1 Friends with FX

Measured by daily turnover, the foreign exchange (FX) marketthe market in which currencies are traded against each otheris by far the worlds largest market. Current estimates put daily turnover at approximately USD 5.1 trillion for 2016. This is about 10 to 15 times larger than the daily turnover in global fixed- income markets and about 50 times larger than the global turnover in equities.

It involves market participants from every time zone connected through electronic communications networks that link players as large as multibillion-dollar investment funds and as small as individuals trading for their accountall brought together in real-time. International trade would be impossible without the trade in currencies that facilitates it, and so too would cross-border capital flows that connect all financial markets globally through the FX market.

Even investors adhering to a purely domestic portfolio mandate are increasingly affected by what happens in the foreign exchange market. Given the globalization of the world economy, most large companies depend heavily on their overseas operations. Almost all companies are exposed to some degree of foreign competition, and the pricing for domestic assetsequities, bonds, real estate, and otherswill also depend on demand from foreign investors. All of these various influences on investment performance reflect developments in the foreign exchange market.

Let us make you comfortable with some of the standard conventions in the FX market, and then well get into the business!

Exchange Rate: a USD/EUR exchange rate of 1.1700 means that 1 euro will buy 1.1700 US dollars (i.e., 1 euro costs 1.1700 US dollars). In this case, the euro is the base currency, and the US dollar is the price currency.

Spot rate: The spot rate is the price quoted for immediate settlement on a currency.

Questions:

1.

The Cross Rate Maze

A research report produced by a dealer includes the following exhibit:

Spot Rate Expected Spot Rate in One

Year

USD/EUR 1.1701 0.9866

CHF/USD 1.1619 1.3118

USD/GBP 0.9900 1.3066

Based on the exhibit, can you list the three currencies from strongest to weakest over the next year?

a) Based on the exhibit, can you list the three currencies from strongest to weakest over the next year?

b) Based on the exhibit, lists the three currencies in order of appreciating the most to appreciating the least (in percentage terms) against the USD over the next year?