EECS 1710 Lecture Notes - Lecture 18: New Zealand Dollar, Foreign Exchange Market, Pound Sterling
24 Jun 2018
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EECS 1710 Lecture 18 Notes
Introduction
Capitalizing on expected exchange rate movements
Assuming that the supply of Swiss francs to be exchanged for pounds is unchanged, the
increased British demand for Swiss francs should cause the value of the Swiss franc to
appreciate against the British pound.
Some large financial institutions attempt to anticipate how the equilibrium exchange
rate will change in the near future based on conditions identified
These institutions may then take a position in the target currency in order to benefit
from their expectations.
Institutional Speculation Based on Expected Appreciation
When financial institutions believe that a particular currency is presently valued lower
than it should be in the foreign exchange market, they may consider investing in that
currency now before it appreciates.
They would hope to liquidate their investment in that currency after it appreciates and
so to benefit from selling it for a higher price than they paid.
EXAMPLE
Chicago Co. expects the exchange rate of the New Zealand dollar (NZ$) to appreciate
from its present level of $.50 to $.52 in 30 days.
Chicago Co. is able to borrow $20 million on a short-term basis from other banks.
Present short-term interest rates (annualized) in the interbank market are as given in
the table.
Given this information, Chicago Co. could proceed
Borrow $20 million.
Convert the $20 million to NZ$40 million (computed as $20,000,000/$.50).
Invest the New Zealand dollars at 6.48 percent annualized, which represents a .54
percent return over the 30-day period [computed as 6.48% (30=360)].
Document Summary
Assuming that the supply of swiss francs to be exchanged for pounds is unchanged, the increased british demand for swiss francs should cause the value of the swiss franc to appreciate against the british pound. When financial institutions believe that a particular currency is presently valued lower than it should be in the foreign exchange market, they may consider investing in that currency now before it appreciates. Present short-term interest rates (annualized) in the interbank market are as given in the table. The supply of swiss francs to be exchanged for pounds is unchanged. The increased british demand for swiss francs should cause the value of the swiss franc to appreciate against the british pound. Some large financial institutions attempt to anticipate how the equilibrium exchange rate will change in the near future based on conditions identified. These institutions may then take a position in the target currency in order to benefit from their expectations.
