252
Barrier Options	p. 255
Pricing Knock-Outs	p. 257
Pricing Knock-Ins	p. 258
Closed Form Solutions	p. 259
Applications of Barrier Options	p. 261
Knock-Out Forwards	p. 262
Combinations	p. 264
Other Path-Dependent Options	p. 264
Other Non-Path-Dependent Options	p. 267
Correlation	p. 270
Cross Rate Volatility	p. 271
Basket Options	p. 272
Hybrids	p. 275
Summary	p. 277
Practice Problems	p. 278
Factors Affecting Exchange Rates	p. 280
Theories of Exchange Rate Determination	p. 280
Factors Affecting Interest Rates	p. 285
Interrelationship Between Interest Rates and Exchange Rates	p. 286
Time Horizon	p. 287
Long-Term Outlook	p. 287
Short-Term Factors	p. 288
Summary	p. 290
Value at Risk	p. 291
Market Price Risk	p. 291
Factor Sensitivities	p. 291
Duration	p. 292
Using Distribution Theory	p. 293
Multiple Factors	p. 299
Theta	p. 301
Delta	p. 304
Gamma	p. 307
Vega	p. 309
Rho	p. 310
Value at Risk Limits	p. 311
The Problem with Stop-Loss Limits	p. 312
Portfolio Value at Risk	p. 313
Stress Tests	p. 314
Credit Risk	p. 314
NPV Method	p. 317
Potential Exposure	p. 317
Credit Risk Factors	p. 319
Pre-Settlement Risk Limits	p. 321
Techniques to Reduce PSR	p. 321
Liquidity Risk	p. 324
Managing Funding Liquidity Risk	p. 325
Other Types of Financial Risk	p. 327
Practice Problems	p. 328
Solutions to Practice Problems	p. 330
Cumulative Standard Normal Distribution ([mu] = 0, [sigma] = 1)	p. 375
Glossary of Terms	p. 378
Index	p. 387
Table of Contents provided by Ingram. All Rights Reserved.

Foreign Exchange in Practice

The New Environment, Third Edition

At a Glance

Hardcover

Shipping

How to return your order

Defective items

You Can Find This Book In

Other Editions and Formats

Paperback

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