“aussie Carry Trade: Strategies For Earning Interest-driven Profits” – Exchange rates and commodity prices Foreign exchange markets The demand for money and other goods An example of foreign exchange markets is the role of interest rates on cash deposits and the role of exchange rate expectations.

Exchange rates are quoted as foreign currency per unit of local currency or local currency per unit of foreign currency. How much can be exchanged for one dollar? ¥97.385/$ How much can be exchanged for 1 yen? $ /¥ Exchange rates allow us to express the cost or price of a good or service in the same currency. How much does a Nissan cost? ¥2,500,000 Or, ¥2,500,000 x $/¥ = $25,672.50

“aussie Carry Trade: Strategies For Earning Interest-driven Profits”

Depreciation is a decrease in the value of an asset relative to another asset. $1/€ → $1.20/€ means that the dollar has depreciated against the euro. Now it takes $1.20 to buy one euro, so the dollar is not that valuable. Appreciation is an increase in the value of an asset relative to another asset. $1/€ → $0.90/€ means that the dollar has appreciated against the euro. Now it only takes $0.90 to buy one euro, so the dollar is more valuable.

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A deflated currency means that imports are more expensive and imports are cheaper. A deflated currency lowers the price of exports relative to the price of imports. An appreciated currency means that imports are cheap and exports are expensive. An appreciating currency raises the price of imported goods relative to the price of imported goods. An appreciation of the euro against the dollar means a depreciation of the dollar against the euro.

Car production – a major part of international business, strong competition from Ford (USA), Volvo (Sweden), BMW, Mercedes, Audi (Germany), Honda (Japan), Land Rover (GB), Hyundai, Kia ( South Korea) Exchange rates are important for car manufacturers Appreciation of the spoils hurts Korean manufacturers in two ways It lowers the prices of imported cars and thus lowers the domestic price of Korean cars It raises the prices of Korean cars that are exported and thus lowers the price of Korean cars worldwide. The strong depreciation of the Japanese yen in 2013 Nissan was able to lower the dollar prices of some models of cars sold in the USA and still earn high yen profits. The Altima was $580 cheaper and the Armada SUV $4400.

A group of markets where foreign currencies and other assets are exchanged for domestic ones Different organizations buy and sell currency deposits or other assets for investment purposes. The main foreign exchange trading centers are: London, New York, Tokyo, Frankfurt and Singapore. April 2010: The daily volume of foreign exchange transactions was $4.0 trillion In 1989 it was only $600 billion.

Commercial banks and other depository institutions: transactions involve buying/selling deposits in different currencies for investment purposes. Non-bank financial institutions (mutual funds, hedge funds, securities firms, insurance companies, pension funds) can buy/sell foreign assets for investment. Non-financial corporations (corporations) conduct foreign currency transactions to buy/sell goods, services and goods. Central banks: conduct international financial transactions.

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The majority of sales (85% in April 2010) exchange foreign currencies for U.S. dollars. Because of its important role in many foreign exchange transactions, the US dollar is called the vehicle currency, as it is used more often by foreign parties than the USA. Buying and selling in the foreign exchange market is regulated by commercial and investment banks. Transactions of deposit banks in foreign currencies take place in the amount of $ 1 million or more per transaction. Central banks sometimes intervene, but the direct effects of their interactions are small and cross-border. The purpose of CBs’ interactions is to demonstrate their intentions and expectations to market participants.

Computer and communications technology transfer information quickly and have integrated markets. The integration of financial markets suggests that there will not be significant differences in exchange rates across regions. The reason is arbitrage (buy at a low price and sell at a high price) which eliminates price differences between different locations. Why? Buying where the price is low increases demand there and pushes the price up. Selling where it is desirable increases the supply there and lowers the price.

Spot rates are currency exchange rates “on the spot,” or when the trade is done right now. Forward rates are exchange rates for currency exchanges that will take place in the future (“forward”). The first days are usually 30, 90, 180, or 360 days into the future. Fees are negotiated between the two parties at the moment, but the exchange takes place in the future.

Foreign exchange swaps: a combination of a spot sale and a forward purchase. Swaps allow people to meet each other’s needs for a period of time and are often less expensive than different transactions. For example, let’s say that Toyota receives $ 1 million from the sale of America, it plans to use it to pay its suppliers in California in three months, but at the moment it wants to invest the money in euro bonds.

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Futures contracts: a contract entered into by another party for a fixed amount of foreign currency to be delivered/received on a fixed date. Contracts can be bought and sold in markets, and only the current owner is obligated to fulfill the contract. Option contracts: a contract entered into by another party for a fixed amount of foreign currency to be delivered/received on or before the fixed date. Contracts can be bought and sold in markets. The contract gives the owner the option, but not the obligation, to buy or sell the currency if needed.

What drives the demand for investment funds? Rate of return: the percentage change in value that an asset provides over a period of time. Real rate of return: adjusted rate of return, Real rate of return when the average rate of return is 2% and inflation is 1.5%: 2% – 1.5% = 0.5%. If prices are fixed, the rate of return is 0% and (nominal) rates of return = real rates of return. Because the trading of deposits in different currencies takes place every day, we usually assume that prices do not change from day to day. A good idea to make a short time.

The risk of ownership also influences purchasing decisions. Affordability, or the ease of using assets to purchase goods and services, also influences the willingness to purchase goods. We will assume that the risk and volatility of funds in foreign exchange markets are the same, regardless of the financial institution. Risk and volatility are only important when you decide to buy or sell cash deposits. Importers and exporters may worry about risk and liquidity, but they make up a small fraction of the market.

Investors are very concerned about rates of return on investments. The rate of return that investors expect to receive is determined by the rate of interest that the asset will receive in anticipation of appreciation or depreciation. Comparing the rate of return on a local currency deposit with a foreign currency deposit country, consider the interest rate on foreign currency deposits. the expected rate of appreciation or depreciation of a foreign currency relative to the domestic currency.

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Let’s say the interest rate on a dollar deposit is 2%. Let’s say the interest rate on a euro deposit is 4%. Does a euro deposit offer a higher expected rate of return? Suppose today’s exchange rate is $1/€1, and the expected exchange rate next year is $0.97/€1. $100 can be exchanged today for €100. This 100 euros will give you €104 after a year. These 104 euros are expected to be $0.97/€1 x €104 = $ in one year. The rate of return in terms of dollars from investing in euro deposits is ($ – $100)/$100 = 0.88%. The rate of return from a dollar deposit is the interest rate: 2%

The euro has a low expected rate of return: therefore, all investors should be willing to save dollars and no one should be willing to hold euro deposits. Note that the expected rate of appreciation of the euro was ($0.97 – $1) / $1 = -0.03 = -3%. We simplify the analysis by stating that the dollar rate of return on euro deposits is approximately equal to the interest rate on euro deposits plus the expected appreciation rate on euro deposits of 4% + (–3%) = 1% ≈ 0.88% R€ + (Ee$/€ – E$/€)/E$/€

We use the rate of return on deposits made in dollars and the rate of return on deposits made in foreign currency to build a model of foreign exchange markets. This model is balanced when deposits of all funds provide an expected rate of return: interest rate. Interest rates imply that deposits in all currencies are equally desirable assets. Equity of interest means that arbitrage in the foreign exchange market is impossible.

The profit margin is: R$ = R€ + (Ee$/€ – E$/€)/E$/€ Why should this situation hold? Let’s say it’s not like that. Suppose R$ > R€ + (Ee$/€ – E$/€)/E$/€ Now no investor would want to keep euro deposits, lowering the demand and price of euros . Then all investors may want to hold dollar deposits, to drive

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