Is a group project. only need to do my part.Currency pairs to analyse:AUD/USD and EUR/USDForecaste these pairs from 3-6 months (what will happen in the market in the next 3 months - so from now until July- Sept.)My part is to analyse RELATIVE interest rates, RELATIVE inflation rates and RELATIVE exchange rate expectation. The rest is done by other team members.* No presentation needs to be done.
Introduction to Financial Markets The Foreign Exchange Market Part B Topic 5B BAFI 1002 FINANCIAL MARKETS 4/10/18 1 RMIT University© 2 Overview: Foreign Exchange Market Nature of forex market Foreign exchange rates Spot & forward rates Cross Rates & trading positions Why trade foreign exchange History of forex Determinants of exchange rates More Trading Terminologies Going “Long”: When you are buying a currency Going “Short”: When you are selling a currency From the Market Maker’s Point of View: AUD/JPY “Hit on the Left”: Bought Commodity Currency “Hit on the Right”: Sold Commodity Currency More Trading Terminologies Net exchange position terminology Net exchange position: Total foreign currency bought - total sold Long position: More foreign curr bought than sold Short position: More foreign curr sold than bought Square position: Total bought = Total sold Maintaining an FX trading position When the Market Maker has been: “Hit on the Left”: Bought commodity currency To square their position, they need to sell commodity currency “Hit on the Right”: Sold commodity currency To square their position, they need to buy commodity currency Maintaining an FX trading position Why is it important to square the position? In Long/Short Position, they have FX exposure! What do they need to do? Adjust their bid/offer to attract sellers/buyers Increase both bid/offer: to attract sellers and deter buyers Decrease both bid/offer: to attract buyers and deter sellers RMIT University 6 Maintaining an FX trading position Cash flows and T accounts Suppose you do the following: Buy 2m AUD at AUD/EUR = 0.8620 Sell 5m AUD at AUD/EUR = 0.8625 Sell 3m AUD at AUD/EUR = 0.8630 Net position = short 6m AUD To square this position, you would need to buy 6m AUD. The rate you obtain will determine the profit or loss. Maintaining an FX trading position Using a blotter (A$m)Position Buy 20+20Up 20 Buy 10+30Up 30 Sell 5+25Up 25 Sell 15+10Up 10 Sell 15-5Down 5 Sell 10-15Down 15 Buy 150Square Maintaining an FX trading position These cash flows can be shown as follows: AUDEURRates AUD/EUR 2,000,000-1,724,0000.8620 -5,000,0004,312,5000.8625 -3,000,0002,589,0000.8630 6,000,000-5,172,0000.8620 05,500 RMIT University© 10 Overview: Foreign Exchange Market Nature of forex market Foreign exchange rates Spot & forward rates Cross Rates & trading positions Why trade foreign exchange History of forex Determinants of exchange rates History of exchange rate systems Early systems of exchange rate determination The Gold Standard (1879 to 1934): Currency value based on country gold reserve. gold was set at a fixed price exchange rates were also fixed FIXED exchange system The Bretton Woods system (1944 to 1970’s): U.S. dollar fixed at $35 per ounce of gold, all other currencies value based on gold and US dollar reserve. PEGGED exchange system 4/10/18 11 History of exchange rate systems Problems with fixed exchange system: A country will run down its international reserves if it has to keep buying its own currency Balance of payment deficits or surplus will affect a country’s currency reserves and affect monetary stability Vulnerability to speculative attacks: when the fixed rate is too high, central bank forced to buy back domestic currency. The economic conditions of the pegging country must closely match those of the reserve county. 4/10/18 12 RMIT University© 13 Overview: Foreign Exchange Market Nature of forex market Foreign exchange rates Spot & forward rates Cross Rates & trading positions Why trade foreign exchange History of forex Determinants of exchange rates Exchange rate determination The exchange rate for a currency is determined by the buying and selling decisions of those who trade in the FX market Market forces will establish the level of supply and demand The equilibrium exchange rate will be established by the interaction of supply and demand Exchange rate determination Demand for a currency will result from: An increase in exports An increase in capital inflow Supply of a currency will result from: An increase in imports An increase in capital outflow From Rest of the World From Domestic players 4/10/18 15 Exchange rate determination Exchange Rate Quantity of AUD S D The level of supply is directly related to the value of the currency The level of demand is inversely related to the value of the currency Exchange rate determination The foreign exchange market brings together the forces of supply and demand, and establishes an equilibrium exchange rate at which the level of supply equals the level of demand Exchange rate determination Exchange Rate Quantity of AUD S D .60 .70 .50 Equilibrium rate Excess Demand Excess Supply At a higher exchange rate, such as 0.70, there will be an excess supply of the AUD At a lower exchange rate, such as 0.50, there will be an excess demand for the AUD Determinants of the FX value of a country’s currency Economic fundamentals Relative inflation rates Commodity prices Relative economic growth rates Relative interest rates Other factors International speculation/investment Exchange rate expectations Official intervention G S P Y I 4/10/18 19 Relative inflation rates If Australia has higher inflation than its trading partners, it will experience: Less demand for exports, and therefore less demand for AUD More demand for imports, and therefore more supply of the AUD Relative inflation rates Exchange Rate Quantity of AUD S1 D1 ER1 ER2 D2 S2 D: Less demand for exports, and therefore less demand for AUD S: More imports, and therefore more supply of the AUD Q1 Purchasing power parity This parity relationship is based on the “law of one price” It predicts that identical commodities will sell at the same price in different currencies, after adjustment for exchange rates Has been tested empirically (eg. the “Big Mac” index) PPP doesn’t hold in the short run, because not all goods are traded However, adjustments to exchange rates because of inflation will tend to equalise prices and inflation in the long run http://www.economist.com/content/big-mac-index 4/10/18 22 RMIT University 23 Could currency depreciation alone boost exports? RMIT University 24 If so, then “Made in Russia” labels would be common! Russian Rubles are undervalued by 69% In LR: exchange rates would adjust such that identical goods in two diff countries have the same price if expressed in the same currency Commodity prices Australia is a major exporter of commodities (eg. minerals and agricultural products) An increase in commodity prices will increase the value of Australian exports, resulting in an appreciation Trading partners cannot switch suppliers because commodity prices are constant world-wide 4/10/18 25 Commodity prices Relative economic growth rates One effect of higher levels of economic growth is an increased demand for imports This will increase the supply of the AUD, and shift the supply curve to the right Another effect could be to increase the level of overseas borrowing (to finance increased investment) This will increase the demand for the AUD, and shift the demand curve to the right Relative economic growth rates Exchange Rate Quantity of AUD S1 D2 ER1 D1 S2 S: More imports, and therefore more supply of the AUD D: Increase the level of overseas investments, and therefore more demand for AUD Q1 Q2 Relative economic growth rates The net effect of these two factors is difficult to predict in advance Relative interest rates The traditional view was that an increase in interest rates would have the following effects: Encourages capital inflow, increasing demand for the AUD Discourages capital outflow, decreasing supply of the AUD The net effect would be an appreciation of the AUD Relative interest rates Exchange Rate Quantity of AUD S2 D2 ER2 ER1 D1 S1 D: Encourages capital inflow, increasing demand for the AUD S: Discourages capital outflow, decreasing supply of the AUD Q1 Relative interest rates Empirical evidence suggests high interest rates result in depreciation Why? Increase in interest rate may be the result of inflation It is important to distinguish between: Nominal interest rate - the observable rate which includes the effect of inflation Real interest rate - the underlying rate, which is received over and above the inflation rate 4/10/18 32 Relative interest rates If the nominal interest rate is high because the real rate is high: This will lead to capital inflow and appreciation However, real rates are usually constant and high nominal rates usually reflect high inflation rates: This will lead to a depreciation as a result of high inflation (see above) This can be linked to carry trade Determinants of the FX value of a country’s currency Economic fundamentals Relative inflation rates Commodity prices Relative economic growth rates Relative interest rates Other factors International speculation/investment Exchange rate expectations Official intervention International speculation and investment Capital tends to flow into strong economies and out of those with weaker economies Positive or negative economic outlooks will result in massive buying and selling by currency speculators, resulting in significant variation in exchange rates Exchange rate expectations Expectations about future exchange rates can become a self-fulfilling prophecy Eg. If a currency is expected to appreciate, speculators will buy the currency, increasing demand for the currency, causing it to appreciate The opposite occurs if a currency is expected to depreciate Official intervention Exchange rates are also influenced by intervention by central banks For floating exchange rates, the central bank will intervene by “smoothing” and “testing” (Australia “Dirty float”) For fixed exchange rates, significant buying and selling may be required to keep the currency at its target value (e.g China) RMIT University© 38 THE END Microsoft Word - Rubrics BAFI1002 INANCIAL MARKETS SEMESTER 1 2017 SCORING RUBRIC FOR MARKET VIEW PRESENTATION Organization – 1 Mark - Objectives are clearly outlined. - The material presented is informative and follows a logical sequence. Currency Selection and Conclusion – 1 Mark - Clearly identify a single currency pair. - Clearly present their forecasts for these pairs. Presentation Quality – 3 Marks - Information is professionally presented. - Body Language and eye contact. - Notes reading - Length of presentation is within the assigned time limits. Theories and Arguments – 4 Marks - Relevant theories are identified and applied correctly. - Evidence of fundamental and technical analysis. - Use of Graphs, Figures, Diagrams. - Figures, Diagrams are properly labelled and clearly understandable. - Information was well communicated. - Use of appropriate terminology. Referencing – 1 Mark - Properly referenced, either verbally or in writing. - Used proper authentic sources as advised in the document. - Minimum of 4 references used. Microsoft Word - Market View Assignment v2 BAFI1002 FINANCIAL MARKETS MARKET VIEW VIDEO PRESENTATION Background information The foreign exchange market is an ever-so-changing area of the financial markets. In the foreign exchange market we see extremely rapid movements in exchange rates within a matter of seconds. It is this that makes the FX market a very high risk but very high reward area to trade in. Traders often prepare trading strategies that can allow them to take advantage of movements in exchange rates. Generally, trading strategies are based on market analysis, which examines