FXrateCANVAS-Additionalchapter8.pptx

The Foreign Exchange Market

(Forex or FX)

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Foreign Exchange

An exchange rate is the price of a currency in terms of another

Exchange rates are expressed in

Money is bought/sold in a market (Forex, FX).

We buy/sell currencies to buy/sell products in foreign markets (or to invest)

Exchange rates change rapidly (appreciate/depreciate)

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Foreign Exchange

Exchange rates may change due to

Change in supply/demand

Products become more/less desirable

Stability of monetary system, strength of the economy

Three factors impact future exchange rate movements

A country’s price inflation

A country’s interest rate

Market psychology

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Forex is the largest, most liquid market in the world

$5.5 Trillion per day …. Or $220 Billions per hour!

USD makes up the majority of transactions

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How to do currency conversions?

You need a “ foreign exchange quote”. The price of 1 currency given in terms of another.

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You can look up foreign exchange quotes in the newspaper under the business section or look online. Many websites will give you a quote that reflects the last quote of the prior day.

For example, go to this website to check the different rates of US Dollar to other world currencies:

https://www.x-rates.com/table/?from=USD&amount=1

Currency Codes

U.S. Dollar = USD

Mexican Peso = MXN

Canadian Dollar = CAD

British Pound = GBP

Euro = EUR

Japanese Yen = YEN

Australian Dollar = AUD

Chinese Yuan = CNY

…..

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Currency Symbols

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FX Quotes

Cross Tables

Read the table from top to bottom. For example, 1 US Dollar is equal to 1.22 Canadian dollars; 1 US Dollar is equal to 118.91 Japanese Yen; 1 USD is equal to 15.22 Mexican pesos; etc…..

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FX Quotes

Listing in newspaper

EUR/USD = 1.1319

Base currency

means that for every Euro you get 1.13 U.S. Dollars

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Newspapers will usually show quotes like these. The base currency (1 unit) goes first, the foreign currency is second. In this example, the quote reads:

EUR/USD = 1.1319, which means that for every 1 EURO you get 1.1319 U.S. Dollars

FX Quotes

Quotes can be expressed in different ways:

EUR/USD 1.1319

1.1319 USD per EUR

1 EUR = 1.1319 USD

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Other ways of expressing foreign exchange rate quotes.

Example of exchange rate quote:

10 MXN per USD

It means that 10 Mexican pesos equal to 1 U.S. Dollar

How much is 2 USD in MXN?

(2*10=20)20 MXN

How much is 100 MXN in USD?

(100/10=10)10 USD

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Example of exchange rate quote:

10 MXN per USD

Proportion or Ratio:

X = =

X =

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To solve it you simply do a ratio or proportion. Once you have the proportion you can solve for the unknown, or “X”.

Example of exchange rate quote:

10 MXN per USD

Proportion or Ratio:

X = =

X =

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Example of exchange rate quote:

20.5 MXN per USD

It means that 20.5 Mexican pesos equal to 1 U.S. Dollar

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A more realistic quote for the Mexican peso and the US dollar

Do a ratio or proportion!

20.5 MXN per USD

Convert $50 USD to MXN:

X = 50 (20.5) / 1

X = 1025 / 1

X= 1,025 MXN

20.5 MXN per USD

Convert $50 USD to MXN

X = 50 (20.5) / 1

X = 1025 / 1

X= 1,025 MXN

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As long as you set the proportion correctly, it doesn’t matter which currency goes on top or on the bottom. Always compare “orange to oranges” and “apples to apples”. IF you put USD on top, then the other ratio should have USD on top. Or in the second example, pesos on top in both ratios and dollars on the bottom for both ratios being compared!

Foreign Exchange (inverse)

20.5 MXN per USD

Convert $50 USD to MXN:

X = 50 (20.5) / 1

X = 1025 / 1

X= 1,025 MXN

0.048780488 USD per MXN

Convert $50 USD to MXN:

X= 1(50) / (0.048780488)

X = 50/0.048780488

X= 1,025 MXN

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You can also express the inverse of the quote and you would get the same answer.

In the example on the left, the quote is pesos per dollars (20.5 MXN per USD). In the right, we see the inverse: Dollars per Pesos (0.4878 USD per MXN).

The result of converting $50 USD to pesos is the same no matter which quote you use.

Foreign ExchangeDollars to British Pounds

$1USD = £0.5

Convert $40 USD to GBP:

Will I have MORE GBP or LESS GBP after I do my conversion? (is my answer more than 40 or less?)

Less!

(40*0.5= 20 GBP)

£1.00 = $1.55 USD

If I was converting 50 Pounds to U.S…….

Would I have MORE USD or LESS USD after I do my conversion?

More!

(50*1.55= 77.5 GBP)

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Foreign Exchange

$1USD = £0.5

Convert $300 GBP to USD

Will I have MORE USD or LESS USD after I do my conversion? (is my answer more than 300 or less?)

More!

(300/0.5= 600 GBP)

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Foreign Exchange

Always set up your ratios correctly!

“Apples with apples, oranges with oranges”….. Or in other words…. USD with USD, GBP with GBP, Pesos with Pesos.

If you don’t…. Then your math will be wrong!

In this example…..

Notice that dollars are on top on both sides of the equation and AUD are in the bottom on both sides.

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If quote today is:

1.0950 CAD per USD

… and quote tomorrow is:

2.9990 CAD per USD

Which currency appreciated? The USD appreciated in relation to the CAD

(you get more CAD for the same 1 USD)

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The USD appreciated in relation to the CAD. In other words, you need MORE Canadian Dollars “tomorrow” to get the same 1 USD. The Canadian dollar DEPRECIATED against the USD and/or the USD APPRECIATED against the CAD

Where can I exchange currency when I travel?

At your bank, at an exchange house at the airport, at exchange house in the city, or using your credit card

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At exchange rate businesses you will see a board with different “quotes”. You may be familiar with those boards at airports, banks, hotels. Or you can use your credit card and the bank will record the exchange rate of the day of the transaction and you’ll be charged in your home currency. Sometimes the bank rate is not in your favor; depends on your bank and your type of card. Beware of “international transaction fees” as well!

I see 2 quotes listed at the bank….Which quote do I use? It depends!

In this example, the Mexican bank’s quotes say:

BUY: 20.5

SELL: 21.5

The bank is showing what THEY are willing to trade for….

When they BUY U.S. Dollars, they pay 20.5 pesos per every 1 dollar

When they SELL U.S. dollars, they ask for 21.5 pesos

20.5

21.5

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It depends!

If you have USD that you want to exchange to Mexican Pesos…. The bank would BUY your USD. You would get 10.5 pesos per every dollar.

If you have MEXICAN PESOS that you want to exchange to dollars, the bank would SELL you USD. You would pay 21.5 pesos for every dollar.

Which one is better?

Exchange House “A”:

BUY: 20.5

SELL: 21.2

Exchange House “B”:

BUY: 21.0

SELL: 21.5

If I am changing my USD to Mexican Pesos…. I want to get MORE pesos….. So I would go to “B”.

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I get more PESOS (21.0) at “B”. If I had gone to “A”, I would only get 20.5 pesos for every dollar.

This is obviously more important as the number of dollars exchanged increases. While the difference in one dollar exchanged may not seem like much, what if you were exchanging $500,000 USD? Then the difference would be significant!

Which one is better?

If I am changing my Mexican Pesos to USD…. I want to pay LESS pesos for every dollar….. So I would go to “A”.

Exchange House “A”:

BUY: 20.5

SELL: 21.2

Exchange House “B”:

BUY: 21.0

SELL: 21.5

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In this example, “A” gives me a better rate. I would pay only 21.2 pesos for every dollar, where in “B” I would have to pay 21.5 pesos for every dollar.

When Do Firms Use The Foreign Exchange Market?

International companies use the foreign exchange market when

the payments they receive for exports, the income they receive from foreign investments, or the income they receive from licensing agreements with foreign firms are in foreign currencies

they must pay a foreign company for its products or services in its country’s currency

they have spare cash that they wish to invest for short terms in money markets

they are involved in currency speculation – the short-term movement of funds from one currency to another in the hopes of profiting from shifts in exchange rates

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What do you need to know?

What is an exchange rate and how to express it

Common currency codes and symbols

How to read cross tables

How to do currency conversions

Understand appreciation/depreciation of currencies

Understand how changes in value of currencies impact companies and consumers

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