FIN415 Class Web Page, Spring '23

Jacksonville University

Instructor: Maggie Foley

The Syllabus

Term Project Part I (due with final) Part I video
Term project part II (excel questions) (due with final) part II - A video part II – B video

Weekly SCHEDULE, LINKS, FILES and Questions

Week

Coverage, HW, Supplements

- Required

Supplemental Reaching Materials

Week

1

Marketwatch Stock Trading Game (Pass code: havefun)

Use the information and directions below to join the game.

1.     URL for your game: 
https://www.marketwatch.com/game/fin415-23spring

2.     Password for this private game: havefun.

3.     Click on the 'Join Now' button to get started.

4.     If you are an existing MarketWatch member, login. If you are a new user, follow the link for a Free account - it's easy!

5.     Follow the instructions and start trading!

6. Game will be over on 4/17/2019

How to Use Finviz Stock Screener  (youtube, FYI)

How To Win The MarketWatch Stock Market Game (youtube, FYI)

How Short Selling Works (Short Selling for Beginners) (youtube, FYI)

-

World Economy of 2022 by World Bank

https://www.worldbank.org/en/news/immersive-story/2022/12/15/2022-in-nine-charts

Highlights from the World Bank Group-IMF 2022 Annual Meetings: Navigating an Uncertain World (youtube)

World Bank shares its 2022 review after a challenging year

https://en.hespress.com/56355-jenna-ortega-accused-of-anti-semitism-for-supporting-palestine.html

Hespress EN, Thursday 5 January 2023 - 19:21

In a study summarizing 2022, the World Bank provided charts showing how various factors disrupted the world and led to a crisis in global development.

“Slowing growth contributed to a reversal of progress on the global poverty agenda and an increase in global debt,” said the World Bank.

Global vaccination campaigns helped nations to begin recovering from the pandemic and brought millions of children back to school, but the report noted that the long-term effects of recent learning losses could linger for years.

It highlighted that as a result of climate change and Russia’s invasion of Ukraine, food inflation and food insecurity increased considerably throughout the year, pushing up the cost of food, fuel, and fertilizer.

The World Bank worked with its partners all year to help turn shareholder contributions and equity into expanded support for countries to meet their most pressing needs, as stated in the report, in order to combat these multiple crises and contribute to a more stable and equitable recovery.

The first element that the World Bank elaborated on is slowing growth.

With worldwide consumer confidence already experiencing a considerably greater decrease than during the lead-up to past global recessions, the global economy is currently experiencing its worst slowdown since a post-recession recovery began in 1970.

The three largest economies in the world, the US, China, and the euro area, have all seen a significant slowdown. Given the situation, even a slight blow to the world economy over the course of the ensuing year might send it into a recession, explained World Bank.

The second element is poverty, as the COVID-19 pandemic dealt the largest setback to global poverty reduction efforts in decades, and the recovery has been highly uneven,” declared the organization.

The year 2022 will now go down in history as the second-worst year for reducing poverty (after 2020).

According to current projections, 7% of the world’s population, or around 574 million people, will still be living in extreme poverty in 2030, which is well behind the worldwide target of 3%.

The third factor is the evolving nature of debt, as overall debt levels for developing nations have risen over the past ten years, with almost 60% of the world’s poorest nations either in debt crisis or at risk of it.

World Bank said that “over-encumbered with debt, the world’s poorest are not able to make critical investments in economic reform, health, climate action, or education, among other key development priorities.

The COVID-19 health response has received the most funding from the World Bank Group, making the disease the fourth aspect of the report.

Over 100 nations received about $14 billion from the organization, including over 30 that were affected by violence, war, and fragility.

The fifth factor is rising food insecurity and inflation as 2022 was characterized by a sharp increase in food insecurity globally.

The World Bank Group has responded by allocating $30 billion over the course of 15 months to alleviate food insecurity.

Ramping up Climate Investment is the organization’s sixth priority on the list.

Delivering a record $31.7 billion in climate finance, the highest ever in a single year in its history, the World Bank Group increased its assistance to help countries address climate and development issues jointly.

Energy was the seventh component because, in the first half of 2022, the world’s energy markets experienced one of the biggest shocks in decades, which caused energy prices to soar, exacerbated energy shortages and security concerns, and slowed down efforts to achieve universal access to affordable, reliable, sustainable, and modern energy by 2030.

“The vulnerability and isolation of populations without electricity have prompted countries to increase their focus on energy access and affordability in their COVID-19 recovery plans,” noted the organization.

The eighth element is the body’s response to the learning crisis.

The World Bank recommends that nations keep schools open and extend instructional time in order to address this issue, evaluate students and equip teachers to adapt their instruction to students’ levels of learning.

It also suggested streamlining the curriculum and concentrating on the fundamentals, and establishing a national political commitment to learning recovery that is informed by reliable learning measurement.

Part II In class exercise – practice of converting currencies

If the dollar is pegged to gold at US $1800 = 1 ounce of gold and the British pound is pegged to gold at £1200 = 1 ounce of gold. What should be the exchange rate between US$ and British £? How much can you make without any risk if the exchange rate is 1£ = 2$? Assume that your initial investment is $1800. What about the exchange rate set at  1£ = 1.2$? What about your initial investment is £1200?

Solution: 

1£ = 2$ (note that the exchange rate is set at 1£ = 1.5$ since $1800 = £1500=1 ounce of gold è $1.5=1£).

è With $1800, you can buy 1 ounce of gold at US $1800 = 1 ounce of gold. èWith one ounce of gold, you can sell it in UK at £1200 = 1 ounce of gold, so you can get back £1200 è convert £ to $ at $2=1£ as given èget back £1200 * 2$/£ = $2400 > $1800, initial investment è you could make a profit of $600 ($2400 - $1800=$600) è Yes.

1£ = 1.2$ (note that the exchange rate is set at 1£ = 1.5$ since $1800 = £1500=1 ounce of gold è $1.5=1£).

è With $1800, you can buy either 1 ounce of gold at US $1800 = 1 ounce of gold. è With one ounce of gold, you can sell it in UK at £1200 = 1 ounce of gold, so you can get back £1200 è convert £ to $ at $1.2=1£ as givenèget back £1200 * 1.2$/£ = $1440 < $1800 è you will lose $360 ($1440 - $1800=$-360) è No.

è So should convert to £ first and then buy gold in UK è With $1800, you can convert to £1500 ($1800 / (1.2$/£ = £1500 ). è buy gold in UK at £1200 = 1 ounce of gold, so you can get back £1500/£1200 = 1.25 ounce of gold è Sell gold in US at  US $1800 = 1 ounce of gold è So get back 1.25 ounce of gold * $1800 = $2250 > $1800 è you will make a profit of $450 ($2250 - $1800=$450) è Yes.

Homework chapter1-1 (due with first midterm exam)

1. If the dollar is pegged to gold at US $1800 = 1 ounce of gold and the British pound is pegged to gold at €1500 = 1 ounce of gold. What should be the exchange rate between US$ and Euro €? How much can you make without any risk if the exchange rate is 1€ = 1.5$? (hint: $1800 è get gold è sell gold for euro è convert euro back to $) How much can you make without any risk if the exchange rate is 1€ = 0.8$? (hint: $1800 è get euro è buy gold using euro è sell gold for $) Assume that your initial investment is $1800.   (answer: $1.2/euro, $450, $900)

2. What is your opinion on arbitrage across borders? Do you think that arbitrage crypto will work? (Optional homework question)

Crypto arbitrage:Cryptocurrency arbitrage is a strategy in which investors buy a cryptocurrency on one exchange, and then quickly sell it on another exchange for a higher price. Cryptocurrencies trade on hundreds of different exchanges, and often the price of a coin or token may differ on one exchange versus another.

https://www.sofi.com/learn/content/crypto-arbitrage/#:~:text=Cryptocurrency%20arbitrage%20is%20a%20strategy,on%20one%20exchange%20versus%20another.

How I Became A Crypto Billionaire In 5 Years (CNBC)

The FTX Collapse, Explained | What Went Wrong | WSJ (youtube)

Jan 11 Class video (covers in class exercise)

Sam Bankman Fried Explains His Arbitrage Techniques

Nicholas Pongratz, April 9, 2021·3 min read

https://www.yahoo.com/video/sam-bankman-fried-explains-arbitrage-132901181.html

A former ETF trader at Jane Street, Sam Bankman-Fried developed a net worth of $9 billion from trading crypto in three and a half years. He explained his success comes from lucrative arbitrage opportunities in crypto.

Bankman-Fried launched a crypto-trading firm called Alameda Research in 2017. The company now manages over $100 million in digital assets. The firm’s large-scale trades made Bankman-Fried a self-made billionaire by the age of 29. He is also the CEO and founder of the FTX Exchange, a cryptocurrency derivatives trading exchange.

Upon entering the crypto markets, he discovered that Bitcoin was growing very rapidly in trading volumes. This meant there would also be large price discrepancies, making it ideal for arbitrage, taking advantage of the price differences.

The Kimchi Premium

One opportunity he exploited was what is known as the kimchi premium. While Bitcoin was pricing at around $10,000 in the US, it traded for $15,000 on Korean exchanges. This was because of a huge demand for Bitcoin in Korea, Bankman-Fried said.

Around its peak, there was a vast spread of around 50%, he said. However, because the Korean won is a regulated currency, it was difficult to scale this arbitrage. Bankman-Fried said:

“Many found a way to do it for small size. Very, very hard to do it for big size, even though there are billions of dollars a day volume trading in it because you couldn’t offload the Korean won easily for non-crypto.”

Although nowhere near as significant, the premium still exists today. According to CryptoQuant, the premium is listed at 18%.

10% Daily Returns in Japan

Bankman-Fried then sought a similar opportunity in other markets, which he found in Japan. He said:

“It wasn’t trading quite the same premium. But it was trading at a 15% premium or so at the peak, instead of 50%.”

After buying Bitcoin for $10,000 in the US, investors could send it to a Japanese exchange. There they could sell it for $11,500 worth of Japanese yen. At that point, they could convert the amount back to dollars.

Because of the trade’s global nature and the wire transfers involved, it would take up to a day to perform. ”But it was doable, and you could scale it, making literally 10% per weekday, which is just absolutely insane,” Bankman-Fried said.

Bankman-Fried was successful where others were not because he managed to facilitate all the different components involved in the trade. For example, finding the right platform to buy Bitcoin at scale, then getting approval to use Japanese exchanges and accounts. There was also the difficulty of even getting millions of dollars out of Japan and into the US every day.

“You do have to put together this incredibly sophisticated global corporate framework in order to be able to actually do this trade,” Bankman-Fried said. “That’s the real task, the real hard part.”

High Edge, Low Risk

The decentralized aspect of the crypto ecosystem enables these large arbitrage premiums to exist. With other financial markets, there is a cross merging between exchanges and central clearing firms or brokers, Bankman-Fried explained. “So it’s really capital-intensive, and also you have to worry about counterparty risk,” he added.

But once investors and traders come to understand the crypto space intimately, they can figure out where the counterparty risk is close to zero, but the edge is still high.

According to Bankman-Fried:

“There’s a lot of money to be made, if you can really figure out and pinpoint when there is and isn’t a ton of edge and when there is and isn’t a ton of actual counterparty risk.”

Part III: Multilateral Trade vs. Bilateral Trade

Trade agreement (video)

What is MULTILATERALISM? (youtube)

Take away:

· Multilateral trade agreements strengthen the global economy by making developing countries competitive. 

· They standardize import and export procedures giving economic benefits to all member nations. 

· Their complexity helps those that can take advantage of globalization, while those who cannot often face hardships.

For class discussion: Do you agree with the above points? Why or why not?

Multilateral Trade Agreements With Their Pros, Cons and Examples

5 Pros and 4 Cons to the World's Largest Trade Agreements 

https://www.thebalance.com/multilateral-trade-agreements-pros-cons-and-examples-3305949

BY KIMBERLY AMADEO REVIEWED BY ERIC ESTEVEZ Updated October 28, 2020

Multilateral trade agreements are commerce treaties among three or more nations. The agreements reduce tariffs and make it easier for businesses to import and export. Since they are among many countries, they are difficult to negotiate. 

That same broad scope makes them more robust than other types of trade agreements once all parties sign. 

Bilateral agreements are easier to negotiate but these are only between two countries. They don't have as big an impact on economic growth as does a multilateral agreement.

5 Advantages of multilateral agreements

·         Multilateral agreements make all signatories treat each other equally. No country can give better trade deals to one country than it does to another. That levels the playing field. It's especially critical for emerging market countries. Many of them are smaller in size, making them less competitive. The Most Favored Nation Status confers the best trading terms a nation can get from a trading partner. Developing countries benefit the most from this trading status.

·         The second benefit is that it increases trade for every participant. Their companies enjoy low tariffs. That makes their exports cheaper.

·         The third benefit is it standardizes commerce regulations for all the trade partners. Companies save legal costs since they follow the same rules for each country.

·         The fourth benefit is that countries can negotiate trade deals with more than one country at a time. Trade agreements undergo a detailed approval process. Most countries would prefer to get one agreement ratified covering many countries at once. 

·         The fifth benefit applies to emerging markets. Bilateral trade agreements tend to favor the country with the best economy. That puts the weaker nation at a disadvantage. But making emerging markets stronger helps the developed economy over time.

As those emerging markets become developed, their middle class population increases. That creates new affluent customers for everyone.

4 Disadvantages of multilateral trading

·         The biggest disadvantage of multilateral agreements is that they are complex. That makes them difficult and time consuming to negotiate. Sometimes the length of negotiation means it won't take place at all. 

·         Second, the details of the negotiations are particular to trade and business practices. The public often misunderstands them. As a result, they receive lots of press, controversy, and protests. 

·         The third disadvantage is common to any trade agreement. Some companies and regions of the country suffer when trade borders disappear.

·         The fourth disadvantage falls on a country's small businesses. A multilateral agreement gives a competitive advantage to giant multi-nationals. They are already familiar with operating in a global environment. As a result, the small firms can't compete. They lay off workers to cut costs. Others move their factories to countries with a lower standard of living. If a region depended on that industry, it would experience high unemployment rates. That makes multilateral agreements unpopular.

Pros

• Treats all member nations equally.
• Makes international trading easier.
• Trade regulations are the same for everyone.
• Helps emerging markets.
• Multiple nations are covered by one treaty.

Cons

• Negotiations can be lengthy, risk breaking down.
• Easily misunderstood by the public
• Removing trade borders affects businesses.
• Benefits large corporations, but not small businesses.

Examples

Some regional trade agreements are multilateral. The largest had been the North American Free Trade Agreement (NAFTA), which was ratified on January 1, 1994. NAFTA quadrupled trade between the United States, Canada, and Mexico from its 1993 level to 2018. On July 1, 2020, the U.S.-Mexico-Canada Agreement (USMCA) went into effect. The USMCA was a new trade agreement between the three countries that was negotiated under President Donald Trump.

The Central American-Dominican Republic Free Trade Agreement was signed on August 5, 2004. CAFTA-DR eliminated tariffs on more than 80% of U.S. exports to six countries: Costa Rica, the Dominican Republic, Guatemala, Honduras, Nicaragua, and El Salvador. As of November 2019, it had increased trade by 104%, from $2.44 billion in January 2005 to $4.97 billion.

The Trans-Pacific Partnership would have been bigger than NAFTA. Negotiations concluded on October 4, 2015. After becoming president, Donald Trump withdrew from the agreement. He promised to replace it with bilateral agreements. The TPP was between the United States and 11 other countries bordering the Pacific Ocean. It would have removed tariffs and standardized business practices.

All global trade agreements are multilateral. The most successful one is the General Agreement on Trade and Tariffs. Twenty-three countries signed GATT in 1947. Its goal was to reduce tariffs and other trade barriers.

In September 1986, the Uruguay Round began in Punta del Este, Uruguay. It centered on extending trade agreements to several new areas. These included services and intellectual property. It also improved trade in agriculture and textiles. The Uruguay Round led to the creation of the World Trade Organization. On April 15, 1994, the 123 participating governments signed the agreement creating the WTO in Marrakesh, Morocco. The WTO assumed management of future global multilateral negotiations.

The WTO's first project was the Doha round of trade agreements in 2001. That was a multilateral trade agreement among all WTO members. Developing countries would allow imports of financial services, particularly banking. In so doing, they would have to modernize their markets. In return, the developed countries would reduce farm subsidies. That would boost the growth of developing countries that were good at producing food.

Farm lobbies in the United States and the European Union doomed Doha negotiations. They refused to agree to lower subsidies or accept increased foreign competition. The WTO abandoned the Doha round in July 2008.

On December 7, 2013, WTO representatives agreed to the so-called Bali package. All countries agreed to streamline customs standards and reduce red tape to expedite trade flows. Food security is an issue. India wants to subsidize food so it could stockpile it to distribute in case of famine. Other countries worry that India may dump the cheap food in the global market to gain market share. 

Bilateral Trade

By JULIA KAGAN Updated December 21, 2020, Reviewed by TOBY WALTERS, Fact checked by ARIEL COURAGE

https://www.investopedia.com/terms/b/bilateral-trade.asp

What Is Bilateral Trade?

Bilateral trade is the exchange of goods between two nations promoting trade and investment. The two countries will reduce or eliminate tariffs, import quotas, export restraints, and other trade barriers to encourage trade and investment.

In the United States, the Office of Bilateral Trade Affairs minimizes trade deficits through negotiating free trade agreements with new countries, supporting and improving existing trade agreements, promoting economic development abroad, and other actions.

KEY TAKEAWAYS

· Bilateral trade agreements are agreements between countries to promote trade and commerce.

· They eliminate trade barriers such as tariffs, import quotas, and export restraints in order to encourage trade and investment.

· The main advantage of bilateral trade agreements is an expansion of the market for a country's goods through concerted negotiation between two countries.

· Bilateral trade agreements can also result in the closing down of smaller companies unable to compete with large multinational corporations.

Understanding Bilateral Trade

The goals of bilateral trade agreements are to expand access between two countries’ markets and increase their economic growth. Standardized business operations in five general areas prevent one country from stealing another’s innovative products, dumping goods at a small cost, or using unfair subsidies. Bilateral trade agreements standardize regulations, labor standards, and environmental protections.

The United States has signed bilateral trade agreements with 20 countries, some of which include Israel, Jordan, Australia, Chile, Singapore, Bahrain, Morocco, Oman, Peru, Panama, and Colombia.

The Dominican Republic-Central America FTR (CAFTA-DR) is a free trade agreement signed between the United States and smaller economies of Central America, as well as the Dominican Republic. The Central American countries are El Salvador, Guatemala, Costa Rica, Nicaragua, and Honduras. NAFTA replaced the bilateral agreements with Canada and Mexico in 1994. The U.S. renegotiated NAFTA under the United States-Mexico-Canada Agreement, which went into effect in 2020.2

Advantages and Disadvantages of Bilateral Trade

Compared to multilateral trade agreements, bilateral trade agreements are negotiated more easily, because only two nations are party to the agreement. Bilateral trade agreements initiate and reap trade benefits faster than multilateral agreements.

When negotiations for a multilateral trade agreement are unsuccessful, many nations will negotiate bilateral treaties instead. However, new agreements often result in competing agreements between other countries, eliminating the advantages the Free Trade Agreement (FTA) confers between the original two nations.

Bilateral trade agreements also expand the market for a country's goods. The United States vigorously pursued free trade agreements with a number of countries under the Bush administration during the early 2000s.

In addition to creating a market for U.S. goods, the expansion helped spread the mantra of trade liberalization and encouraged open borders for trade. However, bilateral trade agreements can skew a country's markets when large multinational corporations, which have significant capital and resources to operate at scale, enter a market dominated by smaller players. As a result, the latter might need to close shop when they are competed out of existence.

Examples of Bilateral Trade

In October 2014, the United States and Brazil settled a longstanding cotton dispute in the World Trade Organization (WTO). Brazil terminated the case, relinquishing its rights to countermeasures against U.S. trade or further proceedings in the dispute.

Brazil also agreed to not bring new WTO actions against U.S. cotton support programs while the current U.S. Farm Bill was in force, or against agricultural export credit guarantees under the GSM-102 program. Because of the agreement, American businesses were no longer subject to countermeasures such as increased tariffs totaling hundreds of millions of dollars annually.

In March 2016, the U.S. government and the government of Peru reached an agreement removing barriers for U.S. beef exports to Peru that had been in effect since 2003.

The agreement opened one of the fastest-growing markets in Latin America. In 2015, the United States exported $25.4 million in beef and beef products to Peru. Removal of Peru’s certification requirements, known as the export verification program, assured American ranchers expanded market access.

The agreement reflected the U.S. negligible risk classification for bovine spongiform encephalopathy (BSE) by the World Organization for Animal Health (OIE).

The United States and Peru agreed to amendments in certification statements making beef and beef products from federally inspected U.S. establishments eligible for export to Peru, rather than just beef and beef products from establishments participating in the USDA Agricultural Marketing Service (AMS) Export Verification (EV) programs under previous certification requirements.

How Geopolitics Is Redrawing the World’s Busiest Trade Routes

By Bryce Baschuk, December 5, 2022 at 7:00 AM EST

https://www.bloomberg.com/news/newsletters/2022-12-05/supply-chain-latest-how-geopolitics-is-redrawing-trade-routes

American astronomer Carl Sagan once said “you have to know the past to understand the present.”

It’s good advice for anyone looking to make sense of a world still reeling from a pandemic, Brexit, Russia’s war with Ukraine and a trade war between the world’s two largest economies.

This tumultuous period has encouraged C-suites and governments around the world to rethink the economic strategies that have driven the past three decades of globalization.

To understand the forward trajectory of globalization, Bloomberg dove into some data from the past three years to see what trends have emerged since the pandemic first roiled global markets.

In a nutshell, here’s what we found:

· The US is regularly importing more goods from Europe than from China

· China is exporting a greater share of its goods to non-US markets

· Brexit is increasing costs and reducing market access for UK exporters

· China uses its economic might achieve strategic goals

· Germany was slow to cut off imports from Russia after Vladimir Putin invaded Ukraine

· Breaking Up Is Hard to Do

· German imports of Russian goods peaked after Putin invaded Ukraine

Source: Eurostat

Broadly, the data show that the world’s largest trading powers are rewiring their traditional relationships.

That’s led to a new focus on strengthening the reliability of supply chains, shifting from “just in time” to “just in case” trade strategies and reducing dependence on authoritarian regimes like China.

Some of these shifts are marginal, and temporary, while others represent the beginnings of longer-term structural realignments.

Here are a few conclusions we can draw about the future:

· The US and China aren’t engaged in a wholesale decoupling of their economies, but both nations are hedging their bets and deepening their trade flows with other nations

· A strong, mutually beneficial US-EU trade relationship is more valuable and important at a time when both regions are reducing their dependence on China.

· The shift towards market concentration among regional economic hubs will take on increased importance in the coming years — particularly so in the Asia-Pacific region

· The UK must find ways to mitigate the harmful effects of Brexit as EU producers rely less and less on UK exports to feed, clothe and service European citizens

· Russia’s economic influence is approaching a generational nadir and it's likely to remain a pariah state for many years to come

· What’s happening is a kind of “reglobalization” where governments and multinational companies adapt their trade links to accommodate the new economic and geopolitical challenges. And while supply chains may be more insulated against shocks, the next chapter also has the potential to increase costs and make the world a less productive place.

—Bryce Baschuk in Geneva

Homework chapter1-2 (due with first midterm exam)

1) Do you support bilateral trading or multi-lateral trading? Why?

2) What is your opinion about CPTPP? Do you think that the member countries can benefit from the CPTPP? Why or why not?

3) Optional question (for extra credit): Shall the U.S.A. join and lead RCEP? Why do we need both CPTPP and RCEP?

World's Biggest Trade Deal – RCEP (video)

Who will benefit from the world's largest free trade deal? | Inside Story (youtube)

What is the RCEP? | CNBC Explains (youtube)

China and 14 partners sign world's biggest trade deal without US | DW News (video)

The world needs more economic alliances than security ones, analyst says (video)

PUBLISHED WED, NOV 16 20221:02 AM EST, Su-Lin Tan

https://www.cnbc.com/2022/11/16/the-world-needs-more-economic-alliances-than-security-ones-analyst.html

KEY POINTS

Countries should strike up more economic alliances than security and defense ones, as those could make the world “more dangerous,” the president of the Center for China and Globalization said on Tuesday.

“I hope that the U.S. now has settled this midterm, we can get towards economic, global alliances rather than have a lot of security, military, defense alliances which will make us more and more dangerous,” Henry Wang said at the SALT iConnections conference in Singapore.

Echoing Wang’s point, Nicolas Aguzin, CEO of the Hong Kong stock exchange HKEX, said on the same panel that the globalization of trade has created many benefits, including bringing the East and West closer to each other.

Countries should strike up more economic alliances than security and defense ones, as those could make the world “more dangerous,” the president of the Center for China and Globalization said on Tuesday.

Doing that would also circumvent a slide toward deglobalization, which could hold back economic development across the world. The U.S. for example, could consider joining — or “re-joining” — the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), Henry Wang said at the SALT iConnections conference in Singapore.

“The U.S. is the vibe of globalization and [has] always taken the lead on globalization,” Wang said.

“It was a pity to see the U.S. pulling out of the [Trans-Pacific Partnership, which] ... set higher standards for global trade, including the digital economy, and also the liberalization of trade and facilitation of investments.”

Wang added that there should be more economic alliances and fewer security ones such as the AUKUS, Five Eyes and the Quadrilateral Security Dialogue, an informal strategic alliance.

(L-R) Singapore's Minister for Trade and Industry Lim Hng Kiang, New Zealand's Minister for Trade and Export Growth David Parker, Malaysia's Minister for Trade and Industry Datuk J. Jayasiri, Canada's International Trade Minister Francois-Phillippe Champagne, Australia's Trade Minister Steven Ciobo, Chile's Foreign Minister Heraldo Munoz, Brunei's Acting Minister for Foreign Affairs Erywan Dato Pehin, Japan's Minister of Economic Revitalization Toshimitsu Motegi, Mexico's Secretary of Economy Ildefonso Guaj

The Comprehensive and Progressive Agreement for Trans-Pacific Partnership is a multilateral trade deal signed in 2018 that was formed after the United States, under the Trump administration, withdrew from the Trans-Pacific Partnership.

“I hope that the U.S. now has settled this midterm, we can get towards economic, global alliances rather than have a lot of security, military, defense alliances which will make us more and more dangerous,” Wang said.

The CPTPP was formerly known as the TPP, which was part of the United States’ economic and strategic pivot to Asia.

Former U.S. President Donald Trump pulled the U.S. out of the trade pact in 2017, after it drew criticism from the protectionist end of the U.S. political spectrum.

The TPP has since evolved into the CPTPP after other members of the pact forged on with it. It is now one of the biggest trade blocs in the world, attracting applicants such as China.

The U.S. has not indicated any desire to rejoin the CPTPP. Instead, it launched its own separate non-trade relationship network with Asia-Pacific, the Indo-Pacific Economic Framework.

Echoing Wang’s point, Nicolas Aguzin, CEO of the Hong Kong stock exchange HKEX, said on the same panel that the globalization of trade has created many benefits, including bringing the East and West closer to each other.

“I mean, it had kept prices very low around the world in a lot of areas; we had productivity,” he said, adding that he doubts deglobalization would become a reality, in light of the complex interconnectedness of global supply chains.

We welcome anyone to join the CPTPP, including the United States, says Canadian ministerWATCH NOW

VIDEO02:47

We welcome anyone to join the CPTPP, including the U.S.: Canadian minister

With new powers emerging, tensions are bound to arise at this juncture of globalization, Aguzin said.

“Asia, as a region, over the next 10 years, we represent about half of the output of the world. I mean you’re going to have some rocky moments, because it’s a big shift. There’s a big shift of power and influence from West to East,” he said.

‘Olympic-style’ competition

Economic alliances and healthy “Olympic-style” competition between the U.S. and China would therefore be better than confrontation, Wang added.

Wang said notes from the Chinese Communist Party meeting in Beijing indicate that Chinese policymakers are keen on “opening up,” which suggests Beijing still has appetite to promote trade and multilateralism.

The appointment of new Cabinet members from developed areas in China, such as Guangdong and Jiangsu, suggests Beijing has its eyes on more development, private businesses and investments from multinational companies, according to Wang.

Rust Belt https://www.investopedia.com/terms/r/rust-belt.asp (FYI)

By JAMES CHEN

Updated Aug 25, 2020

What Is the Rust Belt?

The Rust Belt is a colloquial term used to describe the geographic region stretching from New York through the Midwest that was once dominated by the coal industry, steel production, and manufacturing. The Rust Belt became an industrial hub due to its proximity to the Great Lakes, canals, and rivers, which allowed companies to access raw materials and ship out finished products.

The region received the name Rust Belt in the late 1970s, after a sharp decline in industrial work left many factories abandoned and desolate, causing increased rust from exposure to the elements. It is also referred to as the Manufacturing Belt and the Factory Belt.

KEY TAKEAWAYS

• The Rust Belt refers to the geographic region from New York through the Midwest that was once dominated by manufacturing.
• The Rust Belt is synonymous with regions facing industrial decline and abandoned factories rusted from exposure to the elements.
• The Rust Belt was home to thousands of blue-collar jobs in coal plants, steel and automotive production, and the weapons industry.

Understanding the Rust Belt

The term Rust Belt is often used in a derogatory sense to describe parts of the country that have seen an economic decline—typically very drastic. The rust belt region represents the deindustrialization of an area, which is often accompanied by fewer high-paying jobs and high poverty rates. The result has been a change in the urban landscape as the local population has moved to other areas of the country in search of work.

Although there is no definitive boundary, the states that are considered in the Rust Belt–at least partly–include the following:

• Indiana
• Illinois
• Michigan
• Missouri
• New York; Upstate and western regions
• Ohio
• Pennsylvania
• West Virginia
• Wisconsin

There are other states in the U.S. that have also experienced declines in manufacturing, such as states in the deep south, but they are not usually considered part of the Rust Belt. The region was home to some of America's most prominent industries, such as steel production and automobile manufacturing. Once recognized as the industrial heartland, the region has experienced a sharp downturn in industrial activity from the increased cost of domestic labor, competition from overseas, technology advancements replacing workers, and the capital intensive nature of manufacturing.

Poverty in the Rust Belt

Blue-collar jobs have increasingly moved overseas, forcing local governments to rethink the type of manufacturing businesses that can succeed in the area. While some cities managed to adopt new technologies, others still struggle with rising poverty levels and declining populations.

Below are the poverty rates from the U.S. Census Bureau as of 2018 for each of the Rust Belt states listed above.

Poverty Rates in the Rust Belt. 

There are other U.S. states that have high poverty rates, such as Kentucky (16.9%), Louisiana (18.6%), and Alabama (16.8%). However, the rust belt states have–at a minimum–a double-digit percentage of their population in poverty.

History of the Rust Belt

Before being known as the Rust Belt, the area was generally known as the country's Factory, Steel, or Manufacturing Belt. This area, once a booming hub of economic activity, represented a great portion of U.S. industrial growth and development.

The natural resources that were found in the area led to its prosperity—namely coal and iron ore—along with labor and ready access to transport by available waterways. This led to the rise in coal and steel plants, which later spawned the weapons, automotive, and auto parts industries. People seeking employment began moving to the area, which was dominated by both the coal and steel industries, changing the overall landscape of the region.

But that began to change between the 1950s and 1970s. Many manufacturers were still using expensive and outdated equipment and machinery and were saddled with the high costs of domestic labor and materials. To compensate, a good portion of them began looking elsewhere for cheaper steel and labor—namely from foreign sources—which would ultimately lead to the collapse of the region.

There is no definitive boundary for the Rust Belt, but it generally includes the area from New York through the Midwest.

Decline of the Rust Belt

Most research suggests the Rust Belt started to falter in the late 1970s, but the decline may have started earlier, notably in the 1950s, when the region's dominant industries faced minimal competition. Powerful labor unions in the automotive and steel manufacturing sectors ensured labor competition stayed to a minimum. As a result, many of the established companies had very little incentive to innovate or expand productivity. This came back to haunt the region when the United States opened trade overseas and shifted manufacturing production to the south.

By the 1980s, the Rust Belt faced competitive pressure—domestically and overseas—and had to ratchet down wages and prices. Operating in a monopolistic fashion for an extended period of time played an instrumental role in the downfall of the Rust Belt. This shows that competitive pressure in productivity and labor markets are important to incentivize firms to innovate. However, when those incentives are weak, it can drive resources to more prosperous regions of the country.

The region's population also showed a rapid decline. What was once a hub for immigrants from the rest of the country and abroad, led to an exodus of people out of the area. Thousands of well-paying blue-collar jobs were eliminated, forcing people to move away in search of employment and better living conditions.

Politics and the Rust Belt

The term Rust Belt is generally attributed to Walter Mondale, who referred to this part of the country when he was the Democratic presidential candidate in 1984. Attacking President Ronald Reagan, Mondale claimed his opponent's policies were ruining what he called the Rust Bowl. He was misquoted by the media as saying the rust belt, and the term stuck. Since then, the term has consistently been used to describe the area's economic decline.

From a policy perspective, addressing the specific needs of the Rust Belt states was a political imperative for both parties during the 2016 election. Many believe the national government can find a solution to help this failing region succeed again.

This Could Be a Record Year for US-China Trade

ByShawn Donnan, December 3, 2022 at 6:45 AM EST

https://www.bloomberg.com/news/newsletters/2022-12-03/a-record-year-for-us-china-trade-new-economy-saturday

Bloomberg Cites Trade War as 'Failure of Our Government' (youtube)

Here’s a data point you won’t hear discussed very often: If the last few months of this year hold to trend, the US will have imported more goods from China in 2022 than in any year prior.

The next chunk of data will come Dec. 6 with the US release of October trade numbers, and there’s still time for the trend to shift— especially with China’s current Covid lockdown travails. But what’s already in the books is clear. In the first nine months of the year, the US imported $418 billion in goods from China, or $23.7 billion more than it did in the same period of 2018, the current record holder.

That’s worth thinking about given that, in the six years since Donald Trump launched his trade assault on China, the dominant story has been the supposed decoupling of the world’s two largest economies. The prevailing narrative of late suggests we’re living through the unwinding of an era of hyper-globalization, and that the world is busy reorganizing itself around geopolitical poles centered on Washington and Beijing.

But the trade data is a reminder that rhetoric and even policy don’t always reflect the global economy.

There’s no doubt we’ve been going through a prickly period in the US-China diplomatic and trade relationships, and that there are more hawks than doves these days on both sides.

But for all the pandemic-driven talk of shifting supply chains away from China and reshoring factories, the value of Chinese goods purchased by the US is higher than it’s ever been. (The value of US exports to China this year has also been near record levels. In the first nine months of 2022, US companies sent $108.8 billion in goods to China versus $105.6 billion in the same period of 2021, the last record year.)

That surge in US imports has come despite the Trump tariffs that were meant to rewrite the economic relationship, and without any apparent shock to US employment. All of this is at odds with what protectionists have been arguing for years. Indeed, based on the November jobs numbers, the US has managed to add a whopping 379,000 manufacturing positions in 2022 despite all of those Chinese imports .

There are at least three things to take away from all of this:

1. The trade relationship with China remains America’s largest by some distance. Imports from China accounted for 17% of total US imports through September of this year. No single country comes close, though Canada and Mexico together accounted for a bigger share of total US trade. For America, this state of affairs is kind of a big deal— and a major foreign policy complication— given that China is seen as its main economic and geopolitical rival.

2. The pandemic has made all data messy, so we should be cautious. It’s not just inflation at 40-year highs and the impact on the value of imports that’s affecting the data. American retailers have tended to over-order from China during the pandemic, which likely affected the trade figures as well. It could be that, over the coming years, the change in the relationship everyone is talking about will slowly be reflected in the data.

3. Sometimes it’s worth being wary of rhetoric and narratives. An economy is its people, and people often confound the intentions and expectations of policymakers.

Chapter 2 

Chapter 2 (PPT)

Let’s watch this video together.

Imports, Exports, and Exchange Rates: Crash Course Economics #15

 Topic 1- What is BOP?

The balance of payment of a country contains two accounts: current and capital. The current account records exports and imports of goods and services as well as unilateral transfers, whereas the capital account records purchase and sale transactions of foreign assets and liabilities during a particular year.

 What is the current account?

Balance of payments: Current account (video, Khan academy)

From khan academy

Current vs. Capital Accounts: What's the Difference?

By THE INVESTOPEDIA TEAM, Updated June 29, 2021, Reviewed by ROBERT C. KELLY

https://www.investopedia.com/ask/answers/031615/whats-difference-between-current-account-and-capital-account.asp

Current vs. Capital Accounts: An Overview

The current and capital accounts represent two halves of a nation's balance of payments. The current account represents a country's net income over a period of time, while the capital account records the net change of assets and liabilities during a particular year.

In economic terms, the current account deals with the receipt and payment in cash as well as non-capital items, while the capital account reflects sources and utilization of capital. The sum of the current account and capital account reflected in the balance of payments will always be zero. Any surplus or deficit in the current account is matched and canceled out by an equal surplus or deficit in the capital account.

KEY TAKEAWAYS

· The current and capital accounts are two components of a nation's balance of payments.

· The current account is the difference between a country's savings and investments.

· A country's capital account records the net change of assets and liabilities during a certain period of time.

Current Account

The current account deals with a country's short-term transactions or the difference between its savings and investments. These are also referred to as actual transactions (as they have a real impact on income), output and employment levels through the movement of goods and services in the economy.

The current account consists of visible trade (export and import of goods), invisible trade (export and import of services), unilateral transfers, and investment income (income from factors such as land or foreign shares). The credit and debit of foreign exchange from these transactions are also recorded in the balance of the current account. The resulting balance of the current account is approximated as the sum total of the balance of trade.

Current Account vs. Capital Account

Transactions are recorded in the current account in the following ways:

Exports are noted as credits in the balance of payments

Imports are recorded as debits in the balance of payments

The current account gives economists and other analysts an idea of how the country is faring economically. The difference between exports and imports, or the trade balance, will determine whether a country's current balance is positive or negative. When it is positive, the current account has a surplus, making the country a "net lender" to the rest of the world. A deficit means the current account balance is negative. In this case, that country is considered a net borrower.

If imports decline and exports increase to stronger economies during a recession, the country's current account deficit drops. But if exports stagnate as imports grow when the economy grows, the current account deficit grows.

Capital Account

The capital account is a record of the inflows and outflows of capital that directly affect a nation’s foreign assets and liabilities. It is concerned with all international trade transactions between citizens of one country and those in other countries.

The components of the capital account include foreign investment and loans, banking, and other forms of capital, as well as monetary movements or changes in the foreign exchange reserve. The capital account flow reflects factors such as commercial borrowings, banking, investments, loans, and capital.

A surplus in the capital account means there is an inflow of money into the country, while a deficit indicates money moving out of the country. In this case, the country may be increasing its foreign holdings.

In other words, the capital account is concerned with payments of debts and claims, regardless of the time period. The balance of the capital account also includes all items reflecting changes in stocks.

The International Monetary Fund divides capital account into two categories: The financial account and the capital account.

The term capital account is also used in accounting. It is a general ledger account used to record the contributed capital of corporate owners as well as their retained earnings. These balances are reported in a balance sheet's shareholder's equity section.

https://www.bea.gov/data/intl-trade-investment/international-transactions

Q3 2022	-$217.1 B
Q2 2022	-$238.7 B

U.S. Current-Account Deficit Narrows in 3rd Quarter 2022 U.S. International Transactions The U.S. current-account deficit, which reflects the combined balances on trade in goods and services and income flows between U.S. residents and residents of other countries, narrowed by $21.6 billion, or 9.1 percent, to $217.1 billion in the third quarter of 2022. The narrowing mostly reflected a decreased deficit on goods that was partly offset by a decreased surplus on primary income and an increased deficit on secondary income. The third-quarter deficit was 3.4 percent of current-dollar gross domestic product, down from 3.8 percent in the second quarter.

https://www.bea.gov/sites/default/files/2022-12/trans322-fax_0.pdf

• Exports of goods increased $7.2 billion to $547.0 billion, while imports of goods decreased $32.5 billion to $818.2 billion.

• Exports of services increased $4.9 billion to $234.0 billion, while imports of services increased $1.6 billion to $173.5 billion.

• Receipts of primary income increased $15.2 billion to $314.0 billion, while payments of primary income increased $26.8 billion to $268.4 billion.

• Receipts of secondary income decreased $0.8 billion to $42.7 billion, while payments of secondary income increased $9.0 billion to $94.9 billion.

• Net financial-account transactions were −$294.2 billion in the third quarter, reflecting net U.S. borrowing from foreign residents.

· Trade in goods (table 2) Exports of goods increased $7.2 billion to $547.0 billion, reflecting increases in nonmonetary gold and in capital goods, mostly civilian aircraft engines and parts and other industrial machinery, that were partly offset by a decrease in foods, feeds, and beverages, mostly soybeans and corn. Imports of goods decreased $32.5 billion to $818.2 billion, reflecting widespread decreases in consumer goods and in industrial supplies and materials. The decrease in consumer goods was led by household and kitchen appliances and other household goods, and the decrease in industrial supplies and materials was led by metals and nonmetallic products.

· Trade in services (table 3) Exports of services increased $4.9 billion to $234.0 billion, reflecting increases in other business services, mainly professional and management consulting services, and in travel, mostly education-related travel and other personal travel. Imports of services increased $1.6 billion to $173.5 billion, reflecting increases in travel, mostly other personal travel and education-related travel, and in financial services, mostly financial intermediation services indirectly measured and financial management services, that were partly offset by a decrease in transport, mostly sea freight transport.

· Primary income (table 4) Receipts of primary income increased $15.2 billion to $314.0 billion, and payments of primary income increased $26.8 billion to $268.4 billion. The increases in both receipts and payments primarily reflected increases in other investment income, mostly interest on loans and deposits. These increases were mainly due to higher short-term interest rates that resulted from significant federal funds rate hikes by the Federal Reserve Board in May, June, July, and September. U.S. other investment assets and liabilities are mainly denominated in U.S. dollars.

· Secondary income (table 5) Receipts of secondary income decreased $0.8 billion to $42.7 billion, reflecting a decrease in general government transfers, mostly fines and penalties. Payments of secondary income increased $9.0 billion to $94.9 billion, reflecting an increase in general government transfers, mostly international cooperation.

· Financial-Account Transactions (tables 1, 6, 7, and 8) Net financial-account transactions were −$294.2 billion in the third quarter, reflecting net U.S. borrowing from foreign residents.

· Financial assets (tables 1, 6, 7, and 8) Third-quarter transactions increased U.S. residents’ foreign financial assets by $411.0 billion. Transactions increased portfolio investment assets, mostly equity and long-term debt securities, by $368.9 billion; direct investment assets, mainly equity, by $56.7 billion; and reserve assets by $0.8 billion. Transactions decreased other investment assets by $15.5 billion, resulting from partly offsetting transactions in loans and deposits.

· Liabilities (tables 1, 6, 7, and 8) Third-quarter transactions increased U.S. liabilities to foreign residents by $671.2 billion. Transactions increased portfolio investment liabilities, mostly long-term debt securities and equity, by $463.2 billion; other investment liabilities, mostly loans, by $106.6 billion; and direct investment liabilities, mostly equity, by $101.4 billion.

 What is the Capital Account

Balance of payments: Capital account (video, Khan Academy)

https://fred.stlouisfed.org/tags/series?t=capital+account

Top Trading Partners - November 2021

https://www.census.gov/foreign-trade/statistics/highlights/toppartners.html

Rank	Country	Exports	Imports	Total Trade	Percent of Total Trade
---	Total, All Countries	1,724.4	2,737.0	4,461.4	100.0%
---	Total, Top 15 Countries	1,200.5	2,117.7	3,318.3	74.4%
1	Canada	298.5	371.0	669.5	15.0%
2	Mexico	273.9	382.1	655.9	14.7%
3	China	124.5	462.6	587.0	13.2%
4	Japan	67.5	122.6	190.1	4.3%
5	Germany	60.8	119.0	179.8	4.0%
6	Korea, South	60.0	95.6	155.6	3.5%
7	Vietnam	9.7	109.6	119.4	2.7%
8	United Kingdom	62.9	52.2	115.2	2.6%
9	India	39.7	73.5	113.1	2.5%
10	Taiwan	35.9	77.0	112.9	2.5%
11	Netherlands	60.1	28.6	88.7	2.0%
12	France	38.1	47.8	85.9	1.9%
13	Switzerland	32.2	51.2	83.4	1.9%
14	Ireland	13.4	68.0	81.5	1.8%
15	Italy	23.3	57.0	80.3	1.8%

· JANUARY 5, 2023 — The U.S. Census Bureau and the U.S. Bureau of Economic Analysis announced today that the goods and services deficit was $61.5 billion in November, down $16.3 billion from $77.8 billion in October, revised.

· Exports, Imports, and Balance (Exhibit 1) November exports were $251.9 billion, $5.1 billion less than October exports. November imports were $313.4 billion, $21.5 billion less than October imports. The November decrease in the goods and services deficit reflected a decrease in the goods deficit of $15.3 billion to $84.1 billion and an increase in the services surplus of $1.0 billion to $22.5 billion. Year-to-date, the goods and services deficit increased $120.1 billion, or 15.7 percent, from the same period in 2021. Exports increased $439.4 billion or 18.9 percent. Imports increased $559.5 billion or 18.1 percent.

Topic 2: Trade war with China to reduce trade deficit (current account deficit)

For Class Discussion:

Has the US won the trade war against China? Can trade war help reduce the US current account deficit?

America v China: why the trade war won't end soon | The Economist (youtube)

2022 : U.S. trade in goods with China

NOTE: All figures are in millions of U.S. dollars on a nominal basis.

https://www.census.gov/foreign-trade/balance/c5700.html

2022 : U.S. trade in goods with China

NOTE: All figures are in millions of U.S. dollars on a nominal basis, not seasonally adjusted unless otherwise specified. Details may not equal totals due to rounding. Table reflects only those months for which there was trade.

Month	Exports	Imports	Balance
January 2022	11,475.2	47,846.9	-36,371.7
February 2022	11,594.0	42,260.0	-30,666.0
March 2022	13,375.1	47,373.5	-33,998.4
April 2022	11,201.7	41,772.2	-30,570.5
May 2022	12,321.3	43,864.4	-31,543.1
June 2022	11,678.4	48,625.3	-36,946.9
July 2022	12,267.2	46,664.1	-34,396.9
August 2022	12,906.7	50,348.8	-37,442.1
September 2022	11,953.5	49,247.9	-37,294.4
October 2022	15,698.3	44,572.0	-28,873.6
November 2022	15,576.0	36,876.4	-21,300.4
TOTAL 2022	140,047.5	499,451.6	-359,404.1

Month	Exports	Imports	Balance
Jan-21	12,860.90	39,111.20	-26,250.20
Feb-21	9,410.50	34,027.40	-24,617.00
Mar-21	12,542.30	40,229.00	-27,686.70
Apr-21	11,759.90	37,589.80	-25,829.90
May-21	12,411.30	38,732.10	-26,320.70
Jun-21	12,102.00	39,946.00	-27,843.90
Jul-21	11,720.00	40,368.30	-28,648.30
Aug-21	11,258.70	42,997.30	-31,738.70
Sep-21	10,910.60	47,414.00	-36,503.40
Oct-21	16,635.30	48,032.20	-31,396.80
Nov-21	16,069.00	48,385.00	-32,316.00
TOTAL 2021	137,680.50	456,832.20	-319,151.00

U.S. tariffs on Chinese goods didn’t bring companies back to the U.S., new research finds

These tariffs instead resulted in collateral damage to the U.S. economy

By Jiakun Jack Zhang and Samantha A. Vortherms, September 22, 2021 at 5:00 a.m. EDT

https://www.washingtonpost.com/politics/2021/09/22/us-tariffs-chinese-goods-didnt-bring-companies-back-us-new-research-finds/

Treasury Secretary Janet L. Yellen recently argued that tariffs from the U.S.-China trade war — covering more than $307 billion worth of goods — “hurt American consumers,” yet the negotiations “really didn’t address in many ways the fundamental problems we have with China.”

U.S. tariffs on Chinese exports jumped sixfold between 2018 and 2020, but tariffs failed to decouple the two economies. As the Biden administration conducts its comprehensive review of China trade policy and contemplates new tariffs, our research helps explain whether existing tariffs achieved their policy objective.

Tariffs increase the cost of doing business overseas by making those goods more expensive to import. The Trump administration’s logic was that tariffs would hurt U.S. and other multinational corporations engaged in U.S.-China trade — and push more companies to divest from China and shift supply chains to the United States. Tariff proponents argued the Chinese economy would suffer, giving U.S. negotiators more leverage over China at the negotiating table.

Fear of ‘terrorism’ shaped U.S. foreign policy after 9/11. Will the U.S. make China the next big obsession?

In fact, these tariffs resulted in collateral damage to the U.S. economy without pressuring China to change its economic policies. Here’s why.

The U.S. hoped to see multinationals walk away from China.

In a recent working paper, we built a new data set on foreign-invested enterprises registered in China to identify multinationals that choose to divest each year.

We found that new U.S. tariffs in 2018 and 2019 had a minimal effect on divestment. More than 1,800 U.S.-funded subsidiaries closed in the first year of the trade war, a 46 percent increase over the previous year. U.S. company exits immediately after the onset of the trade war were not concentrated in manufacturing or information technology, two sectors most directly affected by the trade war.

We estimate that less than 1 percent of the increase in U.S. firm exits during this period was due to U.S. tariffs. And U.S. firms were no more likely to divest than firms from Europe or Asia. Instead, company exits were driven more by the company’s capacity to mitigate political risk. Larger and older multinational were significantly less likely to exit China after the onset of the trade war.

These findings may surprise politicians, but are fully in line with recent research explaining how tariffs pass through to U.S. consumers. Rather than leaving China or finding alternative suppliers, U.S. firms simply raised prices for their customers. Survey data show large U.S. businesses remain optimistic about the Chinese market and plan to increase their investments there. Most of these firms are already “In China, for China” — those that are exposed to tariffs are taking advantage of workarounds such as the first sale rule or passing on costs to suppliers.

Tariffs provided little leverage — for either country

If U.S. multinationals aren’t rushing to exit China, are they pressuring the U.S. government for tariff relief, as the Chinese government hoped? Many analysts believed the U.S. business community would push back, and stop the trade war from escalating. We investigated the political behavior of a sample of 500 large U.S. multinationals with subsidiaries in China to see if they engaged in political activities such as commenting, testifying or lobbying in opposition to the U.S. Section 301 tariffs.

We found that most U.S. companies adopted an apolitical strategy. They didn’t exit China, but also didn’t put public pressure on Washington to roll back the tariffs. Even though 63 percent of U.S. multinationals in our sample were adversely impacted by the trade war, only 22 percent chose to voice opposition and 7 percent chose to exit China. The majority (65 percent) did neither.

The U.S. and China finally signed a trade agreement. Who won?

Many of the multinationals we coded as “voicing opposition” did so through associations such as the US-China Business Council rather than under their own name. An even larger number unsuccessfully lobbied for tariff exclusion for specific products, rather than a more general rollback of Section 301 tariffs.

Smaller businesses saw greater collateral damage

Our findings suggest that U.S. companies aren’t divesting from China as much as U.S. policymakers would like — or pushing back against tariffs as much as Chinese policymakers had hoped. Instead, large companies responded to the increased cost of business by passing the cost of tariffs on to their customers. And individual consumers in the United States paid higher prices for imports from China.

Smaller companies and those newer to China were more likely to exit. Firms with older and larger subsidiaries in China face higher sunk costs from leaving China altogether, which makes them more likely to continue China operations.

This finding parallels reports about small businesses in the United States who were unable to find alternative suppliers or afford expensive lobbyists during the trade war. The higher tariffs on raw materials imported from China made it tougher for some small businesses, particularly if they lacked the leverage to pass these costs on to customers or the resources to mitigate them.

Would other trade tools work?

Despite intensifying political hostility between Beijing and Washington and the mounting economic cost of tariffs, Chinese and U.S. businesses remain deeply integrated in terms of financial, knowledge and production networks. And despite the trade war, foreign investment inflows into China grew by 4.5 percent from 2019 — and hit a record $144.37 billion in 2020. There‘s little sign that U.S. multinationals have embraced the idea of decoupling from China.

While U.S. Trade Representative Katherine Tai justified the Biden administration’s hesitancy to remove tariffs on the grounds that tariffs provide leverage against China, our research demonstrates that U.S. tariffs haven’t produced the intended results. Instead, multinationals continue to navigate the uncertain U.S.-China relationship and related political risks. Smaller firms, in particular, may find it difficult to absorb the costs generated by the trade war.

The lack of U.S. leverage resulting from the trade war may dispel the notion that tariffs are “tough on China” and may help focus the policy debate on the harm to U.S. consumers from tariffs that remain in place. The Biden administration has at its disposal an array of alternative tools besides tariffs for economic competition with China that may result in less collateral damage on the U.S. economy.

After all, economic coercion can be a double-edged sword: These tools tend to inflict collateral damage on one’s economy while hurting that of the target, but tariffs are the bluntest tool of all.

Chapter 2 part 1  (Due with the first mid term exam)

1. Based on the classroom discussion, and documents posted and available online, do you think that the trade war against China could help US to reduce its trade deficit (or current account deficit)? Please be specific.

2. United States Current Account deficit accounted for 3.4 % of the country's Nominal GDP in Sep 2022, compared with a 3.8 % deficit in the previous quarter. What is your opinion about the increasing current account deficit since the outbreak of the Covid 19 pandemic? Is the US current account deficit a problem? Why or why not?

For reference, please visit https://www.imf.org/external/pubs/ft/fandd/basics/current.htm

3-.      Internet exercises (not required, information for intereted students only)

a.      IMF, world bank and UN are only a few of the major organizations that track, report and aid international economic and financial development. Based on information provided in those websites, you could learn about a country’s economic outlook.

      IMF: www.imf.org/external/index.htm

      UN: www.un.org/databases/index.htm

      World bank: www.worldbank.org’

      Bank of international settlement: www.bis.org/index.htm

b.    St. Louis Federal Reserve provides a large amount of recent open economy macroeconomic data online. You can track down BOP and GDP data for the major industrial countries. 

      Recent international economic data: research.stlouisfed.org/publications 

      Balance of Payments statistics: research.stlouisfed.org/fred2/categories/125

Balance of payments: Current account (video, Khan academy) (FYI)

Balance of payments: Capital account (video, Khan Academy) (FYI)

Current vs. capital accounts: what is the difference (youtube)?

Reference of useful websites for global economy

International Trade Statistics (PDF)

Current Account (BOP) Data – World Bank

http://data.worldbank.org/indicator/BN.CAB.XOKA.CD

IMF, world bank and UN are only a few of the major organizations that track, report  and aid international economic and financial development. Using these website, you can summarize the economic outlook for each country.

IMF: www.imf.org/external/index.htm

UN: www.un.org/databases/index.htm

World bank: www.worldbank.org

Bank of international settlement:  www.bis.org/index.htm

St. Louis Federal Reserve provides a large amount of recent open economy macroeconomic data online. You can track down BOP and GDP data for the major industrial countries. 

Recent international economic data: research.stlouisfed.org/publicaitons/ie

Global Current Account Balances Widen Amid War and Pandemic

https://www.imf.org/en/Blogs/Articles/2022/08/04/blog-global-current-account-balances-widen-amid-war-pandemic-080422

The war in Ukraine and resulting increase in commodity prices are expected to contribute to a further widening this year.

Giovanni Ganelli, Pau Rabanal, Niamh Sheridan August 4, 2022

The lingering pandemic and Russia’s invasion of Ukraine are dealing a setback to the global economy. This is affecting trade, commodity prices, and financial flows, all of which are changing current account deficits and surpluses.

Global current account balances—the overall size of deficits and surpluses across countries—are widening for a second straight year, according to our latest External Sector Report. After years of narrowing, balances widened to 3 percent of global gross domestic product in 2020, grew further to 3.5 percent last year, and are expected to expand again this year.

Larger current account balances aren’t necessarily negative on their own. But global excess balances—the portion not justified by differences in countries’ economic fundamentals, such as demographics, income level and growth potential, and desirable policy settings, using the Fund’s revised methodology—could fuel trade tensions and protectionist measures. That would be a setback for the push for greater international economic cooperation and could also increase the risk of disruptive currency and capital flow movements.

Pandemic effects in 2021

The pandemic widened global current account balances, and it’s still having an asymmetric impact on countries depending, for example, on whether they are exporters or importers of tourism and medical goods.

The pandemic and associated lockdowns also shifted consumption to goods from services as people reduced travel and entertainment. This also widened global balances as advanced economies with deficits increased goods imports from emerging market economies with surpluses. In 2021, we estimate that this shift increased the United States deficit by 0.4 percent of gross domestic product and contributed to an increase of 0.3 percent of GDP in China’s surplus.

Surplus economies like China saw also increases due to greater shipments of medical goods that often flowed to the United States and other deficit economies. Surging transportation costs also contributed to widening global balances in 2021.

War and tightening in 2022

Commodity prices are one of the biggest drivers of external positions, and last year’s rally in oil prices from pandemic lows affected exporters and importers asymmetrically. Russia’s February invasion of Ukraine exacerbated the surge in energy, food, and other commodity prices, widening global current account balances by raising surpluses for commodity exporters.

Monetary policy tightening is driving currency movements as rising inflation is leading many central banks to accelerate the withdrawal of monetary stimulus. Revised expectations about the pace of the US monetary tightening brought about sizable currency realignment this year, contributing to the projected widening of balances.

Capital flows to emerging markets were disrupted so far in 2022 by increased risk aversion triggered by the war, with further outflows amid changing expectations about the increased pace of monetary tightening in advanced economies. Cumulative outflows from emerging markets have been very large, about $50 billion, with a magnitude that’s similar to outflows during March 2020 but a pace that’s slower.

Our outlook for next year and beyond is for a steady decline of global current account balances as pandemic and war impacts moderate, though this expectation is subject to considerable uncertainty. Global current account balances could continue to widen should fiscal consolidation in current account deficit countries take longer than expected. Moreover, the stronger dollar could widen the US current account deficit and increase global current account balances.

Other factors that could widen these balances include a prolonged war that keeps commodity prices elevated for longer, the varying degrees of central bank interest-rate increases, and greater geopolitical tension causing economic fragmentation, disrupting supply chains, and potentially triggering a reorganization of the international monetary system.

A more fragmented trade system could either increase or decrease global balances, depending on how trade blocs are reconfigured. Either way, though, it would reduce technology transfers, and decrease the potential for export-led growth in low-income countries and thus unambiguously erode welfare gains from globalization.

Policy priorities

The war in Ukraine has exacerbated existing trade-offs for policymakers, including between fighting inflation and safeguarding economic recovery and between providing support to those affected and rebuilding fiscal buffers. Multilateral cooperation is key in dealing with the policy challenges generated by the pandemic and the war, including to tackle the humanitarian crisis.

Policies to promote external rebalancing differ based on individual economies’ positions and needs. For economies with larger-than-warranted current account deficits that reflect large fiscal shortfalls, such as the United States, it’s critical to reduce government deficits with a combination of higher revenue and lower spending.

Rebalancing is a different proposition for countries with excessive surpluses, such as Germany and the Netherlands, which can be reduced by intensifying reforms that encourage public and private investment and discourage excessive private saving, including by expanding social safety nets in some emerging markets.

Rolling back U.S.-China tariffs would ease inflation in the U.S., former Treasury secretary says

PUBLISHED TUE, NOV 30 2021, Weizhen Tan

https://www.cnbc.com/2021/11/30/removing-us-china-trade-tariffs-would-ease-inflation-jacob-lew.html

KEY POINTS

· Eliminating tariffs imposed on goods during the worst of the trade war would help ease inflation in the U.S., former Treasury Secretary Jacob Lew told CNBC.

· But there’s currently “no political space” to do so, he said on CNBC’s “Street Signs Asia.”

· Worries over inflation have shot up this year, as energy prices spiked and the ongoing supply chain crisis led to shortages of goods. But Lew said there’s been “a bit of excess nervousness about inflation.”

U.S. fiscal stimulus package is unlikely despite omicron: Ex-Treasury Secretary

Eliminating tariffs imposed on goods during the worst of the trade war would help ease inflation in the U.S., former Treasury Secretary Jacob Lew told CNBC on Tuesday.

But there’s currently “no political space” to do so, he said on CNBC’s “Street Signs Asia.”

“I think that the United States and China have deep differences. I’ve never thought it should just be about negotiating the exchange of one good or another on one side or the other. It should be about a level playing field,” Lew said. He served as treasury secretary from 2013 to 2017 during the Obama administration.

He continued: “I’ve thought from the beginning that the tariffs were an ineffective way to deal with their attacks on American consumers. And right now, with inflation being an issue, rolling back tariffs would actually reduce inflation in the United States.”

Relations between Washington and Beijing took a turn for the worse in 2018, when the Trump administration imposed tariffs on billions of dollars worth of Chinese goods and Beijing retaliated with similar punitive measures, drawing both sides into a protracted trade war.

U.S. tariffs on Chinese goods stood at an average of 19.3% on a trade-weighted basis in early 2021, while Chinese tariffs on American products were at about 20.7%, according to data compiled by think tank Peterson Institute for International Economics earlier this year.

Before the trade war, U.S. tariffs on Chinese goods were on average 3.1% in early 2018 while China’s tariffs on American goods were at 8%, the data showed.

Referring to rolling back tariffs, Lew said: “Both the leaders have to, I think, create political space in our two countries for these issues to be issues where you can move and make progress, because otherwise we either stay where we are. It gets worse. I think we can do better.”

American businesses are bearing most of the cost burden from the elevated tariffs imposed at the height of the U.S.-China trade war, according to a report from Moody’s Investors Service earlier this year.

The ratings agency said that U.S. importers absorbed more than 90% of additional costs resulting from the 20% U.S. tariff on Chinese goods. That means U.S. importers pay around 18.5% more in price for a Chinese product subject to that 20% tariff rate, while Chinese exporters receive 1.5% less for the same product, according to the report.

‘Excess nervousness’ about inflation

Worries over inflation have shot up this year, as energy prices spiked and the ongoing supply chain crisis led to shortages of goods.

The U.S. consumer price index, which tracks a basket of products ranging from gasoline and health care to groceries and rent, rose 6.2% in October from a year ago, the highest in 30 years.

But Lew told CNBC it’s likely “much of the inflation that we’re seeing will work its way through.”

“I don’t think anyone is predicting hyperinflation,” he said. “But I think there’s been a bit of excess nervousness about inflation. And candidly, the public reaction to inflation is very strong.”

But Lew warned that policymakers have to walk a fine line and ensure that measures used to combat inflation don’t slow the economy down so much that they dampen growth.

— CNBC’s Yen Nee Lee, Jeff Cox contributed to this report.

Khan Academy’s view of the trade deficit with China (video)

In class exercise:

3. If U.S.  imports > exports, then the supply of dollars > the demand of the dollars in the foreign exchange market, ceteris paribus. True/False?      

Solution: Import means using $ (spending $, or out flow of $) to buy foreign goods è   In the FX market, supply of $ increases è So when supply increases and assume that demand is unchanged,  the value of $ will drop

2.      If Japan exports > imports, then yen would appreciate against other currencies.     True/False?      

Solution: Export means selling domestic products for yen ( in flow of yen from importers who will pay yen for the goods made in Japan; there is an increased demand for yen) è   In the FX market, demand of yen increases è So when demand increases and assume that supply is unchanged,  the value of yen will rise.

3.      If the interest rate rises in the U.S., ceteris paribus, then capital will flow out of the U.S.      True/False?      

Solution: Interest rate rises è financial market will become more attractive to foreign investorsècapital will flow in, not out of the U.S.

Part II of Chapter 2 --- Evolution of international monetary system

Finance: The History of Money (combined) (video, fan to watch)

Review of history of money: A brief history of money - From gold to bitcoin and cryptocurrencies (video)

·         Bimetallism: Before 1875

·         Classical Gold Standard: 1875-1914

The Gold Standard Explained in One Minute (video)

§  International value of currency was determined by its fixed relationship to gold.

§  Gold was used to settle international accounts, so the risk of trading with other countries could be reduced.

·         Interwar Period: 1915-1944

§  Countries suspended gold standard during the WWI, to increase money supply and pay for the war.

§  Countries relied on a partial gold standard and partly other countries’ currencies during the WWII

·         Bretton Woods System: 1945-1972

The Bretton Woods Monetary System (1944 - 1971) Explained in One Minute (video)

§  All currencies were pegged to US$.

§  US$ was the only currency that was backed by gold.

§  US$ was world currency at that time.

·         The Flexible Exchange Rate Regime: 1973-Present

FLOATING AND FIXED EXCHANGE RATE (video)

For class discussion:

Read the following. Is there any knowledge that is new to you?

Bretton Woods Agreement and System

By JAMES CHEN Updated April 28, 2021, Reviewed by SOMER ANDERSON

https://www.investopedia.com/terms/b/brettonwoodsagreement.asp#:~:text=The%20Bretton%20Woods%20System%20required,the%20IMF%20and%20World%20Bank.

What Was the Bretton Woods Agreement and System?

The Bretton Woods Agreement was negotiated in July 1944 by delegates from 44 countries at the United Nations Monetary and Financial Conference held in Bretton Woods, New Hampshire. Thus, the name “Bretton Woods Agreement.”

Under the Bretton Woods System, gold was the basis for the U.S. dollar and other currencies were pegged to the U.S. dollar’s value. The Bretton Woods System effectively came to an end in the early 1970s when President Richard M. Nixon announced that the U.S. would no longer exchange gold for U.S. currency.

The Bretton Woods Agreement and System Explained

Approximately 730 delegates representing 44 countries met in Bretton Woods in July 1944 with the principal goals of creating an efficient foreign exchange system, preventing competitive devaluations of currencies, and promoting international economic growth. The Bretton Woods Agreement and System were central to these goals. The Bretton Woods Agreement also created two important organizations—the International Monetary Fund (IMF) and the World Bank. While the Bretton Woods System was dissolved in the 1970s, both the IMF and World Bank have remained strong pillars for the exchange of international currencies.

Though the Bretton Woods conference itself took place over just three weeks, the preparations for it had been going on for several years. The primary designers of the Bretton Woods System were the famous British economist John Maynard Keynes and American Chief International Economist of the U.S. Treasury Department Harry Dexter White. Keynes’ hope was to establish a powerful global central bank to be called the Clearing Union and issue a new international reserve currency called the bancor. White’s plan envisioned a more modest lending fund and a greater role for the U.S. dollar, rather than the creation of a new currency. In the end, the adopted plan took ideas from both, leaning more toward White’s plan.

It wasn't until 1958 that the Bretton Woods System became fully functional. Once implemented, its provisions called for the U.S. dollar to be pegged to the value of gold. Moreover, all other currencies in the system were then pegged to the U.S. dollar’s value. The exchange rate applied at the time set the price of gold at $35 an ounce.

KEY TAKEAWAYS

· The Bretton Woods Agreement and System created a collective international currency exchange regime that lasted from the mid-1940s to the early 1970s.

· The Bretton Woods System required a currency peg to the U.S. dollar which was in turn pegged to the price of gold.

· The Bretton Woods System collapsed in the 1970s but created a lasting influence on international currency exchange and trade through its development of the IMF and World Bank.

Benefits of Bretton Woods Currency Pegging

The Bretton Woods System included 44 countries. These countries were brought together to help regulate and promote international trade across borders. As with the benefits of all currency pegging regimes, currency pegs are expected to provide currency stabilization for trade of goods and services as well as financing.

All of the countries in the Bretton Woods System agreed to a fixed peg against the U.S. dollar with diversions of only 1% allowed. Countries were required to monitor and maintain their currency pegs which they achieved primarily by using their currency to buy or sell U.S. dollars as needed. The Bretton Woods System, therefore, minimized international currency exchange rate volatility which helped international trade relations. More stability in foreign currency exchange was also a factor for the successful support of loans and grants internationally from the World Bank.

The IMF and World Bank

The Bretton Woods Agreement created two Bretton Woods Institutions, the IMF and the World Bank. Formally introduced in December 1945 both institutions have withstood the test of time, globally serving as important pillars for international capital financing and trade activities.

The purpose of the IMF was to monitor exchange rates and identify nations that needed global monetary support. The World Bank, initially called the International Bank for Reconstruction and Development, was established to manage funds available for providing assistance to countries that had been physically and financially devastated by World War II.1 In the twenty-first century, the IMF has 189 member countries and still continues to support global monetary cooperation. Tandemly, the World Bank helps to promote these efforts through its loans and grants to governments.2

The Bretton Woods System’s Collapse

In 1971, concerned that the U.S. gold supply was no longer adequate to cover the number of dollars in circulation, President Richard M. Nixon devalued the U.S. dollar relative to gold. After a run on gold reserve, he declared a temporary suspension of the dollar’s convertibility into gold. By 1973 the Bretton Woods System had collapsed. Countries were then free to choose any exchange arrangement for their currency, except pegging its value to the price of gold. They could, for example, link its value to another country's currency, or a basket of currencies, or simply let it float freely and allow market forces to determine its value relative to other countries' currencies.

The Bretton Woods Agreement remains a significant event in world financial history. The two Bretton Woods Institutions it created in the International Monetary Fund and the World Bank played an important part in helping to rebuild Europe in the aftermath of World War II. Subsequently, both institutions have continued to maintain their founding goals while also transitioning to serve global government interests in the modern-day.

The Evolution of US Currency

Video

At times, America may not be the most popular nation in the world, but one thing is for sure: it is famous for its green. The greenback has been iconic since its inception.

This infographic above misses a few key instances in US currency history – namely the birth of the Federal Reserve in 1913 and Nixon ending convertibility to gold in 1971. Both events were catalysts to massive money printing which leaves the USD with only a fraction of the purchasing power that it once had.

Bitcoin Could Become World Reserve Currency, Says Senator Rand Paul

CONTRIBUTOR Namcios  Bitcoin Magazine, PUBLISHED OCT 25, 2021 1:55PM EDT

https://www.nasdaq.com/articles/bitcoin-could-become-world-reserve-currency-says-senator-rand-paul-2021-10-25

Bitcoin could rise to that spot as people keep losing faith and confidence in governments and their policies, Paul said.

As people lose confidence in the government institutions, bitcoin could benefit and rise to become the world's reserve currency, Senator Rand Paul said.

"I've started to question now whether or not cryptocurrency could actually become the reserve currency of the world as more and more people lose confidence in the government," he said.

Senator Paul has never publicly endorsed any cryptocurrency other than Bitcoin.

Bitcoin could become the world's reserve currency if more people lose trust in the government, said Senator Rand Paul, who accepted BTC donations in its 2016 campaign. The Republican Senator was interviewed on Axios, discussing the future of bitcoin and fiat currency in the U.S.

"The government currencies are so unreliable — they're also fiat currencies. They're not backed by anything," Sen. Paul said.

A Gallup poll published on September 30 highlighted how Americans' trust in government remains low. The survey found that overall trust in the federal government to handle international problems sits at a record-low 39%, whereas confidence in the judicial branch is at 54%, down 13 points since 2020. U.S. citizens' trust in their state (57%) and local (66%) governments continues to be higher than trust in the federal government.

As people keep losing faith in their government's ability to handle problems and best represent their interests, Bitcoin and cryptocurrencies are set to benefit and be even more embraced, Senator Paul highlighted.

 -

"I've started to question now whether or not cryptocurrency could actually become the reserve currency of the world as more and more people lose confidence in the government," he said.

The Senator has touted cryptocurrency before. During his presidential campaign in 2016, in addition to donations in U.S. dollars, Paul accepted donations in bitcoin.

Even though the Republican Senator was not specific about which cryptocurrency he was referring to in the interview, he has not publicly endorsed any cryptocurrency other than BTC, indicating he was likely referring to bitcoin itself. Which shouldn't come as a surprise, given that BTC is the only cryptocurrency suitable to function as currency.

Central Bank Digital Currency (CBDC)

By SHOBHIT SETH Updated August 25, 2021, Reviewed by ERIKA RASURE

https://www.investopedia.com/terms/c/central-bank-digital-currency-cbdc.asp

What Is a Central Bank Digital Currency (CBDC)?

The term central bank digital currency (CBDC) refers to the virtual form of a fiat currency. A CBDC is an electronic record or digital token of a country's official currency. As such, it is issued and regulated by the nation's monetary authority or central bank. As such, they are backed by the full faith and credit of the issuing government. CBDCs can simplify the implementation of monetary and fiscal policy and promote financial inclusion in an economy by bringing the unbanked into the financial system. Because they are a centralized form of currency, they may erode the privacy of citizens. CBDCs are in various stages of development around the world.

KEY TAKEAWAYS

· A central bank digital currency is the virtual form of a country's fiat currency.

· A CBDC is issued and regulated by a nation's monetary authority or central bank.

· CBDCs promote financial inclusion and simplify the implementation of monetary and fiscal policy.

· As a centralized form of currency, they may erode the privacy of citizens.

Although they aren't formally being used, many countries are exploring the introduction and use of CBDCs in their economy.

How Central Bank Digital Currencies (CBDCs) Work

Fiat money is the term that refers to currency issued by a country's government. It comes in the form of banknotes and coins. It is considered a form of legal tender that can be used for the sale and purchase of goods and services along with kinds of transactions. A central bank digital currency is the virtual form of fiat money. As such, it has the full faith and backing of the issuing government, just like fiat money does.

CBDCs are meant to represent fiat currency. The goal is to provide users with convenience and security of digital as well as the regulated, reserve-backed circulation of the traditional banking system. They are designed to function as a unit of account, store of value, and medium of exchange for daily transactions. CBDCs will be backed by the full faith of the issuing government—just like fiat currency. Central banks or monetary authorities will be solely liable for their operations.

There were 83 countries around the world pursuing CBDC development as of October 2021.Their reasons for pursuing this venture varied. For example:

Sweden's Riksbank began developing an electronic version of the krona (called e-krona) after the country experienced a decline in the use of cash.

The United States wants to introduce CBDCs in its monetary system to improve the domestic payments system.

Developing countries may have other reasons. For instance, a significant number of people in India are unbanked. Setting up the physical infrastructure to bring the unbanked into the financial ecosystem is costly. But establishing a CBDC can promote financial inclusion in the country's economy.

 CBDCs are not meant to be interchangeable with the national currency (fiat or otherwise) of a country or region.

Types of CBDCs

There are two types of CBDCs: Wholesale and retail central bank digital currencies. We've listed some of the main features of each below.

Wholesale CBDCs

Wholesale CBDCs use the existing tier of banking and financial institutions to conduct and settle transactions. These types of CBDCs are just like traditional central bank reserves.

One type of wholesale CBDC transaction is the interbank payment. It involves the transfer of assets or money between two banks and is subject to certain conditions. This transfer comes with considerable counterparty risk, which can be magnified in a real-time gross settlement (RTGS) payment system.

A digital currency's ledger-based system enables the setting of conditions, so a transfer won't occur if these conditions are not satisfied. Wholesale CBDCs can also expedite and automate the process for cross-border transfers.

Current real-time settlement systems mostly work in single jurisdictions or with a single currency. The distributed ledger technology (DLT) available in wholesale CBDCs can extend the concept to cross-border transfers and expedite the process to transfer money across borders.5

Retail CBDCs

Wholesale CBDCs improve upon a system of transfers between banks. Retail CBDCs, on the other hand, involve the transfer of central government-backed digital currency directly to consumers. They eliminate the intermediary risk or the risk that banking institutions might become illiquid and sink depositor funds.

There are two possible variants of retail CBDCs are possible, depending on the type of access they provide:

Value- or cash-based access: This system involves CBDCs that are passed onto the recipient through a pseudonymous digital wallet. The wallet will be identifiable on a public blockchain and, much like cash transactions, will be difficult to identify parties in such transactions. According to Riksbank, the development of a value- or cash-based access system is easier and quicker compared to token-based access.

Token- or account-based access: This is similar to the access provided by a bank account. Thus, an intermediary will be responsible for verifying the identity of the recipient and monitoring illicit activity and payments between accounts. It provides for more privacy. Personal transaction data is shielded from commercial parties and public authorities through a private authentication process.

 The two types of CBDCs are not mutually exclusive. It is possible to develop a combination of both and have them function in the same economy.

Advantages and Disadvantages of CBDCs

Advantages

CBDCs simplify the process of implementing monetary policy and government functions. They automate the process between banks through wholesale CBDCs and establish a direct connection between consumers and central banks through retail CBDCs. These digital currencies can also minimize the effort and processes for other government functions, such as distribution of benefits or calculation and collection of taxes.

Disbursement of money through intermediaries introduces third-party risk to the process. What if the bank runs out of cash deposits? What if there is a bank run due to a rumor or an external event? Events like these have the potential to upset the delicate balance of a monetary system. A CBDC eliminates third-party risk. Any residual risk that remains in the system rests with the central bank.

One of the roadblocks to financial inclusion for large parts of the unbanked population, especially in developing and poor countries, is the cost associated with developing the banking infrastructure needed to provide them with access to the financial system. CBDCs can establish a direct connection between consumers and central banks, thus eliminating the need for expensive infrastructure.

CBDCs can prevent illicit activity because they exist in a digital format and do not require serial numbers for tracking. Cryptography and a public ledger make it easy for a central bank to track money throughout its jurisdiction, thereby preventing illicit activity and illegal transactions using CBDCs.

Disadvantages

CBDCs don't necessarily solve the problem of centralization. A central authority (the central bank) is still responsible for and invested with the authority to conduct transactions. Therefore, it still controls data and the levers of transactions between citizens and banks.

Users would have to give up some degree of privacy since the administrator is responsible to collect and disseminate digital identifications. The provider would become privy to every transaction conducted. This can lead to privacy issues, similar to the ones that plague tech behemoths and internet service providers (ISPs). For example, criminals could hack and misuse information, or central banks could disallow transactions between citizens.

The legal and regulatory issues pertaining to CBDCs are a black hole. What will be the role of these currencies and who will regulate them? Considering their benefits in cross-border transfers, should they be regulated across borders? Experiments in CBDCs are ongoing, and this could translate to a long-term frame.

The portability of these systems means that a strong CBDC issued by a foreign country could end up substituting a weaker country's currency. A digital U.S. dollar could substitute the local currency of a smaller country or a failing state. Let's look at Ecuador, which replaced its official currency (the sucre) with the U.S. dollar in 2000 after high inflation forced citizens to convert their money to U.S. dollars.

CBDCs vs. Cryptocurrencies

The idea for central bank digital currencies owes its origins to the introduction of cryptocurrencies which are digital currencies secured by cryptography. This makes them hard to duplicate or counterfeit. They are decentralized networks that are based on blockchain technology. The invention of a secure and immutable ledger allows transactions to be tracked. It also enables seamless and direct transfers, without intermediaries and between recipients simplifies the implementation of monetary policy in an economy.

The cryptocurrency ecosystem also provides a glimpse of an alternate currency system in which cumbersome regulation does not dictate the terms of each transaction. Established in 2009, Bitcoin is one of the world's most popular cryptocurrencies. No physical coins actually trade hands. Instead, transactions are traded and recorded on a public, encrypted ledger, which can be accessed by anyone. The process of mining allows all transactions to be verified. No governments or banks back Bitcoin.

Though the current cryptocurrency ecosystem does not pose a threat to the existing financial infrastructure, it has the potential to disrupt and simplify the existing system. Some experts believe the moves by central banks to design and develop their own digital currencies will act as a measure to pre-empt such an eventuality. Facebook's, now Meta's (FB), proposed cryptocurrency, formerly known as Libra, was an example of such a system, one that existed beyond borders and was not regulated by a single regime.

Examples of CBDCs

Central-bank-backed digital currencies haven't been formally established yet. Many central banks have pilot programs and research projects in place that are aimed at determining the viability and usability of a CBDC in their economy. China is the furthest along this route, having already laid down the groundwork and initiated a pilot project for the introduction of a digital yuan.

Russia's plan to create the CryptoRuble was announced by Vladimir Putin in 2017. Speculators suggest that one of the main reasons for Putin's interest in blockchain is that transactions are encrypted, making it easier to discreetly send money without worrying about sanctions placed on the country by the international community.

A number of other central banks have been researching the implementation of a CBDC, including:

Sweden's Riksbank, which began exploring the issuance of a digital currency in its economy in 2017 and has published a series of papers exploring the topic.

The Bank of England (BoE), which is among the pioneers to initiate the CBDC proposal.

The Bank of Canada (BOC).

The central banks of Uruguay, Thailand, Venezuela, and Singapore.1

Gold at $4,000? Analysts share their 2023 outlook as inflation, recession fears linger

DEC 22 20222:10 AM Charmaine Jacob

https://www.cnbc.com/2022/12/22/gold-at-4000-analysts-share-their-2023-outlook-for-prices.html

KEY POINTS

· Gold prices could surge to $4,000 an ounce in 2023 as recession fears persist, said Juerg Kiener, managing director and chief investment officer of Swiss Asia Capital.

· Kiener explained that many economies could face “a little bit of a recession” in the first quarter, which would lead to many central banks slowing their pace of interest rate hikes and make gold instantly more attractive.

Gold prices could surge to $4,000 per ounce in 2023 as interest rate hikes and recession fears keep markets volatile, said Juerg Kiener, managing director and chief investment officer of Swiss Asia Capital.

The price of the precious metal could reach between $2,500 and $4,000 sometime next year, Kiener told CNBC’s “Street Signs Asia” on Wednesday.

There is a good chance the gold market sees a major move, he said, adding “it’s not going to be just 10% or 20%,” but a move that will “really make new highs.”

Kiener explained that many economies could face “a little bit of a recession” in the first quarter, which would lead to many central banks slowing their pace of interest rate hikes and make gold instantly more attractive. He said gold is also the only asset which every central bank owns.

According to the World Gold Council, central banks bought 400 tonnes of gold in the third quarter, almost doubling the previous record of 241 tonnes during the same period in 2018.

“Since [the] 2000s, the average return [on] gold in any currency is somewhere between 8% and 10% a year. You haven’t achieved that in the bond market. You have not achieved that in the equity market.”

Kiener also said investors would look to gold with inflation remaining high in many parts of the world. “Gold is a very good inflation hedge, a great catch during stagflation and a great add onto a portfolio.”

Investors should have some gold in their portfolios: Indian brokerage firm

Despite strong demand for gold, Kenny Polcari, senior market strategist at Slatestone Wealth, disagreed that prices could more than double next year.

“I don’t have a $4,000 price target on it, although I’d love to see it go there,” he said on CNBC’s “Street Signs Asia” on

Thursday.

Polcari argued that gold prices would see some pullback and resistance at $1,900 an ounce. Prices would be determined by how inflation responds to interest rate hikes globally, he said.

“I like gold. I’ve always liked gold,” he said. “Gold should be a part of your portfolio. I think it is going to do better, but I don’t have a $4,000 price target on it.”

Gold rallied on Tuesday as the U.S. dollar weakened after Japan’s central bank adjusted its yield curve control policy. The announcement caused gold prices to rise 1% above the key $1,800 level, before dipping lower Wednesday as the dollar recovered ground.

China’s a big buyer

When asked if supply is low due to high demand, Swiss Asia Capital’s Kiener said “there’s always supply, but maybe not at the price you want.”

But high prices are no match for buyers in China who are paying a premium for the precious metal, he said.

Earlier this month, China’s central bank announced it added about $1.8 billion worth of gold to its reserves, bringing the cumulative value to around $112 billion, Reuters reported.

“Asia has been a big buyer. And if you look at the whole trade, essentially gold is leaving the West, and it’s going into Asia,” he added.

Advice for investors

Nikhil Kamath, co-founder of India’s largest brokerage Zerodha, said investors should allocate 10% to 20% of their portfolio to gold, adding that it’s a “relevant strategy” going into 2023.

“Gold also traditionally has been inversely proportional to inflation, and it has been a good hedge against inflation,” Kamath told CNBC on Wednesday.

“If you look at how much gold you require to buy a mean home in the 70s, you probably require the same or lesser amount of gold today than you did back in the 70s, or the 80s, or the 90s,” he added.

Mar 27, 2020,04:54pm EDT|30,167 views

What If We Had A Gold Standard System, Right Now?

Nathan LewisContributor  https://www.forbes.com/sites/nathanlewis/2020/03/27/what-if-we-had-a-gold-standard-right-now/?sh=1bfba3313e58

For most of the 182 years between 1789 and 1971, the United States embraced the principle of a dollar linked to gold — at first, at $20.67/oz., and then, after 1933, $35/oz. Nearly every economist today will tell you that was a terrible policy. We can tell it was a disaster because, during that time, the United States became the wealthiest and most prosperous country in the history of the world.

This is economist logic.

But, even if some economists might agree with the general principle, they might be particularly hesitant to apply such monetary discipline right now, in the midst of economic and financial turmoil. This kind of event is the whole reason why we put up with all the chronic difficulties of floating currencies, and economic manipulation by central banks. Isn't it?

So, let's ask: What if we were on a gold standard system, right now? Or, to be a little more specific, what if we had been on a gold standard system for the last ten years, and continued on one right now, in the midst of the COVID-19 panic and economic turmoil?

In the end, a gold standard system is just a fixed-value system. The International Monetary Fund tells us that more than half the countries in the world, today, have some kind of fixed-value system — they link the value of their currency to some external standard, typically the dollar, euro, or some other international currency. They have fixed exchange rates, compared to this external benchmark. The best of these systems are currency boards, such as is used by Hong Kong vs. the U.S. dollar, or Bulgaria vs. the euro.

If you think of a gold standard as just a "currency board linked to gold," you would have the general idea. These currency boards are functioning right now to keep monetary stability in the midst of a lot of other turmoil. If you had all the problems of today, plus additional monetary instability as Russia or Turkey or Korea has been experiencing (or the euro ...), it just piles more problems on top of each other.

Actually, it would probably be easier to link to gold than the dollar or euro, because gold's value tends to be stable, while the floating fiat dollar and euro obviously have floating values, by design. If you are going to link your currency to something, it is easier to link it to something that moves little, rather than something that moves a lot. Big dollar moves, such as in 1982, 1985, 1997-98 and 2008, tend to be accompanied by currency turmoil around the world.

But, even within the discipline of a gold standard system, you could still have a fair amount of leeway regarding central bank activity, and also various financial supports that arise via the Treasury and Congress.

Basically, you could do just about anything that is compatible with keeping the value of the dollar stable vs. gold.

In the pre-1914 era, there was a suite of policies to this effect, generally known as the "lender of last resort," and described in Walter Bagehot's book Lombard Street (1873). Another set of solutions resolved the Panic of 1907, without ever leaving the gold standard. The Federal Reserve was explicitly designed to operate on a gold standard system; and mostly did so for the first 58 years of its existence, until 1971. Others have argued that a functional "free banking" system, as Canada had in the pre-1914 era, would allow private banks to take on a lot of these functions, without the need for a central bank to do so.

What could the Federal Reserve do today, while still adhering to the gold standard?

First: It could expand the monetary base, by any amount necessary, that meets an increase in demand to hold cash (base money). Quite commonly, when things get dicey, people want to hold more cash. Individuals might withdraw banknotes from banks. Banks themselves tend to hold more "bank reserves" (deposits) at the Federal Reserve — the banker's equivalent of a safe full of banknotes. This has happened, for example, during every major war. During the Great Depression, the Federal Reserve expanded its balance sheet by a huge amount, as banks increased their bank reserve holdings in the face of uncertainty. Nevertheless, the dollar's value remained at its $35/oz. parity.

Federal Reserve Liabilities 1917-1941.

NATHAN LEWIS

Second: The Federal Reserve could extend loans to certain entities - banks, or corporations - as long as this lending is consistent with the maintenance of the currency's value at its gold parity. In the pre-1914 era, this was done via the "discount window." One way this could come about is by swapping government debt for direct lending. For example, the Federal Reserve could extend $1.0 trillion of loans to banks and corporations, and also reduce its Treasury bond holdings by $1.0 trillion. This would not expand the monetary base. But, it might do a lot to help corporations with funding issues.

What the Federal Reserve would not be able to do is: expand the "money supply" (monetary base) to an excessive amount — an amount that tended to cause the currency's value to fall due to oversupply, compared to its gold parity.

Now we come to a wide variety of actions that are not really related to the Federal Reserve, but rather, to the Treasury and Congress.

In 1933, a big change was Deposit Insurance. The Federal Government insured bank accounts. It helped stop a banking panic at the time. This is a controversial policy even today, and some think it exacerbated the Savings and Loan Crisis of the 1980s, not to mention more issues in 2008. But, nevertheless, it didn't have anything to do with the Federal Reserve.

In 2009, the stock market bottomed when there was a rule change that allowed banks to "mark to model" rather than "mark to market." Banks could just say: "We are solvent, we promise." It worked.

Today, Congress has been making funds available to guarantee business lending, and for a wide variety of purposes that should help maintain financial calm. Whether this is a good idea or not will be debated for a long time I am sure. But, it has nothing to do with the Federal Reserve. All of these actions are entirely compatible with the gold standard.

What about interest rates? Don't we want the Federal Reserve to cut rates when things get iffy? In the 1930s, interest rates were set by market forces. Given the economic turmoil of the time, government bond rates, and especially bill rates, were very low. The yield on government bills spent nearly the whole decade of the 1930s near 0%. Markets lower "risk-free" rates automatically, during times of economic distress, when you just allow them to function without molestation. Every bond trader already knows this.

U.S. interest rates, 1919-1941

NATHAN LEWIS

When we go down the list of all the things that the Federal Reserve, the Treasury, Congress and other regulatory bodies could do, while also adhering to the gold standard, we find that there is really not much left. It turns out that many of the things that supposedly justify floating currencies, are also possible with a gold standard system.

Homework of chapter 2 part ii (due with the first midterm exam)

· Do you support returning to gold standard? Why or why not?

· Do you believe that bitcoin would be the future currency? Why or why not?

· What is the Bretton Woods agreement? Why is the Bretton Woods Agreement a significant event in world financial history?

Optional critical thinking question: Do you think that gold might replace the $ as the world reserve currency in the future? Why or why not? Can the Bitcoin replace the $?

For example, Here’s what would happen if the dollar lost its status as the world’s reserve currency

Even Central Banks Are Buying Gold for the Zombie Apocalypse

Governments in developing economies are building up their bullion holdings as trust breaks down.

By David Fickling November 6, 2022 at 4:30 PM EST

https://www.bloomberg.com/opinion/articles/2022-11-06/central-banks-in-emerging-markets-are-biggest-gold-buyers

The instruction manual for surviving a zombie apocalypse is pretty straightforward. Once you’ve kitted out your bunker with canned goods and firearms, get a supply of bullion. You’ll need it to buy bullets and bribe your way out of a death fight in Thunderdome.

That’s a line of thinking you might associate with cranky gold bugs, but it’s not a million miles away from the rationale behind fund flows in the precious metals market right now — and nations are in the driving seat. Central banks bought 400 metric tons of gold in the September quarter, the World Gold Council reported this week. That’s a record inflow on a par with what they’d purchase over a whole year in normal times.

In the notoriously opaque world of government gold trading, it’s not always immediately clear who the biggest buyers are. Monetary authorities are such big players that they can distort the entire market by showing their hands, one reason that prices plummeted in the 1990s and 2000s when some of the European central banks sold in unison.

There is one obvious factor in common between the declared buyers, however: All are from nations facing serious problems. Turkey, whose lira slumped 52% over the year through September, added 95.5 tons to its gold holdings in the same period. Egypt bought 44.8 tons while its pound fell by 20%. India’s 40.5-ton purchase was matched by an 8.7% weakening of the rupee. Iraq’s dinar is fixed against the dollar, but credit-default swaps protecting against non-payment of its debts surged to nearly 9% in September, even after it bought 33.9 tons of the metal.

That’s a curious situation. Stacking up bullion in the central bank’s vault has long been a powerful signal to investors that a government is going to be a prudent and reliable borrower. No amount of gold buying, though, is going to convince anyone that the fiscally incontinent Egyptian government is a good credit. US 10-year Treasuries, currently yielding 4.2%, also look a much better proposition than a metal that pays no interest, especially now that gold is no longer outperforming the total returns on government debt.

Choose Your Poison

The end of the long bond bull market in 2020 caused gold to outperform the total return on US government debt. They're now moving in parallel again

Bullion does have one crucial advantage: unlike bonds, it doesn’t bind you into a relationship with an unreliable counterparty. US government debt was at one time the hardest form of currency, a true risk-free investment. Then, in February, coordinated sanctions on Russia’s central bank vaporized most of the $498 billion in reserves sitting on its balance sheet. The European Union is now looking at using those funds to pay for the rebuilding of Ukraine, Bloomberg News reported last week. In a world where you can trust no one, it makes sense to bulletproof yourself with metal.

Looked at through that lens, the purchases by Turkey and Egypt come into focus. Though both nations are key US allies, they’ve seen relations deteriorate substantially over the past decade as their governments have found themselves more simpatico with rising authoritarian powers. The path ahead for international relations is more uncertain now than it has been in decades. It makes sense in that world for central bank reserves not to be too heavily committed to ties with any one country.

The behavior of those smaller nations is a clue to the identity of the biggest buyers in the market, too. Declared purchasers only account for about 120 tons of the 400 tons that central banks bought in the September quarter, but you can get a good idea of the other candidates by looking at which countries have been racking up the largest current account surpluses. (Such surpluses, after all, are the balances which governments use to buy their foreign exchange reserves.) Outside of Europe, which stopped large-scale bullion purchases decades ago, the biggest players are all nations whose ties with the US are fraying by the day: China, Russia, and Saudi Arabia.

Follow the Money

Some of the world's biggest current account surpluses are being run up in authoritarian countries whose relations with the US are worsening

The dollar’s role as the world’s preeminent medium of exchange remains unassailable. Some 88% of currency transactions involved the greenback this year, according to the Bank for International Settlements. Still, its share in central bank reserves has been falling rapidly, from 65% at the end of 2016 to 59% earlier this year.

That’s almost certainly a result of Washington’s increasingly muscular view of its currency dominance in recent years, whether it means coercing French banks to obey US sanctions, forcing Hong Kong politicians to be paid with stacks of banknotes, or blockading Russia’s reserves from the global economy.

Going Out of Style

The US dollar has been losing ground as a share of central bank foreign exchange reserves

Such a situation makes gold look like an appealing alternative. Even then, though, there are risks. Venezuela is currently three years into a series of legal cases in London about whether its de facto president or his political rival should control its bullion reserves in the city’s bank vaults. So far, opposition leader Juan Guaido, who’s recognized by the UK government, seems to be winning. When the zombie apocalypse comes, even gold might not be enough to save you.

Chapter 3 International Financial Market/

ppt

References:

Go to www.forex.com and set up a practice account and you can trade with $50,000 virtue money.

Visit http://www.dailyfx.com/to get daily foreign exchange market news.

Part I: international financial centers

The Global Financial Centres Index (GFCI) is a ranking of the competitiveness of financial centres based on over 29,000 financial centre assessments from an online questionnaire together with over 100 indices from organisations such as the World Bank, the Organisation for Economic Co-operation and Development (OECD), and the Economist Intelligence Unit. The first index was published in March 2007. It has been jointly published twice per year by Z/Yen Group in London and the China Development Institute in Shenzhen since 2015, and is widely quoted as a top source for ranking financial centres.

*Ranking

The ranking is an aggregate of indices from five key areas: "business environment", "financial sector development", "infrastructure factors", "human capital", "reputation and general factors". As of September 2022, the top centres worldwide are:

https://www.reuters.com/business/finance/new-york-still-top-moscow-sinks-finance-centre-ranking-2022-09-22/

Key 2022 Highlights

· 3 of the top 10 are United States cities: New York, Los Angeles, San Francisco

· 4 of the top 10 are China’s cities: Hong Kong, Shanghai, Beijing, Shenzhen

· 2 of the top 10 are European cities: London, Paris

· Singapore is the top financial centre in Asia-Pacific (APAC)

· The top 5 financial centres in APAC: Singapore, Hong Kong, Shanghai, Beijing, Shenzhen

· The top 5 financial centres in Europe: London, Paris, Frankfurt, Amsterdam, Geneva

· The top 5 financial centres in MENA: Dubai, Abu Dhabi, Tel Aviv, Casablanca, Doha

By Industry Sector

· Top 5 Banking Centre: Shenzhen, New York, London, Shanghai, Hong Kong

· Top 5 Investment Mgmt Centre: New York, London, Singapore, Beijing, Shanghai

· Top 5 Trading Centre: New York, London, Hong Kong, Shenzhen, Singapore

· Top 5 Insurance Centre: New York, Luxembourg, London, Shenzhen, Hong Kong

· Top 5 Finance: New York, Shenzhen, London, Luxembourg, Singapore

· Top 5 Fintech: New York, London, Singapore, Seoul, Dubai

· Top 5 Govt & Regulatory: New York, London, Seoul, Singapore, Dubai

· Top 5 Professional Services: New York, London, Seoul, Singapore, Hong Kong

https://www.caproasia.com/2022/09/24/the-2022-global-financial-centres-index-32nd-edition-full-ranking/

What Makes a City a Financial Hub?

https://www.investopedia.com/articles/investing/091114/worlds-top-financial-cities.asp

A financial center, or a financial hub, refers to a city with a strategic location, leading financial institutions, reputed stock exchanges, a dense concentration of public and private banks and trading and insurance companies. In addition, these hubs are equipped with first-class infrastructure, communications and commercial systems, and there is a transparent and sound legal and regulatory regime backed by a stable political system. Such cities are favorable destinations for professionals because of the high living standards they offer along with immense growth opportunities.

Here is a look at the top financial hubs across the globe, in no particular order.

KEY TAKEAWAYS

· Cities that are concentrations of commerce, trading, real estate, and banking tend to become global financial hubs.

· These important cities employ a large number of financial professionals and are home to stock exchanges and corporate headquarters for investment banks.

· Found around the world, examples include New York City, Frankfurt, and Tokyo.

London

Since the middle ages, London has been one of the most prominent trade and business centers. The city is one of the most visited places on earth and is among the most preferred places to do business. London is a well-known center for foreign exchange and bond trading in addition to banking activities and insurance services. The city is a trading hub for bonds, futures, foreign exchange and insurance. The United Kingdom’s central bank, the Bank of England, is the second oldest central bank in the world and is located in London. The bank controls the monetary system and regulates the issue of currency notes in the United Kingdom. London is also the seat of the London Stock Exchange, which is the second largest stock exchange in Europe. Another financial paragon is The London bullion market, managed by London Bullion Market Association (LBMA), which is the world's largest market for gold and silver bullion trading. Due to Brexit uncertainty, London may ultimately lose its stature as a global financial hub.

Singapore

From a business perspective, Singapore's attractiveness lies in its transparent and sound legal framework complementing its economic and political stability. The small island located in the Southeast Asia region has emerged as one of the Four Asian Tigers and established itself as a major financial center. Singapore has transformed its economy despite the disadvantages of limited land and resources. Singapore is both diversified and specialized across industries such as chemicals, biomedical sciences, petroleum refining, mechanical engineering and electronics. Singapore has deep capital markets and is a leading insurance and wealth management marketplace. It has a disciplined and efficient workforce with a population made up of people of Chinese, Malay and Indian origin.

Zurich

Zurich, the largest city in Switzerland, is recognized as a financial center globally. The city has a disproportionately large presence of financial institutions and banks and has developed into a hub for insurance and asset management companies. The low tax regime makes Zurich a good investment destination, and the city attracts a large number of international companies. Switzerland’s primary stock exchange, the SIX Swiss Exchange, is in Zurich and is one of the largest in the world, with a market capitalization of $1.4 trillion as of July 2021. The city has a robust business environment and offers many finance sector jobs. Zurich is one of the cleanest, most beautiful and crime free places to live and work.

New York City

New York, commonly regarded as the finance capital of the world, has been ranked first in the World’s Financial Centers by the Global Financial Centres Index.9 New York is famous for Wall Street, the most happening stock market and the New York Stock Exchange (NYSE), the largest stock exchange by market capitalization. The city is a mix of various cultures from across the globe providing a diverse population and workforce. It plays host to some of the largest and finest companies (Fortune 500 and Fortune 1000), biggest banks (Goldman Sachs, Morgan Stanley, and Merrill Lynch, JP Morgan) and industries. It is difficult to find a big name in the world of business that does not have a presence in the city.

Hong Kong

Hong Kong is a key financial hub with a high number of banking institutions. The former British colony also has a sound legal system for both residents and companies and is the home of many fund management companies. Hong Kong has benefited from its strategic location. For more than a century, the city has been a conduit of trade between China and the world. Hence, Hong Kong is China's second largest trading partner after the United States. Its proximity to other countries in the region has also worked in its favor. Hong Kong has an efficient and transparent judicial and legal system with excellent infrastructure and telecommunication services. It has a favorable tax system in place with very few and low tax rates, which adds to its attractiveness. The Hong Kong Stock Exchange is the fourth largest in the world.

Chicago

Chicago owes its fame to the derivative market (CME group), which started at the Chicago Board of Trade (CBOT) in 1848 with commodity futures trading. It is the oldest futures exchange in the world and the second largest by volume, behind the National Stock Exchange of India. The Chicago-based Options Clearing Corporation (OCC) clears all U.S. option contracts. Chicago is the headquarters of over 400 major corporations, and the state of Illinois has more than 30 Fortune 500 companies, most of which are located in Chicago. These companies include State Farm Insurance, Boeing, Archer Daniels Midland and Caterpillar. Chicago also one of the most diverse economies excelling from innovation in risk management to information technology to manufacturing to health. Another financial notable is the Federal Reserve Bank of Chicago.

Tokyo

Tokyo is the capital of the third-largest economy in the world and a major financial center.16 The city is the headquarters of many of the world’s largest investment banks and insurance companies. It is also the hub for the country’s telecommunications, electronic, broadcasting and publishing industries. The Japan Exchange Group (JPX) was established January 1, 2013, by combining the Tokyo Stock Exchange (TSE) Group and the Osaka Securities Exchange. The exchange had a market capitalization of $5.9 trillion as of July 2021. The Nikkei 225 and the TOPIX are the main indices tracking the buzz at the TSE. Tokyo has time and again been rated among the most expensive cities in the world.

Frankfurt

Frankfurt is home to the European Central Bank (ECB) and the Deutsche Bundesbank, the central bank of Germany. It has one of the busiest airports in the world and is the address of many top companies, national and international banks. In 2014, Frankfurt became Europe's first renminbi payment hub. Frankfurter Wertpapierbörse, the Frankfurt Stock Exchange, is among the world’s largest stock exchanges. It had a $2.65 trillion market capitalization as of July 2021. Deutsche Börse Group operates the Frankfurt Stock Exchange.

Shanghai

Shanghai is the world's third most populous city, behind Tokyo and Delhi. The Chinese government in early 2009 announced its ambition of turning Shanghai into an international financial center by 2020. The Shanghai Stock Exchange (SSE) is mainland China’s most preeminent market for stocks in terms of turnover, tradable market value and total market value. The SSE had a market capitalization of $7.63 trillion as of July 2021. The China Securities Regulatory Commission (CSRC) directly governs the SSE. The exchange is considered restrictive in terms of trading and listing criteria. 

For Discussion:

What makes an international financial centre? (video)

Asia’s top financial hub – Singapore or Hong Kong? (youtube)

What Is Libor And Why Is It Being Abandoned?

Here's What Went Wrong With Libor (youtube)

LIBOR vs. SOFR : Introduction, Scandals & Replacement : The Interest-Rate Benchmark

What Is Libor And Why Is It Being Abandoned?

Miranda Marquit, Benjamin Curry Updated: Nov 7, 2022, 7:38pm

https://www.forbes.com/advisor/investing/what-is-libor/

For more than 40 years, the London Interbank Offered Rate—commonly known as Libor—was a key benchmark for setting the interest rates charged on adjustable-rate loans, mortgages and corporate debt.

Over the last decade, Libor has been burdened by scandals and crises. Effective January 2022, Libor will no longer be used to issue new loans in the U.S. It is being replaced by the Secured Overnight Financing Rate (SOFR), which many experts consider a more accurate and more secure pricing benchmark.

Understanding Libor

Libor provided loan issuers with a benchmark for setting interest rates on different financial products. It was set each day by collecting estimates from up to 18 global banks on the interest rates they would charge for different loan maturities, given their outlook on local economic conditions. Libor was calculated in five currencies: UK Pound Sterling, the Swiss Franc, the Euro, Japanese Yen and the U.S. Dollar.

The London Interbank Offered Rate was used to price adjustable-rate mortgages, asset-backed securities, municipal bonds, credit default swaps, private student loans and other types of debt. As of 2019, $1.2 trillion worth of residential mortgage loans and $1.3 trillion of consumer loans had been priced using Libor.

When you applied for a loan based on Libor, a financial firm would take a Libor rate and then tack on an additional percentage. Here’s how it worked for a private student loan, based on the Libor three-month rate plus 2%. If the Libor three-month rate was 0.22%, the base rate for the loan would be 2.22%. Other factors, such as your credit score, income and the loan term, are also factored in.

While Libor is no longer being used to price new loans, it will formally stick around until at least 2023. One-week and two-month Libor have ceased being published, while overnight, 1-month, 3-month, 6-month, and 12-month maturities will continue to be published through June 2023.

With an adjustable-rate loan, your lender sets regular periods where it makes changes to the rate you’re being charged. The lender referenced Libor when adjusting the interest rate on your loan, changing how much you pay each month.

How Is Libor Calculated?

Each day, 18 international banks submit their ideas of the rates they think they would pay if they had to borrow money from another bank on the interbank lending market in London.

To help guard against extreme highs or lows that might skew the calculation, the Intercontinental Exchange (ICE) Benchmark Administration strips out the four highest submissions and the four lowest submissions before calculating an average.

It’s important to note that Libor isn’t set on what banks actually pay to borrow funds from each other. Instead, it’s based on their submissions related to what they think they would pay. As a result, it’s possible for banks to submit lower rates and manipulate Libor fairly easily.

In the past, a panel of bankers oversaw Libor in each currency, but scandals exposing manipulation of Libor has led many national regulators to identify alternatives to Libor.

Libor Scandals and the 2008 Financial Crisis

Libor is being phased out in large part because of the role it played in worsening the 2008 financial crisis, as well as scandals involving Libor manipulation among the rate-setting banks.

Libor and the 2008 Financial Crisis

The use and abuse of credit default swaps (CDS) was one of the major drivers of the 2008 financial crisis. A very wide range of interrelated financial companies insured risky mortgages and other questionable financial products using CDS. Rates for CDS were set using Libor, and these derivative investments were used to insure against defaults on subprime mortgages.

American International Group (AIG) was the biggest player in the CDS disaster. The firm issued vast quantities of CDS on subprime mortgages and countless other financial products, like mortgaged-backed securities. The crash of the real estate market in 2007, followed by the even larger market meltdown in 2008, forced AIG into bankruptcy, resulting in one of the largest government bailouts in history.

Once AIG started falling apart, it became clear that failing subprime mortgages and the securities built on top of them weren’t properly insured, many banks became reluctant to lend to each other. Libor transmitted the crisis far and wide since every day Libor rate-setting banks estimated higher and higher interest rates. Libor rose, making loans more expensive, even as global central banks rushed to slash interest rates.

With rates on trillions of dollars of financial products soaring day after day, and fears about stunted bank lending reducing the flow of money through the economy, markets crashed. Libor was only one of the many factors that created the financial industry disasters of 2008, but its key role in transmitting the crisis to all parts of the global economy has driven many nations to seek safer alternatives.

Libor Manipulation

In 2012, extensive investigations into the way Libor was set uncovered a widespread, long-lasting scheme among multiple banks—including Barclays, Deutsche Bank, Rabobank, UBS and the Royal Bank of Scotland—to manipulate Libor rates for profit.

Barclays was a key player in this complicated scam. Barclays would submit its Libor estimates, claiming that it was lower than what other banks actually charged it. Because a lower rate supposedly indicates a smaller risk of default, it is considered a sign that a bank is in better shape than another bank with a higher rate.

It wasn’t just Barclays, though. At UBS, one trader involved in Libor setting, Thomas Hayes, managed to rake in hundreds of millions of dollars for the bank over the course of three years. Hayes also colluded with traders at the Royal Bank of Scotland on rigging Libor. UBS executives denied all knowledge of what had been going on, although the ring managed to manipulate rate submissions across multiple institutions.

SOFR Is Replacing Libor in the U.S.

It’s not just these scandals that undercut Libor. According to ICE, banks have been changing the way they transact business, and, as a result, Libor rate became a less reliable benchmark.

SOFR is the main replacement for Libor in the United States. This benchmark is based on the rates U.S. financial institutions pay each other for overnight loans.

These transactions take the form of Treasury bond repurchase agreements, otherwise known as repos agreements. They allow banks to to meet liquidity and reserve requirements, using Treasurys as collateral. SOFR comprises the weighted averages of the rates charged in these repo transactions.

How Does the End of Libor Impact Your Loans?

Even if Libor doesn’t completely disappear as soon as expected, there’s a good chance banks and other lenders will start looking for other ways to determine market rates.

If you have an adjustable-rate loan, check to see if it’s based on Libor. For loans based on Libor, find out what index your lender will be switching to. While there might not be a set answer now, keep an eye on the situation. A switch to a different index might mean a higher base rate in the future.

Libor demise and Brexit reshape derivatives market, says BIS

By Huw Jones October 27, 20229:08 AM EDT

https://www.reuters.com/business/finance/libor-demise-brexit-reshape-derivatives-market-says-bis-2022-10-27/

LONDON, Oct 27 (Reuters) - Brexit and the demise of Libor are reshaping the world's over-the-counter (OTC) interest rate derivatives market, where daily turnover totalled $5.2 trillion in April, down from $6.4 trillion in April 2019, the Bank for International Settlements (BIS) said on Thursday.

"The most significant factor contributing to the decline in turnover is the continuing shift away from Libor for major currencies," the BIS said in its latest triennial snapshot of the global OTC interest rate derivatives market.

After banks were fined for trying to rig the London Interbank Offered Rate, or Libor, the bulk of the benchmark's permutations were scrapped at the end of 2021 and replaced with rates compiled by central banks.

Replacing Libor shrank turnover in forward rate agreements or FRAs, a type of derivatives contract, with turnover in dollar FRAs tumbling by 98%.

Sales desks in Britain recorded the highest turnover of interest rate derivatives, at $2.6 trillion, or 46% of global 'net-gross' turnover, down from 51% in 2019.

"Turnover in U.S. dollar swaps has partially shifted from sales desks in the United Kingdom to the United States and Asian financial centres," the BIS said.

"Similarly, turnover in euro swaps has shifted from the United Kingdom to the euro area."

Brexit from the end of 2020 meant that EU banks could no longer trade OTC derivatives in London, forcing them to trade on platforms in the United States in some cases.

Turnover in euro contracts reached $1.8 trillion per day in April 2022 to 34% of global turnover, up from 25% in 2019, as dollar contracts fell from roughly half of the global market in 2019 to 44% in April.

Turnover of euro rate swaps in Britain fell 18% to $1 trillion over the three years, while turnover by dealers, particularly in Germany and France more than tripled, from $124 billion in 2019 to $385 billion in 2022.

Euro-denominated contracts, excluding FRAs, traded in euro area countries accounted for more than a quarter of the global total, the highest share since 2010, BIS said.

Part II: Floating exchange rate system vs. fixed exchange rate system

Class video on 2/1/2023

Currency exchange introduction (khan acadymy)

Supply and demand curves in foreign exchange (khan academy)

Floating and Fixed Exchange Rates- Macroeconomics (youtube)

How Are International Exchange Rates Set?

https://www.investopedia.com/ask/answers/forex/how-forex-exchange-rates-set.asp

By CAROLINE BANTON Updated March 04, 2021, Reviewed by GORDON SCOTT, Fact checked by YARILET PEREZ

International currency exchange rates display how much one unit of a currency can be exchanged for another currency. Currency exchange rates can be floating, in which case they change continually based on a multitude of factors, or they can be pegged (or fixed) to another currency, in which case they still float, but they move in tandem with the currency to which they are pegged.

Knowing the value of a home currency in relation to different foreign currencies helps investors to analyze assets priced in foreign dollars. For example, for a U.S. investor, knowing the dollar to euro exchange rate is valuable when selecting European investments. A declining U.S. dollar could increase the value of foreign investments just as an increasing U.S. dollar value could hurt the value of your foreign investments.

KEY TAKEAWAYS

· Fixed exchange rate regimes are set to a pre-established peg with another currency or basket of currencies.

· A floating exchange rate is one that is determined by supply and demand on the open market as well as macro factors.

· A floating exchange rate doesn't mean countries don't try to intervene and manipulate their currency's price, since governments and central banks regularly attempt to keep their currency price favorable for international trade.

· Floating exchange rates are the most common and became popular after the failure of the gold standard and the Bretton Woods agreement.

Floating vs. Fixed Exchange Rates

Currency prices can be determined in two main ways: a floating rate or a fixed rate. A floating rate is determined by the open market through supply and demand on global currency markets. Therefore, if the demand for the currency is high, the value will increase. If demand is low, this will drive that currency price lower. Of course, several technical and fundamental factors will determine what people perceive is a fair exchange rate and alter their supply and demand accordingly.

The currencies of most of the world's major economies were allowed to float freely following the collapse of the Bretton Woods system between 1968 and 1973. Therefore, most exchange rates are not set but are determined by on-going trading activity in the world's currency markets.

Factors That Influence Exchange Rates

Floating rates are determined by the market forces of supply and demand. How much demand there is in relation to supply of a currency will determine that currency's value in relation to another currency. For example, if the demand for U.S. dollars by Europeans increases, the supply-demand relationship will cause an increase in the price of the U.S. dollar in relation to the euro. There are countless geopolitical and economic announcements that affect the exchange rates between two countries, but a few of the most common include interest rate changes, unemployment rates, inflation reports, gross domestic product numbers, manufacturing data, and commodities.

A fixed or pegged rate is determined by the government through its central bank. The rate is set against another major world currency (such as the U.S. dollar, euro, or yen). To maintain its exchange rate, the government will buy and sell its own currency against the currency to which it is pegged.Some countries that choose to peg their currencies to the U.S. dollar include China and Saudi Arabia.

Short-term moves in a floating exchange rate currency reflect speculation, rumors, disasters, and everyday supply and demand for the currency. If supply outstrips demand that currency will fall, and if demand outstrips supply that currency will rise. Extreme short-term moves can result in intervention by central banks, even in a floating rate environment. Because of this, while most major global currencies are considered floating, central banks and governments may step in if a nation's currency becomes too high or too low.

A currency that is too high or too low could affect the nation's economy negatively, affecting trade and the ability to pay debts. The government or central bank will attempt to implement measures to move their currency to a more favorable price.

Macro Factors

More macro factors also affect exchange rates. The 'Law of One Price' dictates that in a world of international trade, the price of a good in one country should equal the price in another. This is called purchasing price parity (PPP). If prices get out of whack, the interest rates in a country will shift—or else the exchange rate will between currencies. Of course, reality doesn't always follow economic theory, and due to several mitigating factors, the law of one price does not often hold in practice. Still, interest rates and relative prices will influence exchange rates.

Another macro factor is the geopolitical risk and the stability of a country's government. If the government is not stable, the currency in that country is likely to fall in value relative to more developed, stable nations.

Generally, the more dependent a country is on a primary domestic industry, the stronger the correlation between the national currency and the industry's commodity prices.

There is no uniform rule for determining what commodities a given currency will be correlated with and how strong that correlation will be. However, some currencies provide good examples of commodity-forex relationships.

Consider that the Canadian dollar is positively correlated to the price of oil. Therefore, as the price of oil goes up, the Canadian dollar tends to appreciate against other major currencies. This is because Canada is a net oil exporter; when oil prices are high, Canada tends to reap greater revenues from its oil exports giving the Canadian dollar a boost on the foreign exchange market.

Another good example is the Australian dollar, which is positively correlated with gold. Because Australia is one of the world's biggest gold producers, its dollar tends to move in unison with price changes in gold bullion. Thus, when gold prices rise significantly, the Australian dollar will also be expected to appreciate against other major currencies.

Maintaining Rates

Some countries may decide to use a pegged exchange rate that is set and maintained artificially by the government. This rate will not fluctuate intraday and may be reset on particular dates known as revaluation dates. Governments of emerging market countries often do this to create stability in the value of their currencies. To keep the pegged foreign exchange rate stable, the government of the country must hold large reserves of the currency to which its currency is pegged to control changes in supply and demand.

For example:

The Impossible Trinity or "The Trilemma"

– can a country controls its interest rates, exchange rates, and capital flow simultaneously?

Impossible Trinity (youtube)

A - set a fixed exchange rate between its currency and another while allowing capital to flow freely across its borders,

B - allow capital to flow freely and set its own monetary policy, or

C - set its own monetary policy and maintain a fixed exchange rate.

The Impossible Trinity or "The Trilemma", in which two policy positions are possible. If a nation were to adopt position a, for example, then it would maintain a fixed exchange rate and allow free capital flows, the consequence of which would be loss of monetary sovereignty.

The Impossible Trinity - 60 Second Adventures in Economics (5/6) (video)

The impossible trinity (also known as the trilemma) is a concept in international economics which states that it is impossible to have all three of the following at the same time:

·         a fixed foreign exchange rate

·         free capital movement (absence of capital controls)

·         an independent monetary policy

It is both a hypothesis based on the uncovered interest rate parity condition, and a finding from empirical studies where governments that have tried to simultaneously pursue all three goals have failed. The concept was developed independently by both John Marcus Fleming in 1962 and Robert Alexander Mundell in different articles between 1960 and 1963.

Policy choices

According to the impossible trinity, a central bank can only pursue two of the above-mentioned three policies simultaneously. To see why, consider this example:

Assume that world interest rate is at 5%. If the home central bank tries to set domestic interest rate at a rate lower than 5%, for example at 2%, there will be a depreciation pressure on the home currency, because investors would want to sell their low yielding domestic currency and buy higher yielding foreign currency. If the central bank also wants to have free capital flows, the only way the central bank could prevent depreciation of the home currency is to sell its foreign currency reserves. Since foreign currency reserves of a central bank are limited, once the reserves are depleted, the domestic currency will depreciate.

Hence, all three of the policy objectives mentioned above cannot be pursued simultaneously. A central bank has to forgo one of the three objectives. Therefore, a central bank has three policy combination options.

Options

In terms of the diagram above (Oxelheim, 1990), the options are:

· Option (a): A stable exchange rate and free capital flows (but not an independent monetary policy because setting a domestic interest rate that is different from the world interest rate would undermine a stable exchange rate due to appreciation or depreciation pressure on the domestic currency).

· Option (b): An independent monetary policy and free capital flows (but not a stable exchange rate).

· Option (c): A stable exchange rate and independent monetary policy (but no free capital flows, which would require the use of capital controls.

Currently, Eurozone members have chosen the first option (a) while most other countries have opted for the second one (b). By contrast, Harvard economist Dani Rodrik advocates the use of the third option (c) in his book The Globalization Paradox, emphasizing that world GDP grew fastest during the Bretton Woods era when capital controls were accepted in mainstream economics. Rodrik also argues that the expansion of financial globalization and the free movement of capital flows are the reason why economic crises have become more frequent in both developing and advanced economies alike. Rodrik has also developed the "political trilemma of the world economy", where "democracy, national sovereignty and global economic integration are mutually incompatible: we can combine any two of the three, but never have all three simultaneously and in full."

(from Wikipedia)

Summary

Key Terms (Lesson summary: the foreign exchange market (article) | Khan Academy)

Key term	Definition
foreign exchange market	a market in which one currency is exchanged for another currency; for example, in the market for Euros, the Euro is being bought and sold, and is being paid for using another currency, such as the yen.
demand for currency	a description of the willingness to buy a currency based on its exchange rate; for example, as the exchange rate for Euros increases, the quantity demanded of Euros decreases.
appreciate	when the value of a currency increases relative to another currency; a currency appreciates when you need more of another currency to buy a single unit of a currency.
depreciate	when the value of a currency decreases relative to another currency; a currency depreciates when you need less of another currency to buy a single unit of a currency.
floating exchange rates	when the exchange rate of currencies are determined in free markets by the interaction of supply and demand

· Why the demand for a currency is downward sloping

When the exchange rate of a currency increases, other countries will want less of that currency. When a currency appreciates (in other words, the exchange rate increases), then the price of goods in the country whose currency has appreciated are now relatively more expensive than those in other countries. Since those goods are more expensive, less is imported from those countries, and therefore less of that currency is needed.

· The equilibrium exchange rate is the interaction of the supply of a currency and the demand for a currency

As in any market, the foreign exchange market will be in equilibrium when the quantity supplied of a currency is equal to the quantity demanded of a currency. If the market has a surplus or a shortage, the exchange rate will adjust until an equilibrium is achieved.

For Discussion:

1. Who are the major players in the FX market? Who are the Major Players in the FOREX MARKET? (youtube)

2. As compared with stock market, FX market is more volatile or less? Why?

The forex market is far more volatile than the stock market, where profits can come easily to an experienced and focused trader. However, forex also comes with a much higher level of leverage and less traders tend to focus less on risk management, making it a riskier investment that could have adverse effects. www.cmcmarkets.com

What’s Ahead for the US Dollar in 2023? (youtube)

Barclays shares its forecast for the Japanese yen (youtube)

Europe's economy and markets could outperform the U.S. in 2023: Deutsche Bank (youtube)

Currency experts are turning bullish on the euro as Europe looks to hold off a recession

PUBLISHED WED, JAN 11 20235:37 AM EST Elliot Smith

https://www.cnbc.com/2023/01/11/experts-bullish-on-euro-as-europe-looks-to-hold-off-a-recession.html

KEY POINTS

· “The euro is trading within its late December range, but incoming data since the beginning of 2023 suggest to us that it should be stronger,” Steve Englander, head of global G-10 FX research at Standard Chartered, said in a note Monday.

· Incoming data trends suggest a need for continued hawkishness in Frankfurt and a potential cooling of rate hikes in Washington, some analysts highlighted this week.

· This would be positive for the euro.

As markets head into a year of uncertainty against a backdrop of shifting economic data and monetary policy, analysts are turning positive on the outlook for the euro

.

Having fallen below parity with the U.S. dollar in the second half of 2022, the common currency recovered in recent months to trade within a tight range at just above $1.07 on Wednesday morning.

Central to the euro’s weakness last year was aggressive monetary policy tightening from the U.S. Federal Reserve while the European Central Bank was much later out of the blocks in hiking interest rates to contain runaway inflation.

However, incoming data trends suggest a need for continued hawkishness in Frankfurt and a potential cooling of rate hikes in Washington, several analysts highlighted this week. This closing of the interest rate gap would be positive for the euro.

The economic threat posed by sky-high energy prices in the euro zone has also faded amid an unseasonably mild winter in much of northern Europe.

“The euro is trading within its late December range, but incoming data since the beginning of 2023 suggest to us that it should be stronger,” Steve Englander, head of global G-10 FX research at Standard Chartered, said in a note Monday.

“Both euro area core inflation and economic surprises have continued to strengthen, making it easier for the European Central Bank to maintain a hawkish tone. Energy concerns that loomed large as a EUR-negative in mid-2022 are beginning to ebb.”

Euro zone annual headline inflation slid to 9.2% in December from 10.1% in November, Eurostat preliminary figures revealed last week. But core inflation, which excludes volatile energy, food, alcohol and tobacco prices, rose by more than expected to hit a new record high of 5.2%.

Both the ECB and the Fed have continued to strike a hawkish tone in recent weeks as they focus on dragging inflation back toward target. ECB policymaker Robert Holzmann told a conference on Wednesday that “policy interest rates will have to rise significantly further to reach levels that are sufficiently restrictive to ensure a timely return of inflation to the 2% medium-term target.”

However, Englander pointed out that the data surprises in the U.S. have been “middling to weaker” than in Europe, indicating less upward pressure on rates.

He highlighted that the average hourly earnings (AHE) trend in the latest release was “far more benign” than those the Federal Open Market Committee (FOMC) was working with in mid-December, when 6-month annualized earnings growth through November was 5.3% and rising.

“The 6M annualised wage increase in December fell to 4.4% in the latest release. The December non-manufacturing ISM was the lowest since 2010, other than when COVID struck with all its force in 2020,” Englander noted.

Fed Chairman Jerome Powell has repeatedly emphasized the importance of wages in bringing core services inflation down, pointing to wage growth as a risk factor in the Fed’s mission to reduce it.

“If productivity growth trends have not changed since pre-Covid, this would leave AHE growth consistent with 3-3.5% underlying inflation,” Englander said.

“This is not 2%, but wage growth consistent with 3-3.5% inflation is not an acute inflation problem, especially if the wage trend continues to head lower.”

Reduced core services inflation would allow the Fed room to half its aggressive rate hiking cycle later in the year, and perhaps even begin to reverse it.

The ‘Fed pivot’

This potential turning point for markets, widely referred to as the “Fed pivot,” would be the “missing link” to catalyze a more robust upward trajectory for the euro, according to Deutsche Bank

The U.S. dollar “defied historical experience last year by overshooting relative to the prevailing growth, inflation and monetary policy mix,” Saravelos said in a note Monday.

“With negative China and European drivers turning more supportive quicker than we anticipated a few months ago the risks are shifting towards an earlier dollar drop. We would buy EUR/USD targeting 1.10 by Q2 and move up our year-end forecast to 1.15,” he said.

Saravelos agreed with Englander’s assessment that the relative policy cycles in the U.S. and the euro zone point to the Fed pivoting before the ECB.

“In Europe, the latest PMI numbers show there may not even be a recession this winter, the unemployment rate is still declining and fiscal policy is structurally easy,” he said.

“In contrast, the debt ceiling poses downside risks to U.S. fiscal policy this year, the market is already pricing the Fed’s desired level of real rates, and U.S. labor tightness metrics (e.g. the vacancy rate) are turning faster than Europe.”

What’s more, after 2022′s global uncertainty, markets are sitting on “extremely large USD cash exposure,” Saravelos said. He suggested this could be vulnerable to further liquidation given that two of the main drivers of the greenback’s safe-haven appeal last year — Europe’s energy shock and China’s zero-Covid policy — have turned a corner.

China’s reopening in itself could also provide a boost to the euro, he argued, since it is a pro-cyclical currency and “turning points over the last decade have coincided with a turn in the external growth cycle.”

“Tight central bank policy is a big headwind to global growth, but China’s shift away from zero-Covid policy is a tailwind, while also helping prevent upside pressure on the broad dollar via USDCNY (U.S. dollar versus Chinese yuan).”

Part III: Forex quote

What Are Currency Pairs? (youtube)

Live Forex Quotes & Currency Rates | Forexlive 2/2/2022

When a currency is quoted, it is done in relation to another currency, so that the value of one is reflected through the value of another. Therefore, if you are trying to determine the exchange rate between the U.S. dollar (USD) and the Japanese yen (JPY), the forex quote would look like this:

USD/JPY = 119.50,  USD is the Base currency / JPY is the Quote currency, 1 UDS = 119.5 JPY

This is an indirect quote

Base currency vs. quote currency (counter currency)

This is referred to as a currency pair. The currency to the left of the slash is the base currency, while the currency on the right is called the quote or counter currency. The base currency (in this case, the U.S. dollar) is always equal to one unit (in this case, US$1), and the quoted currency (in this case, the Japanese yen) is what that one base unit is equivalent to in the other currency. The quote means that US$1 = 119.50 Japanese yen. In other words, US$1 can buy 119.50 Japanese yen. The forex quote includes the currency abbreviations for the currencies in question.

Direct Currency Quote vs. Indirect Currency Quote

There are two ways to quote a currency pair, either directly or indirectly. A direct currency quote is simply a currency pair in which the domestic currency is the quoted currency; while an indirect quote, is a currency pair where the domestic currency is the base currency. So if you were looking at the Canadian dollar as the domestic currency and U.S. dollar as the foreign currency, a direct quote would be USD/CAD, while an indirect quote would be CAD/USD. The direct quote varies the domestic currency, and the base, or foreign currency, remains fixed at one unit. In the indirect quote, on the other hand, the foreign currency is variable and the domestic currency is fixed at one unit. 

· Direct currency quote:  foreign currency / domestic currency, such as JPY / USD (one JPY for how many USD)

·         Indirect currency quote: domestic currency / foreign currency, such as USD/JPY (one USD for how many JPY)

For example, if Canada is the domestic currency, a direct quote would be 1.18 USD/CAD and means that USD$1 will purchase C$1.18 . The indirect quote for this would be the inverse (1/1.18), 0.85 CAD/USD, which means with C$1, you can purchase US$0.85. 

In the forex spot market, most currencies are traded against the U.S. dollar, and the U.S. dollar is frequently the base currency in the currency pair. In these cases, it is called a direct quote. This would apply to the above USD/JPY currency pair, which indicates that US$1 is equal to 119.50 Japanese yen. 

However, not all currencies have the U.S. dollar as the base. The Queen's currencies - those currencies that historically have had a tie with Britain, such as the British pound, Australian Dollar and New Zealand dollar - are all quoted as the base currency against the U.S. dollar. The euro is quoted the same way as well. In these cases, the U.S. dollar is the counter currency, and the exchange rate is referred to as an indirect quote. This is why the EUR/USD quote is given as 1.25, for example, because it means that one euro is the equivalent of 1.25 U.S. dollars. 

-

Most currency exchange rates are quoted out to four digits after the decimal place, with the exception of the Japanese yen (JPY), which is quoted out to two decimal places. 

Cross Currency ( You can find the cross exchange rates at www.forex.com)
When a currency quote is given without the U.S. dollar as one of its components, this is called a cross currency. The most common cross currency pairs are the EUR/GBP, EUR/CHF and EUR/JPY. These currency pairs expand the trading possibilities in the forex market, but it is important to note that they do not have as much of a following (for example, not as actively traded) as pairs that include the U.S. dollar, which also are called the majors. (https://www.investopedia.com/university/forexmarket/forex2.asp)

*

Summary:

USD  /  JPY  =  119.50   è 1 US$ = 119.5 YEN, to US residents this is an indirect quote; to a Japanese, it is a indirect quote.

Base  / quote

JPY  /  USD  =  1/119.50   è 1 YEN = (1/119.5)$, to US residents this is a direct quote; to a Japanese, it is a direct quote.

Base  / quote

Direct quote = 1/(indirect quote)  or  indirect quote = 1/ (direct quote)  *** Inverse relationship

Exchange rate primer (khan academy)

The exchange rate is the price of one currency in terms of the other (Khan academy)

In the foreign exchange market, a currency is being bought and sold, and the price of that currency is given in some other currency. That price is expressed as an exchange rate.

When an exchange rate changes, the value of one currency will go up while the value of the other currency will go down. When the value of a currency increases, it is said to have appreciated. On the other hand, when the value of a currency decreases, it is said to have depreciated.

The exchange rate of a currency is expressed as the units of another currency needed to buy a single unit of the currency. For example, the exchange rate for currency A is given below:

Common misperceptions

A common misperception is that a strong currency is always what is best for a country. On the one hand, if a currency appreciates, all of its imported goods get a lot cheaper. If a country tends to import a lot more goods than they export, then an appreciated currency might be desirable. But on the other hand, if a country relies heavily on exports, an appreciating currency isn’t such a great thing. When a currency appreciates, the exports from a country that use that currency will decrease because all of those goods are more expensive to countries other currencies. (khan academy)

In Class Exercise

1 The dollar-euro exchange rate is $1.25 = €1.00 and the dollar-yen exchange rate is ¥100 = $1.00. What is the euro-yen cross rate?

a) ¥125 = €1.00

b) ¥1.00 = €125

c) ¥1.00 = €0.80

d) None of the above

Answer: a) $1.00 = ¥100 è $1.25= ¥125. And $1.25 = €1.00è¥125 = $1.25= €1.00

Or, $1.25 = €1.00 è $1 = €0.8 è since $1.00 = ¥100 è €0.8 = ¥100 è¥125 = €1.00

2 The AUD/$ spot exchange rate is AUD1.60/$ and the SF/$ is SF1.25/$. The AUD/SF cross exchange rate is:

a) 0.7813

b) 2.0000

c) 1.2800

d) 0.3500

Answer: c)

Rational:

Or, AUD1.60/$ è 1$ = AUD1.60, is SF1.25/$ è1$=SF1.25, so AUD1.60 = SF1.25è AUD (1.60/1.25)= SF 1

3 The euro-pound cross exchange rate can be computed as:

a) S(€/£) = S($/£) × S(€/$)

b)

c)

d) all of the above

Answer: d)

Carry the currency symbol!

For example: S(€/£) = S($/£) × S(€/$) è This is correct.

Part IV: what is BID and ASK price on Forex

Forex: Bid and Ask (video)

Basics of Bid price and Ask price - Foreign currency Exchange Rates (youtube)

Bid and Ask
As with most trading in the financial markets, when you are trading a currency pair there is a bid price (buy) and an ask price (sell). Again, these are in relation to the base currency. When buying a currency pair (going long), the ask price refers to the amount of quoted currency that has to be paid in order to buy one unit of the base currency, or how much the market will sell one unit of the base currency for in relation to the quoted currency.

The bid price is used when selling a currency pair (going short) and reflects how much of the quoted currency will be obtained when selling one unit of the base currency, or how much the market will pay for the quoted currency in relation to the base currency.

The quote before the slash is the bid price, and the two digits after the slash represent the ask price (only the last two digits of the full price are typically quoted). Note that the bid price is always smaller than the ask price. Let's look at an example:

USD/CAD = 1.2000/05
Bid = 1.2000 (bid rate is 1.2 CAD /$),  sell 1$ at 1.2 CAD
Ask= 1.2005 (ask rate is 1.2005  CAD/$), buy 1$ at 1.2005 CAD

If you want to buy this currency pair, this means that you intend to buy the base currency and are therefore looking at the ask price to see how much (in Canadian dollars) the market will charge for U.S. dollars. According to the ask price, you can buy one U.S. dollar with 1.2005 Canadian dollars.

However, in order to sell this currency pair, or sell the base currency in exchange for the quoted currency, you would look at the bid price. It tells you that the market will buy US$1 base currency (you will be selling the market the base currency) for a price equivalent to 1.2000 Canadian dollars, which is the quoted currency.

Whichever currency is quoted first (the base currency) is always the one in which the transaction is being conducted. You either buy or sell the base currency. Depending on what currency you want to use to buy or sell the base with, you refer to the corresponding currency pair spot exchange rate to determine the price.

(https://www.investopedia.com/university/forexmarket/forex2.asp)

Exercise I:

Assume you have $1000 and bid rate is $1.52/£ and ask rate is $1.60 /£.

GBP/USD = 1.5200/1.6000

Meanwhile, the bid rate is quoted as 0.625 £/$ and the ask rate is quoted as 0.6579 £/$.  

USD/GBP = 0.6250 /0.6579

If you convert it to £ and then convert it back to $, what will happen? 

Answer:

Sell at bid and buy at ask price (ask is always higher than bid so you buy high and sell low, since you are dealing with the bank).

You can either buy and sell dollar: 

with $1000, you sell at bid 0.625 £/$ so you get 625£

($1000* 0.625 £/$ = 625£). With 625£, you sell at bid $1.52/£, so you get $950 (625£ * $1.52/£ = $950)

Or with 625£, you can buy $ at ask price 0.6579 £/$ è so you get $950 (625£ / 0.6579 £/$ = $950)

Note: It is easier to use USD/GBP to get £ first, since USD/GBP is based on one dollar’s equivalent value in £. Then it is easier to use GBP/USD to get back $, since GBP/USD is based on the equivalent value of £ in $.

Exercise II:

Suppose the spot ask exchange rate is $1.90 = £1.00 and the spot bid exchange rate is $1.89 = £1.00. If you were to buy $1,000,000 worth of £ and then sell them 10 minutes later, how much of your $1,000,000 would be lost by the bid-ask spread? (Hint: You buy at ask and sell at bid)

                 Answer:

GBP at $1.60 /£ and buy $ at 0.6579 £/$.  So $1000 / 1.6 $/£    *  0.6579 £/$ = $950

¥125 = €1.00)

Exercise III: The AUD/$ spot exchange rate is AUD1.60/$ and the SF/$ is SF1.25/$.  The AUD/SF cross exchange rate is: (answer: 1.2800)

Why a strong dollar isn't as good as you think (video)

Deutsche Bank Sees Choppy Outlook for Dollar in 2023 (youtube)

Dollar higher as strong U.S. data backs a hawkish Fed

PUBLISHED WED, JAN 25 202311:20 PM ESTUPDATED THU, JAN 26 20234:01 PM EST

Nicolas Economou | Nurphoto | Getty Images

https://www.cnbc.com/2023/01/26/dollar-near-eight-month-low-ahead-of-central-bank-meetings.html

The dollar edged higher against the euro on Thursday after data showed the U.S. economy maintained a strong pace of growth in the fourth quarter, backing the case for the U.S. Federal Reserve to maintain its hawkish stance for longer.

Gross domestic product increased at a 2.9% annualized rate last quarter, the Commerce Department said in its advance fourth-quarter GDP growth estimate. The economy grew at a 3.2% pace in the third quarter. Economists polled by Reuters had forecast GDP rising at a 2.6% rate.

A separate report from the Labor Department showed initial claims for state unemployment benefits dropped 6,000 to a seasonally adjusted 186,000 for the week ended Jan. 21.

“A somewhat mixed picture painted by the U.S. data,” said Stuart Cole, head macro economist at Equiti Capital in London.

The data point to an economy that is continuing to show resilience in the face of the rapid monetary tightening so far delivered by the Fed, Cole said.

“But a big contributor to this growth story was inventories, a component that is almost certain to weaken as we go through 2023,” he said.

“I think it reinforces the expectation of the Fed moving to 25 basis points moves now,” Cole said.

The euro was 0.2% lower at $1.08889, but not far from the nine-month high of $1.09295 touched on Monday. Against the yen, the dollar was up 0.5% at 130.25 yen.

Attention now turns to next week’s central bank meetings, including the Federal Reserve and the European Central Bank.

Traders broadly expect the Fed to increase rates by 25 basis points (bps) next Wednesday, a step down from a 50 bps increase in December. Meanwhile, the ECB has all but committed to raising its key rate by half a percentage point next week.

The Aussie touched a new 7-month high of $0.71425 on growing expectations that more Reserve Bank of Australia interest rate hikes are due after data showed Australian inflation surged to a 33-year high last quarter.

The Canadian dollar rose to a two-month high against its U.S. counterpart on Thursday, a day after the Bank of Canada raised interest rates as expected in a move that could mark the end of the central bank’s aggressive tightening campaign.

Part V:  Eurodollar, Eurobond

Eurodollar

Eurodollar explained (video)

The term eurodollar refers to U.S. dollar-denominated deposits at foreign banks or at the overseas branches of American banks. By being located outside the United States, eurodollars escape regulation by the Federal Reserve Board, including reserve requirements. Dollar-denominated deposits not subject to U.S. banking regulations were originally held almost exclusively in Europe, hence the name eurodollar. They are also widely held in branches located in the Bahamas and the Cayman Islands.

(https://www.investopedia.com/terms/e/eurodollar.asp)

Euroyen

By ADAM HAYES Updated December 08, 2020, Fact checked by DANIEL RATHBURN

What Are Euroyen?

The term euroyen refers to all Japanese yen (JPY)-denominated deposits held outside of Japan. It can also refer to trading in yen in the eurocurrency market.

A eurocurrency is any currency held or traded outside its country of issue, and euroyen thus refers to all Japanese yen (JPY) deposits held or traded outside Japan. The "euro-" prefix in the term arose because originally such overseas currencies were held primarily in Europe, but that is no longer the case and a eurocurrency can now involve any domestic currency that is held anywhere else in the world that local banking regulations permit.

KEY TAKEAWAYS

· Euroyen refers to deposits denominated in Japanese yen (JPY) held outside of Japan itself.

· Also known as offshore yen, the establishment of Euroyen allowed Japan to liberalize its capital markets and grow its position in international trade.

· Rates on euroyen are set against a benchmark: either Euroyen TIBOR or Yen LIBOR.

Understanding Euroyen

Euroyen can also be referred to as "offshore yen," and refers to japanese yen held overseas. The offshore yen market was initially established in December 1986 as part of the liberalization and internationalization of Japanese financial markets and increased the country's stature in terms of global trade.

There are two euroyen benchmark rates: Euroyen TIBOR (published at 1 p.m. Tokyo time, with a panel dominated by Tokyo banks) and the Yen LIBOR (London Interbank Offered Rate, published at 11:55 a.m. London time with a panel dominated by non-Japanese banks in London).

Both domestic JPY and euroyen TIBOR rates are published by the Japanese Bankers Association (JBA), but after the LIBOR manipulation scandal broke in 2012 they have been published by a focused entity called the JBA TIBOR Administration (JBATA) in an effort to enhance the credibility of the published rates.

Both Yen LIBOR and Euroyen TIBOR rates were caught up in the LIBOR scandal. A number of large banks, both Japanese and foreign, paid hundreds of millions of dollars in settlement of euroyen-related claims and associated penalties arising from the case.

The Intercontinental Exchange, the authority responsible for LIBOR, will stop publishing one-week and two-month USD LIBOR after Dec. 31, 2021. All other LIBOR will be discontinued after June 30, 2023.

Euroyen Examples

Examples of euroyen would be yen deposits held in U.S. banks or banks elsewhere in Asia, and yen traded in London. Like all eurocurrencies, euroyen deposits fall outside the regulatory purview of the national central bank of the home country, the Bank of Japan (BoJ) in this case. Therefore, euroyen deposits may offer slightly different interest rates than those available for yen deposits in Japan.

Rates on JPY deposits in Japan are directly affected by interest rates set by the Bank of Japan and by liquidity in the Japanese money market, and are linked to a rate called Japanese yen Tokyo Interbank Offered Rate (TIBOR). Euroyen deposit rates, by contrast, are set in the eurocurrency market.

Advantages and Disadvantages of Eurocurrency Markets

https://www.investopedia.com/terms/e/eurocurrencymarket.asp#:~:text=Advantages%20and%20Disadvantages%20of%20Eurocurrency%20Markets&text=They%20can%20simultaneously%20offer%20lower,a%20run%20on%20the%20banks.

· The main benefit of eurocurrency markets is that they are more competitive. They can simultaneously offer lower interest rates for borrowers and higher interest rates for lenders.

· That is mostly because eurocurrency markets are less regulated.

· On the downside, eurocurrency markets face higher risks, particularly during a run on the banks.

What is a Eurobond What is EUROBOND? What does EUOBOND mean? (video)

A eurobond is denominated in a currency other than the home currency of the country or market in which it is issued. These bonds are frequently grouped together by the currency in which they are denominated, such as eurodollar or euroyen bonds. Issuance is usually handled by an international syndicate of financial institutions on behalf of the borrower, one of which may underwrite the bond, thus guaranteeing purchase of the entire issue.   https://www.investopedia.com/terms/e/eurobond.asp

HOMEWORK (CHAPTER 3) (Due with the first mid term exam)

1. Is USD expected to rise in 2023? Why or why not?

2. Is EURO expected to rise in 2023? Why or why not?

3. “SOFR Is Replacing Libor in the U.S”. What is Libor? What is SOFT?

4. What is impossible trinity?

5. Bid/Ask Spread

Compute the bid/ask percentage spread for Mexican peso retail transactions in which the ask rate is $.11 and the bid rate is $.10.  HINT: BID ASK SPREAD = (ASK-BID)/ASK  (Answer: 9.09%)

6. Indirect Exchange Rate

If the direct exchange rate of the euro is worth $1.25, what is the indirect rate of the euro? That is, what is the value of a dollar in euros? (Answer: 0.8€)

7. Cross Exchange Rate

Assume Poland currency (the zloty) is worth $.17 and the Japanese yen is worth $.008. What is the cross rate of the zloty with respect to yen? That is, how many yen equal a zloty? (Answer: 21.25¥)

8. Foreign Exchange exercise

You just came back from Canada, where the Canadian dollar was worth $.70.

You still have C$200 from your trip and could exchange them for dollars at the airport, but the airport foreign exchange desk will only buy them for $.60. Next week, you will be going to Mexico and will need pesos. The airport foreign exchange desk will sell you pesos for $.10 per peso. You met a tourist at the airport who is from Mexico and is on his way to Canada. He is willing to buy your C$200 for 1,300 pesos. Should you accept the offer or cash the Canadian dollars in at the airport? Explain. (Answer: You can only get $1,200 peso if you accept the offer in the airport)

9. What is Eurodollar? What is Euroyen? What is Eurobond?

10. Why does the world bank make a big cut to its 2023 growth outlook?

Please refer to https://www.cnbc.com/2023/01/11/world-bank-global-economy-to-enter-recession.html

World Bank makes big cut to its 2023 growth outlook, says globe is ‘perilously close’ to recession

PUBLISHED TUE, JAN 10 202310:51 PM ESTUPDATED TUE, JAN 10 202311:21 PM EST Jihye Lee

https://www.cnbc.com/2023/01/11/world-bank-global-economy-to-enter-recession.html

KEY POINTS

· The World Bank slashed its 2023 global economy growth outlook to 1.7% for 2023 from its earlier projection of 3%.

· It would mark “the third weakest pace of growth in nearly three decades, overshadowed only by the global recessions caused by the pandemic and the global financial crisis,” the World Bank said.

Why the World bank slashed its global growth outlook

The World Bank slashed its global growth forecasts from projections it made in mid-2022 on the back of what it sees as broadly worsening economic conditions.

The international development institution downgraded almost all of its forecasts for advanced economies in the world, cutting its growth outlook for the global economy to 1.7% for 2023, it said in its latest report, Global Economic Prospects. The organization earlier projected the world economy to expand by 3% in 2023.

The adjustment was led by a significant downgrade to its prospects for the U.S. economy — it now forecasts 0.5% growth from an earlier projection of 2.4%.

The World Bank cut its growth outlook for China for 2023 from 5.2% to 4.3%, Japan from 1.3% to 1% , and Europe and Central Asia from 1.5% to 0.1%.

“Global growth has slowed to the extent that the global economy is perilously close to falling into recession,” the World Bank said, attributing an “unexpectedly rapid and synchronous” global monetary policy tightening behind the sluggish growth.

The downgraded estimates would mark “the third weakest pace of growth in nearly three decades, overshadowed only by the global recessions caused by the pandemic and the global financial crisis.”

The World Bank said that tighter monetary policies from central banks around the world may have been necessary to tame inflation, but they have “contributed to a significant worsening of global financial conditions, which is exerting a substantial drag on activity.”

“The United States, the euro area, and China are all undergoing a period of pronounced weakness, and the resulting spillovers are exacerbating other headwinds faced by emerging market and developing economies,” it said.

The global financial organization adjusted its 2024 forecasts lower as well, to 2.7% from an earlier prediction of 3% growth.

China is ‘key variable’

A faster-than-expected China reopening poses great uncertainty for its economic recovery, the World Bank said in its report.

“The economic recovery [in China] may be delayed if reopening results in major outbreaks that overburden the health sector and sap confidence,” the report said. “There is significant uncertainty about the trajectory of the pandemic and how households, businesses, and policy makers in China will respond.”

World Bank President David Malpass said on CNBC’s “Closing Bell” on Tuesday that “China is a key variable and there may be an upside for China if they push through Covid as quickly as they seem to be doing.”

“China’s big enough by itself to really lift global demand and supply,” he said.

“One of the questions for the world would be, which does it do most — if it’s mostly putting upward pressure on global demand, then that raises commodity prices. But it also means that the Fed will be hiking for a longer period of time,” he said.

How companies like Amazon, Nike and FedEx avoid paying federal taxes (FYI)

PUBLISHED THU, APR 14 20228:05 AM EDT

https://www.cnbc.com/2022/04/14/how-companies-like-amazon-nike-and-fedex-avoid-paying-federal-taxes-.html

The current United States tax code allows some of the biggest company names in the country to not pay any federal corporate income tax.

In fact, at least 55 of the largest corporations in America paid no federal corporate income taxes on their 2020 profits, according to the Institute on Taxation and Economic Policy. The companies include names like Whirlpool, FedEx, Nike, HP and Salesforce.

“If a large, very profitable company isn’t paying the federal income tax, then we have a real fairness problem on our hands,” Matthew Gardner, a senior fellow at the Institute on Taxation and Economic Policy (ITEP), told CNBC.

What’s more, it is entirely legal and within the parameters of the tax code that corporations can end up paying no federal corporate income tax, which costs the U.S. government billions of dollars in lost revenue.

″[There’s] a bucket of corporate tax breaks that are deliberately in the tax code … . And overall, they cost the federal government roughly $180 billion each year. And for comparison, the corporate tax brings in about $370 billion of revenue a year,” Chye-Ching Huang, executive director of the NYU Tax Law Center, told CNBC, citing research from the Tax Foundation.

CNBC reached out to FedEx, Nike, Salesforce and HP for comment. They either declined to provide a statement or did not respond before publication.

The 55 corporations cited by ITEP would have paid a collective total of $8.5 billion. Instead, they received $3.5 billion in tax rebates, collectively draining $12 billion from the U.S. government, according to the institute. The figures don’t include corporations that paid only some but not all of these taxes.

“I think the fundamental issue here is there are two different ways in which corporations book their profits,” Garrett Watson, senior policy analyst at the Tax Foundation, told CNBC. “The amount of profits that corporations may be reporting for financial purposes may be very different from the profits that they are reporting [for tax purposes.]”

Some tax expenditures, which come in many different forms, are used by some companies to take advantage of rules that enable them to lower their effective tax rates.

For example, Gardner’s research into Amazon’s taxes from 2018 to 2021 showed a reported $79 billion of pretax U.S. income. Amazon paid a collective $4 billion in federal corporate income tax in those four years, equating to an effective annual tax rate of 5.1%, according to Gardner’s ITEP report, about a quarter of the federal corporate tax rate of 21%.

Amazon told CNBC in a statement, “In 2021, we reported $2.3 billion in federal income tax expense, $5.2 billion in other federal taxes, and more than $4 billion in state and local taxes of all types. We also collected an additional $22 billion in sales taxes for U.S. states and localities.”

One controversial form of federal tax expenditure is the offshoring of profits. The foreign corporate income tax — anywhere between 0% and 10.5% — can incentivize the shifting of profits to tax havens.

For example, Whirlpool, a U.S. company known for manufacturing home appliances both in the U.S. and Mexico, was cited in a recent case involving both U.S. and Mexican taxes.

″[Whirlpool] did that by having the Mexican operation owned by a Mexican company with no employees, and then having that Mexican company owned by a Luxembourg holding company that had one employee,” Huang told CNBC. “And then it tried to claim that due to the combination of the U.S., Mexico and Luxembourg tax rules ... it was trying to take advantage of the disconnect between all of those tax systems to to avoid tax and all of those countries and of court said, no, that goes too far.”

Whirlpool defended its actions in a statement to CNBC: “The case before the Sixth Circuit has never been about trying to avoid U.S. taxes on the profits earned in Mexico. This tax dispute has always been about when those profits are taxed in the U.S. In fact, years before the original Tax Court decision in 2020, Whirlpool had already paid U.S. tax on 100% of the profits it earned in Mexico. Simply put, the IRS thought Whirlpool should have paid those U.S. taxes earlier.”

Average effective corporate tax rate falls to 9% with tax reform, estimates UPenn Wharton (CNBC, video)

Despite record profits in 2021, many corporations are paying barely any taxes

19 profitable Fortune 100 corporations that reported they will owe little or no taxes for 2021

https://www.americanprogress.org/article/these-19-fortune-100-companies-paid-next-to-nothing-or-nothing-at-all-in-taxes-in-2021/

How to solve the debt ceiling problem – by ChatGPT (Thanks, Adam)

To solve the debt ceiling problem, Congress may need to increase the limit or agree on spending cuts and revenue increases to reduce the debt. However, this can be a politically divisive issue, as raising the debt ceiling may be seen as increasing government spending, while cutting spending or raising revenue can be politically unpopular.

References:

"The Debt Limit: History and Recent Increases" Congressional Research Service, 2021

"Debt Ceiling 101" Committee for a Responsible Federal Budget, 2021

It's also worth noting that the US has temporarily suspended the debt ceiling through July 2024, so the issue may not become relevant until later in the decade.

Chapter 4

Chapter 4 Exchange Rate Determination

Chapter 4 PPT

Part I: What determines the strength of a currency? 

Currency value is determined by demand and supply, if not manipulated by the government.

What Determines The Strength Of A Currency?

Richard Barrington

Q: What factors determine the strength of a currency?

A: Currency trading is complicated by the fact that there are so many factors involved. Not only are there a number of country-specific variables that go into determining a currency's strength, but there are also other benchmarks--other currencies, for example, as well as commodities--against which a currency's strength can be measured.

However, three crucial factors are as follows:

1. Interest rates. High interest rates help promote a strong currency, because foreign investors can get a higher return by investing in that country. However, the level of interest rates is relative. You've probably noticed that interest rates on CDs, savings accounts and money market accounts are very low right now. So are U.S. Treasury bond rates and the U.S. federal funds rate. Ordinarily, this would weaken the U.S. dollar, except for the fact that interest rates behind other major world currencies are also low.

2. Economic policies. Tight fiscal discipline and anti-inflationary monetary policies help promote a strong currency. Again, this is all relative--the U.S. has its fiscal problems, but so do many other nations around the world.

3. Stability. A strong government with a well-established rule of law and a history of constructive economic policies are the type of things that attract investment and thus promote a strong currency. In the case of the U.S. dollar, its strength is further augmented by the fact that commodities are generally traded in dollars, and many countries use the dollar as a reserve currency.

Speaking of stability, that is probably what governments seek for their currencies, more so than strength. A strong currency makes a country's exports more expensive, hurting that nation's trade competitiveness. On the other hand, a weak currency makes imports more expensive, boosting domestic inflation. So the ideal course is to aim down the middle and avoid destabilizing fluctuations.

(https://www.forbes.com/sites/moneybuilder/2011/12/01/what-determines-the-strength-of-a-currency/#539f066216c6)

http://www.investopedia.com/video/play/main-factors-influence-exchange-rates/ (VIDEO)

Please also read the following article to learn more about how changes in demand and supply work on exchange rate.

FYI (https://opentextbc.ca/principlesofeconomics/chapter/29-2-demand-and-supply-shifts-in-foreign-exchange-markets/)

The foreign exchange market involves firms, households, and investors who demand and supply currencies coming together through their banks and the key foreign exchange dealers. Figure 1 (a) offers an example for the exchange rate between the U.S. dollar and the Mexican peso. The vertical axis shows the exchange rate for U.S. dollars, which in this case is measured in pesos. The horizontal axis shows the quantity of U.S. dollars being traded in the foreign exchange market each day. The demand curve (D) for U.S. dollars intersects with the supply curve (S) of U.S. dollars at the equilibrium point (E), which is an exchange rate of 10 pesos per dollar and a total volume of $8.5 billion.

Figure 1. Demand and Supply for the U.S. Dollar and Mexican Peso Exchange Rate. (a) The quantity measured on the horizontal axis is in U.S. dollars, and the exchange rate on the vertical axis is the price of U.S. dollars measured in Mexican pesos. (b) The quantity measured on the horizontal axis is in Mexican pesos, while the price on the vertical axis is the price of pesos measured in U.S. dollars. In both graphs, the equilibrium exchange rate occurs at point E, at the intersection of the demand curve (D) and the supply curve (S).

Figure 1 (b) presents the same demand and supply information from the perspective of the Mexican peso. The vertical axis shows the exchange rate for Mexican pesos, which is measured in U.S. dollars. The horizontal axis shows the quantity of Mexican pesos traded in the foreign exchange market. The demand curve (D) for Mexican pesos intersects with the supply curve (S) of Mexican pesos at the equilibrium point (E), which is an exchange rate of 10 cents in U.S. currency for each Mexican peso and a total volume of 85 billion pesos. Note that the two exchange rates are inverses: 10 pesos per dollar is the same as 10 cents per peso (or $0.10 per peso). In the actual foreign exchange market, almost all of the trading for Mexican pesos is done for U.S. dollars. What factors would cause the demand or supply to shift, thus leading to a change in the equilibrium exchange rate? The answer to this question is discussed in the following section.

Expectations about Future Exchange Rates

One reason to demand a currency on the foreign exchange market is the belief that the value of the currency is about to increase. One reason to supply a currency—that is, sell it on the foreign exchange market—is the expectation that the value of the currency is about to decline. For example, imagine that a leading business newspaper, like the Wall Street Journal or the Financial Times, runs an article predicting that the Mexican peso will appreciate in value. The likely effects of such an article are illustrated in Figure 2. Demand for the Mexican peso shifts to the right, from D₀ to D₁, as investors become eager to purchase pesos. Conversely, the supply of pesos shifts to the left, from S₀ to S₁, because investors will be less willing to give them up. The result is that the equilibrium exchange rate rises from 10 cents/peso to 12 cents/peso and the equilibrium exchange rate rises from 85 billion to 90 billion pesos as the equilibrium moves from E₀ to E₁.

Figure 2. Exchange Rate Market for Mexican Peso Reacts to Expectations about Future Exchange Rates. An announcement that the peso exchange rate is likely to strengthen in the future will lead to greater demand for the peso in the present from investors who wish to benefit from the appreciation. Similarly, it will make investors less likely to supply pesos to the foreign exchange market. Both the shift of demand to the right and the shift of supply to the left cause an immediate appreciation in the exchange rate.

Figure 2 also illustrates some peculiar traits of supply and demand diagrams in the foreign exchange market. In contrast to all the other cases of supply and demand you have considered, in the foreign exchange market, supply and demand typically both move at the same time. Groups of participants in the foreign exchange market like firms and investors include some who are buyers and some who are sellers. An expectation of a future shift in the exchange rate affects both buyers and sellers—that is, it affects both demand and supply for a currency.

The shifts in demand and supply curves both cause the exchange rate to shift in the same direction; in this example, they both make the peso exchange rate stronger. However, the shifts in demand and supply work in opposing directions on the quantity traded. In this example, the rising demand for pesos is causing the quantity to rise while the falling supply of pesos is causing quantity to fall. In this specific example, the result is a higher quantity. But in other cases, the result could be that quantity remains unchanged or declines.

This example also helps to explain why exchange rates often move quite substantially in a short period of a few weeks or months. When investors expect a country’s currency to strengthen in the future, they buy the currency and cause it to appreciate immediately. The appreciation of the currency can lead other investors to believe that future appreciation is likely—and thus lead to even further appreciation. Similarly, a fear that a currency might weaken quickly leads to an actual weakening of the currency, which often reinforces the belief that the currency is going to weaken further. Thus, beliefs about the future path of exchange rates can be self-reinforcing, at least for a time, and a large share of the trading in foreign exchange markets involves dealers trying to outguess each other on what direction exchange rates will move next.

In class exercise

Think about the changes in demand and supply when the following changes occur. And draw demand and supply curve to explain.

1) Inflation goes up  è currency demand high or low? è currency value up or down? Answer: $ will devalue. Supply for $ increase, demand for$ decrease

2) Real interest rate goes up   è currency demand high or low? è currency value up or down? Answer: $ will appreciate. Supply for $ decrease, demand for$ increase

1) Domestic residents’ income goes up  è currency demand high or low? è currency value up or down?

· Current account goes up è currency demand high or low? è currency value up or down? Your opinion?

2) Public debt goes up è currency demand high or low? è currency value up or down? Answer: $ will devalue. Supply for $ increase

3) Recession or crisis è currency demand high or low? è currency value up or down? Answer: $ will devalue. Supply for $ increase, demand for$ decrease

4) Other accidental events è currency demand high or low? è currency value up or down?

Note:

· For the each of the scenarios above, can you draw the demand and supply curve?*

· If not yet, please watch the following video.  Supply and demand curves in foreign exchange by Khan Academy (video)

Part II: Fixed exchange rate vs. floating exchange rate

Speculative attack on a currency | Khan Academy (optional)

The country cannot, however, fix exchange rates, allow capital to flow freely and maintain monetary policy sovereignty. For example, Country X links its currency, the X pound, to the Y franc at a one-to-one ratio. This is effective if both Country X and Country Y's central banks maintain a policy rate of 3%. But if Country Y raises interest rates to combat rising inflation, investors would spot an opportunity for arbitrage. X pounds would flood over the border to buy Y francs and earn the higher interest rate.

Y francs would in effect become worth more than X pounds. Thus, either Country X abandons the currency peg and allows the X pound to fall, raises its policy rate to match Country Y's policy rate abandoning monetary policy independence or it sets up capital controls to keep X pounds in the country.

Real-world examples of these trade-offs include the eurozone where countries have opted for side A of the triangle: they forfeit monetary policy control to the European Central Bank but maintain a single currency (in effect a one-to-one peg coupled with free capital flow). The difficulties of maintaining a monetary union across economies as different as Germany and Greece have become clear as the latter has repeatedly appeared poised to drop out of the currency bloc. 

Following World War II, the wealthy opted for side C under the Bretton Woods system, which pegged currencies to the dollar but allowed them to set their own interest rates. Cross-border capital flows were so small that the system held for a couple of decades – the exception being Mundell's native Canada, a situation that gave him special insight into the tensions inherent in the system. Today, most countries allow their currencies to float, meaning they opt for side B.

Analysis of the Best Currency Pairs to Trade

•           USD/EUR – This can be considered the most popular currency pair. In addition, it has the lowest spread among modern world Forex brokers. This currency pair is associated with basic technical analysis. The best thing about this currency pair is that it is not too volatile. If you are not in a position to take any risks, you can think of selecting this as your best Forex pair to trade, without it causing you too much doubt in your mind. You can also find a lot of information on this currency pair, which can help prevent you from making rookie mistakes.

•           USD/GBP – Profitable pips and possible large jumps have contributed a lot towards the popularity of this currency pair. However, you need to keep in mind that higher profits come along with a greater risk. This is a currency pair that can be grouped into the volatile currencycategory. However, many traders prefer to select this as their best currency pair to trade, since they are able to find plenty of market analysis information online.

•           USD/JPY – This is another popular currency pair that can be seen regularly in the world of Forex trading. It is associated with low spreads, and you can usually follow a smooth trend in comparison with other currency pairs. It also has the potential to deliver exciting, profitable opportunities for traders.  

Special Pairs (Or Exotic Currency Pairs)

Typically the best pair for you is the one that you are most knowledgeable about. It can be extremely useful for you to trade the currency from your own country, if it is not included in the majors, of course. This is only true if your local currency has some nice volatility too. In general, knowing your country's political and economical issues results in additional knowledge which you can base your trades on.

You can find such information through economic announcements in our Forex calendar, which also lists predictions and forecasts concerning these announcements. It is also recommended to consider trading the pairs that contain your local currency (also known as 'exotic pairs'). In most cases, your local currency pair will be quoted against USD, so you would need to stay informed about this currency as well.

•           From https://admiralmarkets.com/education/articles/forex-basics/what-are-the-best-currency-pairs-to-trade

Bretton Woods and the Growth of the Eurodollar Market

January 20, 2022

By Paulina Restrepo Echavarria , Praew Grittayaphong

As World War II raged on, delegates from 44 Allied nations gathered at a hotel in Bretton Woods, N. H., to lay out foundations for the reconstruction of the international financial system. The hope was to prevent a repetition of competitive devaluations in the 1930s and to create a stable economic and financial environment for nations to operate in. This resulted in an agreement for countries to fix their exchange rates to the U.S. dollar and the U.S. to peg the dollar to gold.

The fixed exchange rate system constrained the economic policies of many nations, causing policymakers to adopt capital/exchange control measures to keep their monetary autonomy. However, the control measures were not always effective and economic agents around the world began to find loopholes in the system. Among these was the emergence of the eurodollar market: a market for short-term deposits denominated in U.S. dollars at banks outside U.S. territory (PDF), particularly in London.

The Origins and the Spread of the Eurodollar Market

Although there are many possible factors that contributed to the development of the eurodollar market, numerous accounts cited exchange controls implemented by the U.K. in 1957 as the earliest impetus for this development. In response to a potential drain on reserves caused by higher inflation and the Suez crisis, the British government placed severe restrictions (PDF) on sterling credits to nonresidents and banned the use of sterling to finance third-party transactions. To circumvent this issue, the London banks started using dollar deposits as credit instruments for nonresidents.

Another possible factor that drove the demand for dollar deposits was profitable investment opportunities in the U.K. and the financial innovation that followed. During the period of tight monetary policy in the U.K., Midland Bank was able to seek funds denominated in dollar to obtain sterling at a lower interest rate. The bank had bid 30-day dollar-denominated deposits at an interest rate (1.875%) that was higher than the maximum payable under Regulation Q in the U.S., sold these dollars spot for sterling and bought dollars back at a premium of 2.125%. This method helped the bank obtain sterling at the rate of 4% during a time when Bank Rate was 4.5%, according to a 1998 article by Catherine R. Schenk. With tight monetary policy, relatively relaxed controls on the forward exchange market and opportunities for profitable interest arbitrage, the eurodollar market began to expand rapidly.

Rapid Growth in the Eurodollar

The figure below shows the estimated size of the eurodollar market during the heyday of the Bretton Woods era.

Net Size in the Eurodollar Market

SOURCES: Bank for International Settlements annual reports, FRED and authors’ calculations.

NOTES: The figures are based on the dollar liabilities reported by the banks of the eight reporting European countries (Belgium, France, Germany, Italy, Netherlands, Sweden, Switzerland and the U.K.) vis-à-vis banks and nonbank residents outside their own area and vis-à-vis nonbank residents inside the reporting area. For more information, see the BIS annual report (PDF) for 1969.

We can see that from 1964 to 1969, the estimated market size of eurodollar market grew over 252% from $75 billion of 2020 dollars to $264 billion. As the U.S. administration tried to control the outflow of dollars, multinational corporations, eager to find profitable usage of their surplus dollar balances, and banks, equally eager to accommodate demand, found way to get around the controls.

Following its emergence, the eurodollar market played a big role in the Bretton Woods system and also its breakdown and eventual demise in the early 1970s.

https://www.barchart.com/futures/quotes/GE*0/futures-prices

For example https://www.barchart.com/futures/quotes/GEG23/overview

Part III: Will $ collapse?

What Is the U.S. Dollar Index (USDX) and How to Trade It

By JAMES CHEN Updated August 29, 2022 Reviewed by GORDON SCOTT Fact checked by KIRSTEN ROHRS SCHMITT

https://www.investopedia.com/terms/u/usdx.asp

What Is the U.S. Dollar Index (USDX)?

The U.S. dollar index (USDX) is a measure of the value of the U.S. dollar relative to a basket of foreign currencies. The USDX was established by the U.S. Federal Reserve in 1973 after the dissolution of the Bretton Woods Agreement. It is now maintained by ICE Data Indices, a subsidiary of the Intercontinental Exchange (ICE).

The six currencies included in the USDX are often referred to as America's most significant trading partners, but the index has only been updated once: in 1999 when the euro replaced the German mark, French franc, Italian lira, Dutch guilder, and Belgian franc.

Consequently, the index does not accurately reflect present-day U.S. trade.

KEY TAKEAWAYS

· The U.S. Dollar Index is used to measure the value of the dollar against a basket of six foreign currencies.

· These are: the Euro, Swiss franc, Japanese yen, Canadian dollar, British pound, and Swedish krona.

· The index was established shortly after the Bretton Woods Agreement dissolved in 1973 with a base of 100, and values since then are relative to this base.

· The value of the index is a fair indication of the dollar’s value in global markets.

Understanding the U.S. Dollar Index (USDX)

The index is currently calculated by factoring in the exchange rates of six foreign currencies, which include the euro (EUR), Japanese yen (JPY), Canadian dollar (CAD), British pound (GBP), Swedish krona (SEK), and Swiss franc (CHF).

The euro is, by far, the largest component of the index, making up 57.6% of the basket. The weights of the rest of the currencies in the index are JPY (13.6%), GBP (11.9%), CAD (9.1%), SEK (4.2%), and CHF (3.6%).

The index started in 1973 with a base of 100, and values since then are relative to this base. It was established shortly after the Bretton Woods Agreement was dissolved. As part of the agreement, participating countries settled their balances in U.S. dollars (which was used as the reserve currency), while the USD was fully convertible to gold at a rate of $35/ounce.

An overvaluation of the USD led to concerns over the exchange rates and their link to the way in which gold was priced. President Richard Nixon decided to temporarily suspend the gold standard, at which point other countries were able to choose any exchange agreement other than the price of gold. In 1973, many foreign governments chose to let their currency rates float, putting an end to the agreement.

History of the U.S. Dollar Index (USDX)

The U.S. Dollar Index has risen and fallen sharply throughout its history. It reached an all-time high in 1984 at nearly 165. Its all-time low was nearly 70 in 2007. Over the last several years, the U.S. dollar index has been relatively rangebound between 90 and 110.

The index is affected by macroeconomic factors, including inflation/deflation in the dollar and foreign currencies included in the comparable basket, as well as recessions and economic growth in those countries.

The contents of the basket of currencies have only been changed once since the index started when the euro replaced many European currencies previously in the index in 1999, such as Germany's predecessor currency, the Deutschemark.

In the coming years, it is likely currencies will be replaced as the index strives to represent major U.S. trading partners. It is likely in the future that currencies such as the Chinese yuan (CNY) and Mexican peso (MXN) will supplant other currencies in the index due to China and Mexico being major trading partners with the U.S.

The USDX uses a fixed weighting scheme based on exchange rates in 1973 that heavily weights the euro. As a result, expect to see big moves in the fund in response to euro movements.

An index value of 120 suggests that the U.S. dollar has appreciated 20% versus the basket of currencies over the time period in question. Simply put, if the USDX goes up, that means the U.S. dollar is gaining strength or value when compared to the other currencies.

Similarly, if the index is currently 80, falling 20 from its initial value, that implies that it has depreciated 20%. The appreciation and depreciation results are a factor of the time period in question.

How to Trade the USDX

The U.S. dollar index allows traders to monitor the value of the USD compared to a basket of select currencies in a single transaction. It also allows them to hedge their bets against any risks with respect to the dollar. It is possible to incorporate futures or options strategies on the USDX.

These financial products currently trade on the New York Board of Trade. Investors can use the index to hedge general currency moves or speculate. The index is also available indirectly as part of exchange-traded funds (ETFs) or mutual funds.

For instance, the Invesco DB U.S. Dollar Index Bullish Fund (UUP) is an ETF that tracks the changes in value of the US dollar via USDX future contracts. The Wisdom Tree Bloomberg U.S. Dollar Bullish Fund (USDU) is an actively-managed ETF that goes long the U.S. dollar against a basket of developed and emerging market currencies.

Invesco DB also offers its U.S. Dollar Index Bearish Fund (UDN), which shorts the dollar, gaining in value when the dollar weakens.

What Does the Dollar Index Tell You?

The dollar index tracks the relative value of the U.S. dollar against a basket of important world currencies. If the index is rising, it means that the dollar is strengthening against the basket - and vice-versa.

What Currencies Are in the USDX Basket?

The USDX tracks the dollar's (USD) relative strength against a basket of foreign currencies. The weightings have been fixed since 1973 (and later adjusted in 2002 when the euro replaced many European currencies):

Euro (EUR) - 57.6% weight

Japanese yen (JPY) - 13.6%

Pound sterling (GBP) - 11.9%

Canadian dollar (CAD) - 9.1%

Swedish krona (SEK) - 4.2%

Swiss franc (CHF) - 3.6%

How Do You Calculate the USDX Index Price?

The USDX is based on a basket of six currencies with different weightings (see above). The index calculation is simply the weighted average of the U.S. dollar exchange rates against these currencies, normalized by an indexing factor (which is ~50.1435).

USDX = 50.14348112 × EURUSD^-0.576 × USDJPY^0.136 × GBPUSD^-0.119 × USDCAD^0.091 × USDSEK^0.042 × USDCHF^0.036

The Bottom Line

The U.S. Dollar Index (USDX) is a relative measure of the U.S. dollars (USD) strength against a basket of six influential currencies, including the Euro, Pound, Yen, Canadian Dollar, Swedish Korner, and Swiss Franc. The index was created in 1973, but remains useful to this day. The USDX can be used as a proxy for the health of the U.S. economy and traders can use it to speculate on the dollar's change in value or as a hedge against currency exposure elsewhere.

Dollar set for biggest two-day fall since 2009 as rate outlook shifts

PUBLISHED FRI, NOV 11 20222:12 AM ESTUPDATED FRI, NOV 11 20224:11 PM EST Reuters

https://www.cnbc.com/2022/11/11/dollar-dives-investors-cheer-after-us-inflation-misses-forecasts.html

The dollar headed for its biggest two-day drop in almost 14 years on Friday, as investors piled into riskier assets after a cooler reading of U.S. inflation helped temper expectations for the Federal Reserve to keep raising rates as quickly.

Data on Thursday showed consumer inflation rose 7.7% year-on-year in October, its slowest rate since January and below forecasts for 8%.

The dollar staged its biggest drop since late 2015 on Thursday as Treasury yields plunged, while other currencies - the yen and the pound in particular - jumped.

Investor risk appetite got an additional boost from Chinese health authorities easing some of the country’s strict COVID-19 restrictions, including shortening quarantine times for close contacts of cases and inbound travellers.

The dollar index was down nearly 1.7%, having lost over 3% in the last two days - its biggest two-day decline since March 2009.

Risk assets including stocks, emerging-market currencies and commodities rallied. But slowing inflation, while positive for borrowers, reflects a slowing economic backdrop, analysts said.

“It can be a little dangerous in that the ‘bad news’ is still out there and could come back to burn us, particularly with respect to the Fed,” Rabobank currency strategist Jane Foley said.

The dollar has risen by 12% this year against a basket of major currencies, in light of the Fed’s determination to bring inflation, which almost hit double digits earlier this year, back towards its target of 2%.

Other central banks have followed suit, with the exception of the Bank of Japan, and, as a result, the yen has witnessed its largest decline against the dollar since 1979.

The dollar, which has gained 22% in value against the yen this year, its steepest gain since 1979′s 24% rise, was last down 1.6% against the Japanese currency at 138.65 yen.

The futures market shows investors are pricing in a 71.5% chance of a 50-basis-point U.S. rate increase next month, up from around 50/50 a week ago.

“We remain reluctant to jump in on the broader bearish dollar story just yet. First, because it simply appears too early to call victory in the inflation battle, and more evidence will need to come from the jobs markets – which has remained exceptionally tight,” ING strategist Francesco Pesole said.

The yuan also jumped, as investors cheered the slight relaxation in China’s COVID rules, despite cases rising sharply across the country.

The offshore yuan rallied by as much as 1.3% to hit its highest in over a month against the dollar, to 7.0592.

Sterling, meanwhile, pared overnight losses against the dollar and the euro after UK data showed the economy did not contract by as much as expected in the three months to September, although it is still entering what is likely to be a lengthy recession.

The pound rose 1.1% against the dollar to $1.1839, having staged its largest one-day rally the day before since 2017.

The euro extended the previous day’s 2% surge to rise 1.5% to $1.0356, trading around its highest since August.

It also briefly hit session lows versus the Swiss franc , after the head of the Swiss National Bank reiterated the central bank’s commitment to bring inflation down. Against the franc, the euro was last down 0.42% at 0.9795.

Cryptocurrencies were under pressure again, given ongoing turmoil in the crypto world after exchange FTX’s fall.

Dollar's advantages are eroding and index could break below 100 in coming months: Morgan Stanley (video)

Why the Chartmaster thinks a weak dollar signals weak stocks (video)

Part IV: In Class Exercise

Class Exercise1:

Chicago bank expects the exchange rate of the NZ$ to appreciate from $0.50 to $0.52 in 30 days.

—  Chicago bank can borrow $20m on a short term basis.

—  Currency                     Lending Rate              Borrowing rate

                $                              6.72%                          7.20%

                NZ$                        6.48%                          6.96%

Question: If Chicago bank anticipate NZ$ to appreciate, how shall it trade? (refer to ppt)

Answer:

◦       NZ$ will appreciate, so you should buy NZ$ now and sell later. Borrow $à convert to NZ$ today à lend it for 30 days à convert to $ 30 days later àpayback the $ loan.

◦       Convert the borrowed $ to NZ$ today. So your NZ$ worth: $20m / 0.50 $/NZ$=40m NZ$.

◦       Lend NZ$ for 6.48% * 30/360=0.54% and get

 40m NZ$ *(1+0.54%)=40,216,000 NZ$ 30 days lateè at new rate $0.52/1NZ$, 40,216,000 NZ$ equals t 40,216,000 NZ$*$0.52/1NZ$ = $20,912,320

◦       Your borrowed $20m should be paid back for

20m *(1+7.2%* 30/360)=$20.12m. 

◦       So the profit is:

 $20,912,320  - $20.12m =$792,320, a pure profit from thin air!

Class Exercise 2:

Blue Demon Bank expects that the Mexican peso will depreciate against the dollar from its spot rate of $.15 to $.14 in 10 days. The following interbank lending and borrowing rates exist:

                        Lending Rate Borrowing Rate

            U.S. dollar       8.0%    8.3%

            Mexican peso  8.5%    8.7%

    Assume that Blue Demon Bank has a borrowing capacity of either $10 million or 70 million pesos in the interbank market, depending on which currency it wants to borrow.

a.                   How could Blue Demon Bank attempt to capitalize on its expectations without using deposited funds? Estimate the profits that could be generated from this strategy.

b.      Assume all the preceding information with this exception: Blue Demon Bank expects the peso to appreciate from its present spot rate of $.15 to $.17 in 30 days. How could it attempt to capitalize on its expectations without using deposited funds? Estimate the profits that could be generated from this strategy.

Answer:

Part a: Blue Demon Bank can capitalize on its expectations about pesos (MXP) as follows:

1.         Borrow MXP70 million

2.         Convert the MXP70 million to dollars:

a.         MXP70,000,000 × $.15 = $10,500,000

3.         Lend the dollars through the interbank market at 8.0% annualized over a 10 day period. The amount accumulated in 10 days is:

a.         $10,500,000 × [1 + (8% × 10/360)] = $10,500,000 × [1.002222] = $10,523,333

4.         Convert the Peso back to $ at $.14 / peso:

a.         $10,523,333 / $.14 / MXP = MXP 75,166,664

5.         Repay the peso loan. The repayment amount on the peso loan is:

a.         MXP70,000,000 × [1 + (8.7% × 10/360)] = 70,000,000 × [1.002417]=MXP70,169,167

6.         The arbitrage profit is:

a.         MXP 75,166,664 -  MXP70,169,167 = MXP 4,997,497

7.         Convert back to at $0.14 / MXP

a.         We get back   MXP 4,997,497 * $0.14 / MXP = $699,649.6 (solution)

Part b: Blue Demon Bank can capitalize on its expectations as follows:

1.         Borrow $10 million

2.         Convert the $10 million to pesos (MXP):

a.         $10,000,000/$.15 = MXP66,666,667

3.         Lend the pesos through the interbank market at 8.5% annualized over a 30 day period. The amount accumulated in 30 days is:              

a.         MXP66,666,667 × [1 + (8.5% × 30/360)] = 66,666,667 × [1.007083] = MXP67,138,889

4.         Repay the dollar loan. The repayment amount on the dollar loan is:

a.         $10,000,000 × [1 + (8.3% × 30/360)] = $10,000,000 × [1.006917] = $10,069,170

5.         Convert the pesos to dollars to repay the loan. The amount of dollars to be received in 30 days (based on the expected spot rate of $.17) is:

a.         MXP67,138,889 × $.17 = $11,413,611

HW chapter 4 - Due with the second mid term exam

Question 1.       Choose between increase / decrease.

US Inflation goes up, $ will ________increase / decrease____________in value__.

US Real interest rate goes up, $ will ________increase / decrease___________ in value__.

US Current account goes up, $ will ________increase / decrease________ in value__.

US Recession or crisis, $ will ________increase / decrease________ in value__.

For each scenario, please draw a demand and supply curve to support your conclusion.

-           please refer to the PPT of this chapter for how to draw demand and supply curver  Chapter 4 PPT

Question 2: DO you think the US$ will collapse in the near future? Why or why not?

Question 3: What is currency carry trade? Do you have a plan to carry on a currency carry trade?

Question 4: Suppose you observe the following exchange rates: €1 = $.7; £1 = $1.40; and €2.20 = £1.00. Starting with $1,000,000, how can you make money?(Answer: get £ first. Your profit is $100,000)

Question 5:

Assume you have £1000 and bid rate is 1.60$/£ and ask rate is 1.66$/£. If you convert it to £ and then convert it back to $, what will happen? (Answer: $963.86 and lose $36.14. Sell low and buy high here. So sell £ at bid and buy £ at ask )

Question 6:

Suppose you start with $100 and buy stock for £50 when the exchange rate is £1 = $2. One year later, the stock rises to £60. You are happy with your 20 percent return on the stock, but when you sell the stock and exchange your £60 for dollars, you find that the pound has fallen to £1 = $1.75. What is your return to your initial investment of $100? (Answer: 5%)

Question 7:

Baylor Bank believes the New Zealand dollar will depreciate over the next five days from $.52 to $.5. The following annual interest rates apply:

Currency                                            Lending Rate                    Borrowing Rate

      Dollars                                                     5.50%                                      5.80%

      New Zealand dollar (NZ$)                        4.80%                                      5.25%

      Baylor Bank has the capacity to borrow either NZ$11 million or $5 million. If Baylor Bank’s forecast if correct, what will its dollar profit be from speculation over the five day period (assuming it does not use any of its existing consumer deposits to capitalize on its expectations)? (Answer: 0.44 million NZ$ profit)

Question 8: What went wrong with Argentina’s economy? Please refer to the two videos.

· How Argentines Live With Inflation (youtube)

· The Economic Crisis in Argentina | Explained (youtube)

Question 9: What is USDX? Please refer to https://www.investopedia.com/terms/u/usdx.asp

Argentina faces $1.1 billion debt repayment deadline as IMF protests simmer

https://www.reuters.com/world/americas/argentina-faces-billion-dollar-imf-trip-wire-protests-simmer-2022-01-27

By Adam Jourdan and Miguel Lo Bianco, January 27, 2022

BUENOS AIRES, Jan 27 (Reuters) - Argentina is facing deadlines for nearly $1.1 billion in debt repayments to the International Monetary Fund (IMF) by Tuesday amid uncertainty over whether the South American country will pay and tense talks to revamp around $40 billion in loans.

The grains-producing country, which has been battling currency and debt crises for years, is due to pay back $730 million to the IMF on Friday and another $365 million on Tuesday though officials have not confirmed plans to pay.

Cabinet Chief Juan Manzur said there was "political decisiveness and eagerness to pay" the IMF, according to official news outlet Telam.

The IMF did not immediately respond to a request for comment on the looming payments.

That has hit sovereign bond prices, some of which have tumbled to below 30 cents on the dollar. More hard-left politicians within the ruling Peronist coalition have also started hardening their rhetoric against the IMF.

"What we are proposing is not only to stop paying the debt and break with the IMF, but to restructure the entire economy according to the needs of the majority," said Celeste Fierro as she marched in the city outside the central bank building.

Fierro, like others in the march, said the country should not pay back its IMF debts: "We believe in ... breaking with the IMF and ignoring this debt, which is a scam."

Vilma Ripol, another marcher, said the payments should be suspended and that Congress should investigate the debt to avoid a repeat of the 2001 economic crisis.

"It was a disaster in 2001 that took us years to recover and we had paid," she said. "We kept paying and our society kept on going down. Enough already."

Currency crisis of Argentina

https://en.wikipedia.org/wiki/1998%E2%80%932002_Argentine_great_depression

The 2002 crisis of the Argentine peso, however, shows that even a currency board arrangement cannot be completely safe from a possible collapse. When the peso was first linked to the U.S. Dollar at parity in February 1991 under the Convertibility Law, initial economic effects were quite positive: Argentina's chronic inflation was curtailed dramatically and foreign investment began to pour in, leading to an economic boom. Over time, however, the peso appreciated against the majority of currencies as the U.S. Dollar became increasingly stronger in the second half of the 1990s. A strong peso hurt exports from Argentina and caused a protracted economic downturn that eventually led to the abandonment of the peso-dollar parity in 2002. This change, in turn, caused severe economic and political distress in the country. The unemployment rate rose above 20 percent and inflation reached a monthly rate of about 20 percent in April 2002. In contrast, Hong Kong was able to successfully defend its currency board arrangement during the Asian financial crisis, a major stress test for the arrangement. Although there is no clear consensus on the causes of the Argentine crisis, there are at least three factors that are related to the collapse of the currency board system and ensuing economic crisis:

· The lack of fiscal discipline

· Labor market inflexibility

· Contagion from the financial crises in Russia and Brazil.

While the currency crisis is over, the debt problem has not been completely resolved. The government of Argentina ceased all debt payments in December 2001 in the wake of persistent recession and rising social and political unrest. In 2004, the Argentine government made a 'final' offer amounting to a 75 percent reduction in the net present value of the debt. Foreign bondholders rejected this offer and asked for an improved offer. In early 2005, bondholders finally agreed to the restructuring, under which they took a cut of about 70 percent on the value of their bond holdings.

How Argentines Live With Inflation (youtube)

The Economic Crisis in Argentina | Explained (youtube)

First midterm - 2/20/2023

First Mid Term Exam Study Guide

· close book close notes

· in class exam

Multiple Choice questions (32*2.5=80)

1. What is fixed exchange rate system? Floating? Currency board?

2. What is euroyen, Eurodollar, europound, euroeuro

3. What is Impossible Trinity

4. What is BOP? Current account? Capital account?

5. Direct quote? Indirect quote?

6. What is bid ask spread? What is bid price? Ask price? (from dealer’s perspective)

7. European central bank and monetary policy

8. USDX?

9. LIBOR? SOFR?]

Short answer questions (10*2=20 points)

$ value changes due to inflation and interest rate changes. Draw graphs to demonstrate.

Chapter 5 Currency Derivatives 

Chapter 5 PPT

For class discussion: Assume that you are an importer for seafood from Japan. This special seafood is only available in the summer. How can you hedge against the exchange rate risk?

Let’s watch the following videos to understand how the forward and future markets work.

 Forward contract introduction (video, khan academy)

Futures introduction (video, khan academy)

For class discussion:

1. How can forward contract and futures contract help reduce risk?

2. What is margin? What is initial margin? What is maintenance margin? What is a margin call? Why is margin call important to the margin account holder? When the margin account holder receives a margin call, what shall she do? What will happen if she takes no actions?

3. Why does margin account value change constantly?

4. What does “mark to market” mean?

Part 1- Forward market vs. Future market

1.      Difference between the two?

Futures Contracts Compared to Forwards (video)

Forward contract:

·         Privately negotiated;

·         Non-transferable;

·         customized term;

·         carried credit default risk;

·         fully dependent on counterparty;

·         Unregulated.

Futures Market Explained (Video)

Future contract:

·         Quoted in public market

·         Actively traded

·         Standardized contract

·         Regulated

·         No counterparty risk

(FYI)

F = forward rate

S = spot rate

r₁ = simple interest rate of the term currency

r₂ = simple interest rate of the base currency

T = tenor (calculated to the appropriate day count conversion)

2. Future market

Margin account and margin call

Benefits of Futures: Margin (video)

What Is Margin Call? | FXTM Learn Forex in 60 Seconds (Video)

CME (Chicago Merchandise Exchange)

G10 (cmegroup.com)

EURO FX PRICES for Wed, Feb 22nd, 2023

https://www.barchart.com/futures/quotes/E6*0/all-futures

Contract	Last	Change	Open	High	Low	Previous	Volume	Open Int	Time	Links
E6Y00 (Cash)	1.13159	-0.00082	1.13230	1.13585	1.13064	1.13241	149,093	N/A	10:43 CT
E6H22 (Mar '22)	1.13210	-0.00190	1.13315	1.13640	1.13100	1.13400	104,626	678,267	10:42 CT
E6J22 (Apr '22)	1.13620	+0.00090	1.13425	1.13670	1.13425	1.13530	85	2,793	07:24 CT
E6K22 (May '22)	1.13565	-0.00075	1.13590	1.13855	1.13565	1.13640	162	1,330	09:12 CT
E6M22 (Jun '22)	1.13610	-0.00160	1.13700	1.14000	1.13470	1.13770	1,050	10,179	10:40 CT
E6N22 (Jul '22)	1.13955s	+0.00045	N/A	1.13955	1.13955	1.13910	N/A	N/A	02/22/22
E6U22 (Sep '22)	1.14090	-0.00220	1.14200	1.14200	1.14090	1.14310	280	1,817	10:09 CT
E6Z22 (Dec '22)	1.14640	-0.00230	1.15015	1.15015	1.14640	1.14870	208	2,197	10:09 CT
E6H23 (Mar '23)	1.15405s	+0.00085	0.00000	1.15695	1.15045	1.15320	5	72	02/22/22
E6M23 (Jun '23)	1.15940s	+0.00065	0.00000	1.15940	1.15940	1.15875	0	23	02/22/22

Euro Future Contract Specifications

https://www.barchart.com/futures/quotes/E6H19

Part 2 - Calculating Futures Contract Profit or Loss

Short and long position and payoff:

Video https://www.youtube.com/watch?v=13WxmRt75Y8

Calculator (FYI)

For a long position， its payoff:

Value at maturity (long position) = principal * ( spot exchange rate at maturity – settlement price)

For a short position, its payoff:  

Value at maturity (short position) = -principal * ( spot exchange rate at maturity – settlement price)

Note: In the calculator, principal is called contract size

Corrections:

“ Difference Between Spot Rate and Futures Rate

The currency spot rate is the current quoted rate that a currency, in exchange for another currency, can be bought or sold at. The two currencies involved are called a "pair." If an investor or hedger conducts a trade at the currency spot rate, the exchange of currencies takes place at the point at which the trade took place or shortly after the trade. Since currency forward rates are based on the currency spot rate, currency futures tend to change as the spot rates changes”.///// https://www.investopedia.com/terms/c/currencyfuture.asp

Exercise 1: Amber sells a March futures contract and locks in the right to sell 500,000 Mexican pesos at $0.10958/Ps (peso). If the spot exchange rate at maturity is $0.095/Ps, the value of Amber’s position on settlement is?

Answer: -500000*(0.095-0.10958). With this futures contract, Amber should sell 500,000 Mexican pesos to the buyer at $0.10958/ Ps. The market price at maturity is $0.095/Ps, so Amber can buy 500,000 Mexican pesos at $0.095/Ps, and then sell to the buyer at $0.10958/ Ps. So Amber wins!

Exercise 2: Amber purchases a March futures contract and locks in the right to sell 500,000 Mexican pesos at $0.10958/Ps (peso). If the spot exchange rate at maturity is $0.095/Ps, the value of Amber’s position on settlement is?

Answer: 500000*(0.095-0.10958). With this futures contract, Amber should buy 500,000 Mexican pesos from the seller at $0.10958/ Ps. The market price at maturity is $0.095/Ps, so Amber can buy 500,000 Mexican pesos at $0.10958/ Ps for something that worth only $0.095/ Ps. So Amber lost money!

Exercise 3: Amber sells a March futures contract and locks in the right to sell 500,000 Mexican pesos at $0.10958/Ps (peso). If the spot exchange rate at maturity is $0.11/Ps, the value of Amber’s position on settlement is?

Answer: -500000*(0.11-0.10958). With this futures contract, Amber should sell 500,000 Mexican pesos to the buyer at $0.10958/ Ps. The market price at maturity is $0.11/Ps, so Amber can buy 500,000 Mexican pesos at $0.11/Ps, and then sell to the buyer at $0.10958/ Ps. So Amber lost money!

Exercise 4: Amber purchases a March futures contract and locks in the right to sell 500,000 Mexican pesos at $0.10958/Ps (peso). If the spot exchange rate at maturity is $0.11/Ps, the value of Amber’s position on settlement is?

Answer: 500000*(0.11-0.10958). With this futures contract, Amber should buy 500,000 Mexican pesos from the seller at $0.10958/ Ps. The market price at maturity is $0.11/Ps, so Amber can buy 500,000 Mexican pesos at $0.10958/ Ps, for something that worth $0.11/ Ps. So Amber wins!

Exercise 3: You expect peso to depreciate on 4/4. So you sell peso future contract (6/17) on 4/4 with future rate of $0.09/peso. And on 6/17, the spot rate is $0.08/peso. Calculate the value of your position on settlement

Answer: -500000*(-0.08+0.09)

HW of chapter 5 part I (Due with the second mid-term)

Calculator FYI

1.                                          Consider a trader who opens a short futures position. The contract size is £62,500; the maturity is six months, and the settlement price is $1.60 = £1; At maturity, the price (spot rate) is $1.50 = £1. What is his payoff at maturity?

(Answer: £6250)

2.                                          Consider a trader who opens a long futures position. The contract size is £62,500; the maturity is six months, and the settlement price is $1.60 = £1; At maturity, the price (spot rate) is $1.50 = £1. What is his payoff at maturity?

(Answer: -£6250)

3.                                          Consider a trader who opens a short futures position. The contract size is £62,500, the maturity is six months, and the settlement price is $1.40 = £1; At maturity, the price (spot rate) is $1.50 = £1. What is his payoff at maturity?

(Answer: -£6250)

4. Consider a trader who opens a long futures position. The contract size is £62,500, the maturity is six months, and the settlement price is $1.40 = £1; At maturity, the price (spot rate) is $1.50 = £1. What is his payoff at maturity?(Answer: £6250)

5. What is Euro Futures contract? What is Micro Euro Futures Contract? Please refer to the articles at

https://insigniafutures.com/learn-to-trade-euro-fx-futures/ and https://insigniafutures.com/micro-euro-currency-futures/

6. Watch this video and explain the following concepts.

Understanding Futures Margin | Fundamentals of Futures Trading Course

· What is margin account?

· What is mark to market?

· What is initial margin?

· What is maintenance margin?

· What is margin call?

· How is margin call triggered?

· What will happen after a margin call is received?

7. Watch the video on Corn price made in April 2022. Do you believe that it is crucial for corn farmers to utilize futures contracts as a risk management strategy, as discussed in the video? What are your reasons for or against this approach?

Corn Trading Analysis | Bill Baruch | CNBC Interview 4.19.22

Chicago Mercantile Exchange (CME) (FYI)

By JAMES CHEN Updated June 20, 2021

https://www.cmegroup.com/markets/products.html#assetClass=sg-48&cleared=Options

video https://www.youtube.com/watch?v=poRK317iMZ4

What Is the Chicago Mercantile Exchange?

The Chicago Mercantile Exchange (CME), colloquially known as the Chicago Merc, is an organized exchange for the trading of futures and options. The CME trades futures, and in most cases options, in the sectors of agriculture, energy, stock indices, foreign exchange, interest rates, metals, real estate, and even weather.

CME was originally called the Chicago Butter and Egg Board and was used for trading agricultural products, such as wheat and corn.

In the 1970s the CME added financial futures, followed shortly by precious metals, Treasuries, and other assets.

In 2007, the CME merged with the Chicago Board of Trade to create CME Group, one of the world's largest financial exchange operators. CME Group now owns several other exchanges in different cities.

Nowadays, CME is also known for trading unusual commodities like Bitcoin futures and weather derivatives.

Understanding the Chicago Mercantile Exchange (CME)

Founded in 1898, the Chicago Mercantile Exchange began life as the "Chicago Butter and Egg Board" before changing its name in 1919. It was the first financial exchange to "demutualize" and become a publicly traded, shareholder-owned corporation in 2000.

The CME launched its first futures contracts in 1961 on frozen pork bellies. In 1969, it added financial futures and currency contracts followed by the first interest rate, bond, and futures contracts in 1972.

Creation of CME Group

In 2007, a merger with the Chicago Board of Trade created the CME Group, one of the largest financial exchanges in the world. In 2008, the CME acquired NYMEX Holdings, Inc., the parent of the New York Mercantile Exchange (NYMEX) and Commodity Exchange, Inc (COMEX). By 2010, the CME purchased a 90% interest in the Dow Jones stock and financial indexes.

The CME grew again in 2012 with the purchase of the Kansas City Board of Trade, the dominant player in hard red winter wheat. And in late 2017, the Chicago Mercantile Exchange began trading in Bitcoin futures.

According to the CME Group, on average it handles 3 billion contracts worth approximately $1 quadrillion annually. In 2021 CME Group ended open outcry trading for most commodities, although outcry trading continues in the Eurodollar options pit. Additionally, the CME Group operates CME Clearing, a leading central counterparty clearing provider.

CME Futures and Risk Management

With uncertainties always present in the world, there is a demand that money managers and commercial entities have tools at their disposal to hedge their risk and lock in prices that are critical for business activities. Futures allow sellers of the underlying commodities to know with certainty the price they will receive for their products at the market. At the same time, it will enable consumers or buyers of those underlying commodities to know with certainty the price they will pay at a defined time in the future.

While these commercial entities use futures for hedging, speculators often take the other side of the trade hoping to profit from changes in the price of the underlying commodity. Speculators assume the risk that the commercials hedge. A large family of futures exchanges such as the CME Group provides a regulated, liquid, centralized forum to carry out such business. Also, the CME Group provides settlement, clearing, and reporting functions that allow for a smooth trading venue.

CME is one of the only regulated markets for trading in Bitcoin futures.

CME Regulation

CME is regulated by the Commodity Futures Trading Commission, which oversees all commodities and derivatives contracts in the United States. The CFTC is responsible for oversight of brokers and merchants, conducts risk surveillance of derivatives trades, and investigates market manipulation and other abusive trade practices. It also regulates trading in virtual assets, such as Bitcoin.

Chicago Mercantile Exchange vs. Chicago Board of Trade

The Chicago Board of Trade (CBOT) is another Chicago-based futures exchange, founded in 1848. The CBOT originally focused on agricultural products, such as wheat, corn, and soybeans; it later expanded to financial products such as gold, silver, U.S. Treasury bonds, and energy. The CME merged with the CBOT in 2006, in a move approved by shareholders of both organizations.

Example of Chicago Mercantile Exchange

Most commodities can be traded anywhere, but there's one you can only trade at the CME: weather. CME is the only futures exchange to offer derivatives based on weather events, allowing traders to bet on cold temperatures, sunshine, or rainfall. In 2020, the CME traded as many as 1,000 weather-related contracts per day, with a total annual volume of over $1 billion.

Euro FX Futures Contract Specs

(http://www.cmegroup.com/trading/fx/g10/euro-fx_contract_specifications.html)

Contract Unit	125,000 euro
Trading Hours	Sunday - Friday 6:00 p.m. - 5:00 p.m. (5:00 p.m. - 4:00 p.m. Chicago Time/CT) with a 60-minute break each day beginning at 5:00 p.m. (4:00 p.m. CT)
Minimum Price Fluctuation	Outrights: .00005 USD per EUR increments ($6.25 USD). Consecutive Month Spreads: (Globex only)  0.00001 USD per EUR (1.25 USD) All other Spread Combinations:  0.00005 USD per EUR (6.25 USD)
Product Code	CME Globex: 6E CME ClearPort: EC Clearing: EC
Listed Contracts	Contracts listed for the first 3 consecutive months and 20 months in the March quarterly cycle (Mar, Jun, Sep, Dec)
Settlement Method	Deliverable
Termination Of Trading	9:16 a.m. Central Time (CT) on the second business day immediately preceding the third Wednesday of the contract month (usually Monday).
Settlement Procedures	Physical Delivery EUR/USD Futures Settlement Procedures
Position Limits	CME Position Limits
Exchange Rulebook	CME 261
Block Minimum	Block Minimum Thresholds
Price Limit Or Circuit	Price Limits
Vendor Codes	Quote Vendor Symbols Listing

Million Dollar Pips The Life Of A Day Trader (FYI)

http://www.youtube.com/watch?v=unM_0Vh00K4

Foreign Exchange Market (FYI)

http://www.youtube.com/watch?v=-qvrRRTBYAk

Bullish option strategies example onoptionhouse

Bearish option strategies example onoptionhouse

Option Strategy graphs (FYI)

Future Trading Guide (FYI)

Futures - Mechanics of the Futures Market

Currency war explained – bear talk cartoon (FYI)

http://www.youtube.com/watch?v=1jA7c1_Jtvg

How to Trade Euro FX Futures & Options

https://insigniafutures.com/learn-to-trade-euro-fx-futures/

What is a commodity futures contract?

A commodity futures contract is an agreement to buy or sell a particular commodity at a future date. The price and the amount of the commodity are fixed at the time of the agreement (purchase / sale). Similar to trading stocks, commodity futures contracts trade on regulated futures exchanges such as the CME (Chicago Mercantile Exchange) or the ICE (Intercontinental Exchange). These contracts typically can be bought and sold throughout the duration of the contract. The majority of commodity futures contracts are liquidated prior to the delivery / expiration date.

A commodity futures option gives the purchaser the right to buy or sell a particular futures contract at a future date for a particular price. These contracts can also be bought and sold throughout the duration of the contract’s term.

The Futures Contract:

Euro FX futures – ticker symbol: 6E.

The Euro Currency, known, as Euro FX futures and options, allow you to take positions on the value of the euro currency versus the U.S. dollar. These deep and liquid currency contracts grant traders wide exposure to the economy of the Eurozone, a monetary union of 19 of the 28 European Union member states which have adopted the euro as their common currency. The Eurozone ranks as the fourth largest trading partner of U.S.

Euro FX futures and options are valuable tools for gaining or hedging exposure to the euro as well as managing exposures to the U.S. dollar. Given the importance of these two currencies in the world economy, you can see increased activity in times of global market volatility driven by interest rate changes, inflation announcements and other monetary policy changes as well as payroll, unemployment and geopolitical events.

All futures & options contracts have symbols which are used to identify the contracts you wish to trade. For the Euro FX the root symbols are…

Futures: 6E

Options: EUU

As these are ‘futures’ contracts, there will be contracts available to trade with different months & years. Many traders will choose to trade the most active month, also known as the “front” month, as this will typically be the contract with the most trading volume.

When placing an order, you will identify the exact contract you wish to trade by appending the month and year codes to the root symbol. For example, if you wish to trade a September 2020 Euro FX futures contract, the full symbol will be: 6E.U20

In this example, 6E is the root symbol (a period is then inserted), U is the month code for September and 20 is the last two digits of the contract year. A period is always used between the root symbol and the month/year code.

Trade Entry:

When trading futures and options, you can either go long (buy) if you think prices will rise or go short (sell) if you think prices will drop.

To enter a futures contract trade, we will enter the following information into the trading platform.

• Number of contracts to be traded

• Trade direction – Buy 0r Sell

• Exact contract symbol – i.e. 6E.U20

• Order Type: Market, Limit or Stop

• Order Price (if Limit or Stop order)

• Order Duration: Day (current trading session) or GTC (Good Till Canceled)

Once your order has been entered, our trading platform will give you a ticket number for the order as well as a notification when the order gets filled. If/when the order is executed, you will then have either a long or short position depending on the Trade Direction you chose. You can modify or cancel any working order prior to it being filled or expiring.

Determining Profit or Loss:

The Euro FX futures contract trades in 0.00005 point increments. As each contract is equal to 125,000 Euros, a 0.00005 price move equates to $6.25 (0.00005 x 125,000). If Euro FX prices were to move up or down .00200 points, that would equate to $250.00 +/-.

For this example, let’s assume you went long (bought) one (1) September 2020 Euro FX futures contract at a price of 1.12750. If Sep’20 Euro FX futures prices were to rise to 1.13085, that would be a 0.00335 point gain or $418.75 (.00335 x 125,000). Conversely, if the Sep’20 Euro FX price dropped to 1.12410, that would be a 0.0034 point loss or $425 (0.0034 x 125,000).

Margin Requirements:

How much money do I need to trade?

When trading commodity futures contracts, the futures exchanges will set what are called Margin Requirements for each commodity. Margins in futures trading is NOT similar to margins in stock/equity trading. Think of margin requirements as a performance bond. The dollar amount you must have available in your account in order to trade one particular commodity futures contract. To view the current, initial margin requirements for the Euro FX (or any other major futures contract), please visit our Margin Requirements web page. You’ll find the margin requirement for this contract under the ‘Currencies’ section of the table.

Micro Euro Currency Futures Contract

https://insigniafutures.com/micro-euro-currency-futures/

At 1/10 the size of the full Euro FX futures contract, the Micro Euro Currency futures contract can be used for gaining or hedging exposure to the euro as well as managing exposures to the U.S. dollar. Given the importance of these two currencies in the world economy, you can see increased activity in times of global market volatility driven by interest rate changes, inflation announcements and other monetary policy changes as well as payroll, unemployment and geopolitical events.

How Risky Are Futures? (FYI)

By THE INVESTOPEDIA TEAM Updated July 13, 2022 Reviewed by JEFREDA R. BROWN

https://www.investopedia.com/ask/answers/031015/how-risky-are-futures.asp#:~:text=Futures%2C%20in%20and%20of%20themselves,stocks%2C%20bonds%2C%20or%20currencies.&text=Moreover%2C%20futures%20tend%20to%20be%20highly%20liquid.

Futures are financial derivatives—contracts that allow for the delivery of some underlying asset in the future, but with a price determined today in the market. While they are classified as financial derivatives, that does not inherently make them more or less risky than other types of financial instruments. Indeed, futures can be very risky since they allow speculative positions to be taken with a generous amount of leverage.

But, futures can also be used to hedge, thus reducing somebody's overall exposure to risk. Here we consider both sides of the risk coin with respect to trading futures.

KEY TAKEAWAYS

· A futures contract is an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price.

· The intended reason that companies or investors use future contracts is as a hedge to offset their risk exposures and limit themselves from any fluctuations in price.

· Because futures traders can take advantage of far greater leverage than the underlying assets in many cases, speculators can actually face increased risk and margin calls that magnify losses.

What Are Futures?

Futures, in and of themselves, are not any riskier than other types of investments, such as owning equities, bonds, or currencies. That is because futures prices depend on the prices of those underlying assets, whether it is futures on stocks, bonds, or currencies.

Trading the S&P 500 index futures contract cannot be said to be substantially riskier than investing a mutual fund or exchange-traded fund (ETF) that tracks the same index, or by owning the individual stocks that make up the index.

Moreover, futures tend to be highly liquid. For instance, the U.S. Treasury bond futures contract is one of the most heavily traded investment assets in the world.

As with any similar investment, such as stocks, the price of a futures contract may go up or down. Like equity investments, they do carry more risk than guaranteed, fixed-income investments. However, the actual practice of trading futures is considered by many to be riskier than equity trading because of the leverage involved in futures trading.

Hedging Equals Less Risk

Futures contracts were initially invented and popularized as a way for agricultural producers and consumers to hedge commodities such as wheat, corn, and livestock.

A hedge is an investment made to reduce the risk of adverse price movements in another asset. Normally, a hedge consists of taking an offsetting position in a related security—and so futures contracts on corn, for example, could be sold by a farmer at the time that he plants his seed. When harvest time comes, the farmer can then sell his physical corn and buy back the futures contract.

This strategy is known as a forward hedge, and effectively locks in the farmer's selling price for his corn at the time he plants it—it doesn't matter if the price of corn rises or falls in the interim, the farmer has locked in a price and therefore can predict his profit margin without worry.

Likewise, when a company knows that it will be making a purchase in the future for a particular item, it should take a long position in a futures contract to hedge its position.

For example, suppose that Company X knows that in six months it will have to buy 20,000 ounces of silver to fulfill an order. Assume the spot price for silver is $12/ounce and the six-month futures price is $11/ounce. By buying the futures contract, Company X can lock in a price of $11/ounce. This reduces the company's risk because it will be able to close its futures position and buy 20,000 ounces of silver for $11/ounce in six months.

Futures contracts can be very useful in limiting the risk exposure that an investor has in a trade. Just like the farmer or company above, an investor with a portfolio of stocks, bonds, or other assets can use financial futures to hedge against a drop in the market. The main advantage of participating in a futures contract is that it removes the uncertainty about the future price of an asset. By locking in a price for which you are able to buy or sell a particular item, companies are able to eliminate the ambiguity having to do with expected expenses and profits.

Leverage Equals More Risk

Leverage is the ability to margin investments with an investment of only a portion of their total value. The maximum leverage available in purchasing stocks is generally no more than 50%.

Futures trading, however, offers much greater leverage—up to 90% to 95%. This means that a trader can invest in a futures contract by putting up only 10% of the actual value of the contract. The leverage magnifies the effect of any price changes in such a way that even relatively small changes in price can represent substantial profits or losses. Therefore, a relatively small drop in the price could lead to a margin call or forced liquidation of the position.

Because of the leverage used in futures trading, it is possible to sustain losses greater than one's original investment. Conversely, it is also possible to realize very large profits. Again, it is not that the actual asset a trader is investing in carries more inherent risk; the additional risk comes from the nature and process of how futures contracts are traded.

To handle the additional leverage wisely, futures traders have to practice superior money management by using prudent stop-loss orders to limit potential losses. Good futures traders are careful not to over-margin themselves, but instead to maintain enough free, uncommitted investment capital to cover draw-downs in their total equity. Trading futures contracts requires more trading skill and hands-on management than traditional equity investing.

Chapter 5 Part II

Currency Option market

NASDAQ OMX PHLX (Philadelphia Stock Exchange) trades more than 2,600 equity options, sector index options and U.S. dollar-settled options on major currencies. PHLX offers a combination of cutting-edge electronic and floor-based options trading.

Nasdaq:  http://www.nasdaq.com/includes/swiss-franc-specifications.stm ( èèèèèèè)

1. What is Call and put option? Difference between the two?

American call option (video, khan academy)

American put option (video, khan academy)

Call payoff diagram (video, khan academy)

Put payoff diagram (video, khan academy)

For discussion:

· When shall you consider a call option?

· When shall you buy a put option?

· Can you draw a call payoff diagram?

· What about a put payoff diagram?

2. Calculate the payoff for both call and put?

· For call: Profit = Spot rate – strike price – premium; if option is exercised (when spot rate > strike price)

        Or, Profit = -premium,  if option is not exercised (expired when spot rate < strike price)

In general, profit = max((spot rate – strike price - premium), -premium )  ----------   Excel syntax

Excel payoff diagram for call and put options (very helpful)

(Thanks to Dr. Greene http://www2.gsu.edu/~fncjtg/Fi8000/dnldpayoff.htm)

Calculator of Call and Put Option

Example: Jim is a speculator . He buys a British pound call option with a strike of $1.4 and a December settlement date. Current spot price as of that date is $1.39. He pays a premium of $0.12 per unit for the call option. Just before the expiration date, the spot rate of the British pound is $1.41.At that time, he exercises the call option and sells the pounds at the spot rate to a bank. One option contract specifies 31,250 units. What is Jim’s profit or loss? Assume Linda is the seller of the call option. What is Linda’s profit or loss?

(refer to ppt. Answer:

Spot rate is $1.39, Jim’s total profit: -0.12*31250

Spot rate is $1.41, Jim’s total profit: (1.41-1.4-0.12)*31250=(-0.11)*31250

Spot rate is $1.39, Linda’s total profit: 0.12*31250

Spot rate is $1.41, Linda’s total profit: -((1.41-1.4-0.12)*31250)=0.11*31250

*** the loss of taking the long position of the option is just the gain of taking the short position. It is a zero sum game.

· For put: Profit = strike price - Spot rate – premium,  if option is exercised (when spot rate < strike price)

        Or, Profit = -premium,  if option is not exercised (expired when spot rate > strike price)

In general, profit = max((strike price - spot rate - premium), -premium )  ----------   Excel syntax

Example A speculator bought a put option (Put premium on £ = $0.04 / unit, X=$1.4, One contract specifies £31,250 )

He exercise the option shortly before expiration, when the spot rate of the pound was $1.30. What is his profit? What is the profit of the seller? (refer to ppt) When spot rate was $1.5, what are the profits of seller and buyer?

Answer:

Spot rate is $1.30, option buyer’s total profit: (1.4 - 1.3 – 0.04) *31250

Spot rate is $1.50, option buyer’s total profit: -0.04*31250

Spot rate is $1.30, option seller’s total profit: -(1.4 - 1.3 – 0.04) *31250

Spot rate is $1.50, option seller’s total profit: 0.04*31250

*** the loss of taking the long position of the option is just the gain of taking the short position. It is a zero sum game.

FYI: Spot rate = $1.3/€, Strike price = $1.4/€, Premium = 0.1$

www.jufinance.com/option_diagram

HW Chapter 5 Part II (Due with the second mid term exam)

1. You are a speculator who buys a put option on Swiss francs for a premium of $.05, with an exercise price of $.60. The option will not be exercised until the expiration date, if at all. If the spot rate of the Swiss franc is $.55 on the expiration date, how much is the payoff of this put option? And your profit? (And also, please draw the payoff diagram to a long put option holder, optional for extra credits.www.jufinance.com/option_diagram). (Answer: 0.05; $0)

2.   You purchase a call option on Swiss francs for a premium of $.05, with an exercise price of $.50. The option will not be exercised until the expiration date, if at all. If the spot rate on the expiration date is $.58. How much is the payoff of this call option? And your profit? (And also, please draw the payoff diagram to a long call option holder, optional for extra credits www.jufinance.com/option_diagram). (Answer: $0.08; $0.03)

3. You are a speculator who buys a call option on Swiss francs for a premium of $.05, with an exercise price of $.60. The option will not be exercised until the expiration date, if at all. If the spot rate of the Swiss franc is $.55 on the expiration date, how much is the payoff of this long option? And your profit? (And also, please draw the payoff diagram to both the long and short call option holders, optional for extra credits www.jufinance.com/option_diagram). (Answer: -$0.05; 0)

4.   You purchase a put option on Swiss francs for a premium of $.05, with an exercise price of $.50. The option will not be exercised until the expiration date, if at all. If the spot rate on the expiration date is $.58, how much is the payoff of this long option? And your profit? (And also, please draw the payoff diagram to both the long and short put option holders, optional, for extra credits. www.jufinance.com/option_diagram). (Answer: -$0.05; 0)

5. Optional assignment for critical thinking: Set up a practice account at https://www.cmegroup.com/education/practice.html and click on the “trading simulator” to start trading on the future market. Choose a specific future contract, such as euro future contract expired in March, and you can start the game.

Chapter 7  International Arbitrage And Interest Rate Parity

Chapter 7 PPT

Summary of current interest rates of a large number of central banks

https://www.global-rates.com/en/interest-rates/central-banks/central-banks.aspx

Tables - current and historic Brazilian central bank interest rates

change date	percentage
august 04 2022	13.750 %
june 15 2022	13.250 %
may 04 2022	12.750 %
march 16 2022	11.750 %
february 02 2022	10.750 %
december 09 2021	9.250 %
october 27 2021	7.750 %
september 22 2021	6.250 %
august 04 2021	5.250 %
june 16 2021	4.250 %

Tables - current and historic Turkish central bank interest rates

change date	percentage
february 23 2023	8.500 %
november 24 2022	9.000 %
october 20 2022	10.500 %
september 22 2022	12.000 %
august 18 2022	13.000 %
december 16 2021	14.000 %
november 19 2021	15.000 %
october 21 2021	16.000 %
september 23 2021	18.000 %
march 18 2021	19.000 %

Interest Rates Today: The Highest Interest Rates in the World

Here is a list of countries offering the highest deposit interest rates worldwide:

COUNTRY	DEPOSIT INTEREST RATE	INFLATION RATE	DIFFERENCE
Zimbabwe	92%	269%	-177%
Argentina	70.07%	83%	-12.93%
Venezuela	36%	114%	-78%
Moldova	19.5%	33.97%	14.47%
Uzbekistan	17.9%	12.2%	5.7%
Madagascar	13.75%	9.31%	4.44%
Hungary	12.5%	20.1%	-7.6%
Georgia	11.81%	11.5%	0.31%
Uganda	10.05%	10%	0.05%
Brazil	10.03%	7.17%	2.86%
Egypt	9.1%	15%	-5.9%

Source: Trading Economics

https://www.gobankingrates.com/banking/which-country-interest-rates/

For class discussion:

· Why not invest in the above countries for higher interest rates? (hint: Interest rate levels determined by the supply and demand of credit: an increase in the demand for money or credit will raise interest rates)

· For US residents, how can you make profits from currency carry trades?

· How can a country’s real interest rate be as high as over 150%? Shall you consider investing in that country?

Zimbabwe’s Interest Rates

Zimbabwe's central bank cut its policy rate by 50 bps to 150% on February 2nd, 2023, saying monthly inflation has been trending down since the last quarter of 2022. Consumer prices went up 1.1% from a month earlier in January, easing from a 2.4% rise in December, prompting the annual rate to ease to 229.8% from 243.8%. The central bank added that its tight monetary policy stance will continue. source: Reserve Bank of Zimbabwe

Argentina’s Interest Rates

Argentina's central bank maintained its benchmark interest rate at 75% in its February meeting, as annual inflation runs near 100%. source: Central Bank of Argentina

Venezuela Interest Rate https://tradingeconomics.com/venezuela/interest-rate

Calendar	GMT	Reference	Actual	Previous	Consensus	TEForecast
2022-06-16	01:30 PM		52%	49%
2022-08-11	05:40 PM		69.5%	60%
2023-02-16	06:30 PM		75%	75%		75.0%

The Central Bank of Venezuela (Banco Central de Venezuela, BCV) is not responsible for setting interest rates.

For class discussion:
How come the interest rates went up in Argentina in 2023, and is this development positive for the country's inhabitants?

Part 1 of chapter 7: Currency carry trade

Currency carry trade (investopedia)

Carry trade basics (Video, Khan academy)

What is a Currency Carry Trade

A currency carry trade is a strategy in which an investor sells a certain currency with a relatively

low interest rate and uses the funds to purchase a different currency yielding a higher interest rate.

A trader using this strategy attempts to capture the difference between the rates, which can often

be substantial, depending on the amount of the leverage used.

Japan Interest Rate

As the Yen Carry Trade Returns, Consider its Role in the Great Recession

By Bill Camarda @ https://www.americanexpress.com/us/foreign-exchange/articles/yen-carry-trade-role-in-recession/

Abstract:

As the global financial crisis of 2007-2008 unfolded, triggering Herculean efforts by central banks to stabilize financial markets through aggressive monetary and fiscal stimuli, some observers pointed to the yen carry trade as a key driver of the bubble that led up to the crisis – and a contributor that helped deepen the crisis as the trades unwound.

A decade later, the yen carry trade appears to be undergoing a revival, as the interest rate spreads between the U.S. and Japan are widening again. It's worth considering the yen carry trade's role in the Great Recession, why it happened, and any lessons that emerge from that episode of economic history.

What is the Yen Carry Trade?

Carry trades involve borrowing in currencies with low interest rates and investing the proceeds in currencies where interest rates are higher, thereby earning relatively easy profits. The "Law of One Price" economic theory predicts that the profit opportunities from price differences of this kind should quickly disappear, as arbitrage rebalances the prices of assets across markets. But carry trade opportunities have often lingered, offering sustained opportunities for profit, and a growing body of academic research now helps to explain that persistence.

For nearly two decades before the global financial crisis, the yen-dollar carry trade was often among the most prominent carry trades. It grew because the Bank of Japan kept interest rates extremely low from the mid-1990s onward in an attempt to reignite Japan's stagnant economy, while the U.S. Federal Reserve generally maintained higher interest rates. The spread between Japanese and U.S. interest rates encouraged many foreign exchange traders to sell yen they had borrowed at low rates and buy dollars they could lend at higher rates.

When the Fed started to raise interest rates in the mid-2000s, the widening spread between U.S. and Japanese rates triggered a sudden increase in the yen-dollar carry trade. The trade grew rapidly in the run-up to the global financial crisis, as even individual currency traders joined hedge funds, banks, and other financial institutions in pursuit of higher returns.

How Did the Yen Carry Trade Affect the Global Financial Crisis?

From 2004-2007, rapid growth in yen carry trades made far more dollars available for investment in the U.S. While some of this money was invested in U.S. Treasury bonds, much of it found its way into higher-yielding assets such as collateralized debt obligations (CDOs) and U.S. subprime residential mortgage backed securities (RMBS) – assets whose prices collapsed in 2007-8.

As the bubble burst and the Great Recession began, the Fed dropped interest rates precipitously, eliminating the differences in rates between Japan and the U.S.; the basis for the yen carry trade disappeared. Yen carry trades quickly unwound, reducing dollar liquidity. Japanese investors, and yen-leveraged American and European investors, sold RMBSes, CDOs and other diverse assets and debt, purchasing dollars which they then sold for yen. This contributed to the collapse of those assets' prices, which in turn added to an extraordinary demand for dollars. The Fed responded by undertaking aggressive quantitative easing – i.e., pouring new dollars into the economy.

The yen carry trade had worked when the yen-dollar exchange rate was relatively stable, or when the yen declined against the dollar – as it did by roughly 20 percent from 2004-2008. But in the wake of Lehman Brothers' September 2008 collapse, the yen rose rapidly along with USD while most other currencies fell by comparison. Japanese investors sold risky dollar-denominated assets and bought yen with the proceeds, pushing the yen up vs. the dollar. American investors who had borrowed in cheaper yen to fund dollar-denominated investments faced rising FX costs in carrying their yen loans. They rushed to sell dollars (and other currencies) to buy yen they could use to repay their yen loans, pushing the yen exchange rate even higher. These events contributed significantly to the volatility then roiling currency markets.

What's Happened Since

A few years after the global financial crisis, Japan's expansionary economic policies contributed to a re-emergence of the yen carry trade, as the yen's value dropped by 26 percent and significant differences between U.S. and Japanese interest rates reappeared. Yen carry trades increased by 70 percent between 2010 and 2013. However, by early 2018, yen carry trade strategies had racked up four straight quarters of losses. The outlook for the yen carry trade seemed poor: the yen was rising against other currencies, traders expected the Bank of Japan to tighten the reins on economic growth and raise interest rates, and traders anticipated higher volatility in connection with growing international trade frictions.

But in August 2018, the Bank of Japan announced that it would keep interest rates extremely low for an indefinite period. Observers noted that the Fed had already raised interest rates several times, and was projecting five rate hikes through the end of 2019. Meanwhile, in the second quarter of 2018, Bloomberg found borrowing yen to purchase dollar assets earned investors an exceptionally attractive return of 4.9 percent, taking into account fluctuations in exchange rates, levels of interest, and the funding costs.

It isn't yet clear how long the recent revival of the yen carry trade will be sustained. Historically, the yen has often been viewed as a safe haven currency. If increased volatility drives FX traders to safety, the yen's value could rise, making the carry trade less profitable.

But if the yen carry trade does keep growing, it could again impact exchange and interest rates. When spreads between interest rates widen, traders inevitably seek to take advantage of them. The experience of 2007-2008 teaches that this can lead to market distortions and even bubbles.

Homework chapter 7-1 (Due with second mid term exam)

1. What are the risks and awards associated with currency carry trade?

2. The interest rate in Argentina has reached 75% this year. Do you suggest engaging in currency carry trade with Argentina? Why or why not? Please refer to the following video. What is suggested by the host? Do you think that his strategy will work? Why or why not?

how to do the carry trade. (VIDEO, BY Robert Booker)

3. Would you recommend the currency carry trade strategy to your friends who are US investors? If so, which currency pair would you recommend that has a strong and reliable currency and a high interest rate in the country?

Published Feb 15, 2023 • 2 minute read

Argentina’s central bank is set to hold its benchmark interest rate steady at 75% this week despite inflation gaining pace once more, but hopes of a potential rate cut early this year are fading as prices heat up, bank sources told Reuters.

https://financialpost.com/pmn/business-pmn/argentina-to-hold-interest-rate-at-75-as-inflation-reheats-bank-sources-say

The South American country hiked rates through most of last year. It put the breaks on monetary tightening in October, and has since left the benchmark rate unchanged on hopes that inflation, running near 100% annually, was cooling.

Although monthly inflation has ticked up since December, the central bank is not expected to make a new hike. Consumer prices rose 6% in January and inflation clocked in at 99% on an annual basis, the government said on Tuesday.

An official central bank source said a rate hike debate was not expected to be “on the agenda” ahead of the board’s weekly meeting on Thursday. The bank normally makes rate decisions mid-month, though these can come at other times.

A central bank adviser told Reuters on condition of anonymity that the rate was unlikely to be raised or lowered this month.

A period of slowing inflation in the second half of last year had seeded hopes that there could be a cut in early 2023.

“At the end of last year it was thought that inflation would decrease slowly and for this reason a possible drop in rates was even analyzed, but now the reality has changed and it does not seem appropriate to make monetary changes,” the person said.

Analysts agreed a hike was unlikely.

“It should be held steady given that the nominal annual monetary policy rate of 75% is consistent with inflation of almost 6.3% per month,” said Roberto Geretto at Argentina investment fund Fundcorp.

“Even if it goes slightly above this number, there would be no great pressure from that side to raise (rates).”

Mauro Mazza of Bull Market Brokers said he expected the bank to leave both the benchmark ‘Leliq’ rate and repo rates steady. He flagged worries about rising Treasury issuance, with the government raising the rates it offered to roll over debt.

Argentina holds elections in October, with the embattled Peronist ruling coalition fighting to avoid defeat by the conservative opposition, which leads in the polls with voters worried about inflation and economic malaise.

The government might walk a fine line between tamping down inflation and supporting growth, said Gustavo Ber from the consulting firm Estudio Ber.

“It is an election year, and all decisions will be short-term,” he said. “It seems unlikely the BCRA (central bank) will move the rate now.”

(Reporting by Jorge Otaola; Editing by Adam Jourdan and David Gregorio)

https://www.google.com/finance/quote/USD-ARS?sa=X&ved=2ahUKEwiCwOC4zcv9AhVCFlkFHU0cCbAQmY0JegQIARAZ&window=5Y

Why is Argentina's Currency SO CRAZY? (youtube)

Chapter 7 Part II Interest Rate Parity

ppt 

In class exercises

1. Locational arbitrage

Exercise 1:       Bank1 – bid   Bank1-ask        Bank2-bid Bank2-ask

£ in $:              $1.60               $1.61               $1.62      $1.63

How can you arbitrage? 

Answer: Buy pound at bank1’s ask price and sell pound at bank2’s bid price. Profit is $0.01/pound

For instance, with $1,610, you can buy £ at bank 1 @ $1.61/£ and get back £1,000.

Then, you can sell £ at bank 2 @ $1.62/£ and get back $1,620, and make a profit of $10.

Pound is cheaper in bank 1 but more expensive in bank 2. Therefore, you can arbitrage.

Hint: Always buy from dealer at ask price, and sell to dealer at bid price.

                        Bank1 – bid   Bank1-ask        Bank2-bid Bank2-ask

£ in $:             $1.6                 $1.61               $1.61      $1.62

How can you arbitrage?

(Answer: Buy pound at bank1’s ask price and sell pound at bank2’s bid price. No Profit )

For instance, with $1,610, you can buy £ at bank 1 @ $1.61/£ and get back £1,000.

Then, you can sell £ at bank 2 @ $1.61/£ and get back $1,610, and make a profit of $0.

Pound is cheaper in bank 1 but more expensive in bank 2. However, there is a bid ask spread, or fees charged by dealers. So no arbitrage opportunities.)

Hint: Always buy from dealer at ask price, and sell to dealer at bid price.

Exercise 2: If you start with $10,000 and conduct one round transaction, how many $ will you end up with ?

(Answer: ($10000 / 0.64($/NZ$)) – the amount obtained from north bank.

($10000 / 0.64($/NZ$))  * 0.645 ($/NZ$)  = $10078.13)

Hint: Always buy from dealer at ask price, and sell to dealer at bid price.

2. Triangular arbitrage

Exercise 1: £ is quoted at $1.60. Malaysian Rinnggit (MYR) is quoted at $0.20 and the cross exchange rate is £1 = MYR 8.1. How can you arbitrage?

Answer: Either $ è MYR è £ è $, or $ è £ è MYR è $, one way or another, you should make money. In this case, it is the latter one. Imagine you have $1,600 è 1,000

Approach one: Yes, $ è GBP è MYR è $ could make a profit of $20.

Approach two: No, $ è MYR è GBP è $ does not work.

Exercise 2:

How can you arbitrage with the above information?

Answer:

Approach 1: Yes. Same as above but sell at bid and buy at ask. Only two rounds: USDà GBPàMYR, or, USD àMYRàGBP. One way  make money and the other one lose money. We start with $1,610 è buy GBP at ask price, so get 1,000 GBP  è sell GBP for rinngit @ 1  GBP  = 8.1 MYR; so get 8,100 MYR è sell Rinngit for $ @ bid price.  8,100 MYR =  8,100 * 0.20 = $1,620, a profit of $10 out of $1,610 initial investment.

The other round is: 1,610$ è 8,009.95 MYR (=1,610/0.201) è976.8GBP (=1,610/0.201/8.2)  è 1,562.9 USD (=1,610/0.201/8.2*1.6)  è a loss of 47.1 USD, so not a good deal

 Approach 2: No, it does not work.

3. Covered Interest Arbitrage (CIA):

Covered interest arbitrage is a financial strategy that involves taking advantage of differences in interest rates between two countries to make a profit. The goal of covered interest arbitrage is to exploit the difference between the interest rate in the country where the investor borrows funds and the interest rate in the country where the investor will invest those funds.

Here's how it works:

· The investor borrows money in a country where interest rates are lower than in another country.

· The investor then converts the borrowed funds into the currency of the country where they want to invest.

· The investor then invests the borrowed funds in that country's financial markets, such as buying bonds or depositing the funds in a bank account.

· The investor also enters into a forward contract to sell the invested funds at a predetermined exchange rate and date, which will cover the borrowed funds plus interest.

· When the forward contract matures, the investor repays the borrowed funds plus interest and receives the proceeds from the investment.

The profit comes from the difference between the interest rate earned on the invested funds and the interest rate paid on the borrowed funds, minus any costs associated with the transaction. This strategy is called "covered" because the investor has hedged their foreign exchange risk by entering into a forward contract.

Exercise 1: Assume you have $800,000 to invest. Current spot rate of pound is $1.60. 90 day forward rate of pound is $1.60. 90 day interest rate in US is 2%. 90 day interest rate in UK is 4%.  How can you arbitrage?

Answer: Convert at spot rate for pound and then deposit pound in UK bank. 90 days later, convert back to $ at forward rate. Refer to the above graph for details)

Exercise 2: You have $100,000 to invest for one year. How can you benefit from engaging in CIA?

Answer: Again, buy at ask and sell at bid.  Convert at spot rate for pound and then deposit pound in European bank. One year later, convert back to $ at forward rate. ($100,000 / 1.13)*(1+6.5%) *1.12 = $105,558. However, if keep the money in US, you can get $100,000*(1+6%) = $106,000 So better to deposit in US and do not participate in CIA)

Interest rate parity (IRP)

· The interest rate parity implies that the expected return on domestic assets = the exchanged rate adjusted expected return on foreign currency assets.

IRP video

IRP is based on that “Investors cannot earn arbitrage profits” by

1. Borrow an amount in a currency with a lower interest rate.
2. Convert the borrowed amount into a currency with a higher interest rate.
3. Invest the proceeds in an interest-bearing instrument in this higher-interest-rate currency.
4. Simultaneously hedge exchange risk by buying a forward contract to convert the investment proceeds into the first (lower interest rate) currency.

For discussion:

Assume the current spot rate of GBP is 1.5$/£. Interest rate in US is 5% and Interest rate is UK is 10%. Shall you invest in US for 5% or shall you invest in UK for a higher return?

***Answer***: It should make no difference at all! Please explain.

Invest in US, return = 5%. Invest in UK, return = 5% as well. Why?

You can borrow at 5% in US, then convert to GBP at 1.5$/GBP, then deposit in US for 10%, convert back to $ at the forward rate, and this forward rate would be 1.4318$/GBP, then your return would be 5%.

$1500 è 1000 GBP è1100 GBP one year later è 1100 GBP * (1.4318$/GBP) =$1574.98, we start from $1500, and 1574.98/1500-1 = 5% of return

Forward rate = 1.4318 $/GBP. Why?

The returns for either approach should both equal to 5%.

So invest in US, by the end of the year, the account value = $1500 *(1+5%)

Invest in UK, 1000 GBP *(1+10%) * Forward rate

Both investments should provide the same returns to investors, since the financial market is efficient è no arbitrage opportunity

$1500 *(1+5%) =1000 GBP *(1+10%) * Forward rate è Forward rate = $1500 *(1+5%) / 1000 GBP *(1+10%) = 1.4318$/GBP

Equation of IRP:

  or 

S_$/¥: spot rate how many $ per ¥. ¥ is the base currency and $ is quoted currency

F_$/¥: forward rate;

So, F = S *(1+ interest rate of quoted currency) / (1+ interest rate of base currency)

Why?

Deposit in ¥ @ the ¥’s rate and then convert back to F (forward rate)

= Convert to $ at spot rate and deposit at $’s rate

So, (1+rate_¥)*F = S* (1+rate_$) è F = S* (1+rate_$) /((1+rate_¥)

Or,

S_¥/$: spot rate how many ¥ per $. ¥ is the base $ quoted

F_¥/$: forward rate;

So, F = S *(1+ interest rate of quoted currency) / (1+ interest rate of base currency)

Why?

Deposit in $ @ the $’s rate and then convert back to F (forward rate)

= Convert to ¥ at spot rate and deposit at ¥’s rate

So, (1+rate_$)*F = S* (1+rate_¥) è F = S* (1+rate_¥) /((1+rate_$)

Or,

The basic equation for calculating forward rates with the U.S. dollar as the base currency is:

Forward Rate = Spot Rate * [(1 + Interest Rate of quoted currency) / (1 + Interest Rate of based currency)]

Spot rate: ¥/$, or USD/YEN (Yen is quoted and $ is based)

Or,

Forward Rate = Spot Rate * ( Interest Rate of quoted currency - Interest Rate of based currency +1 )

Implications of IRP Theory

· If IRP theory holds, then it can negate the possibility of arbitrage. It means that even if investors invest in domestic or foreign currency, the ROI will be the same as if the investor had originally invested in the domestic currency.

· When domestic interest rate is below foreign interest rates, the foreign currency must trade at a forward discount. This is applicable for prevention of foreign currency arbitrage.

· If a foreign currency does not have a forward discount or when the forward discount is not large enough to offset the interest rate advantage, arbitrage opportunity is available for the domestic investors. So, domestic investors can sometimes benefit from foreign investment.

· When domestic rates exceed foreign interest rates, the foreign currency must trade at a forward premium. This is again to offset prevention of domestic country arbitrage.

· When the foreign currency does not have a forward premium or when the forward premium is not large enough to nullify the domestic country advantage, an arbitrage opportunity will be available for the foreign investors. So, the foreign investors can gain profit by investing in the domestic market.

https://www.tutorialspoint.com/international_finance/interest_rate_parity_model.htm

IRP calculator

Exercise 1:  i_$ is 8%; i_SF  is 4%;  If spot rate S =0.68 $/SF, then how much is F₉₀ (90 day forward rate)?

Answer:  

S =0.68 $/SF è CHF/USD = 0.68, so CHF is base currency and USD is the quoted currency.

So, F = 0.68*(1+8%/4) / (1+4%/4) = 0.6867 $/CHF (or CHF/USD = 0.6867)

Exercise 2:  i_$ is 8%; i_yen  is 4%;  If spot rate S = 0.0094 $/YEN, then how much is F₁₈₀ (180 day forward rate)?

Answer: 

S = 0.0094 $/YEN, so $ is the quoted currency, Yen is the base currency.

F = S *(1+ interest rate of quoted currency) / (1+ interest rate of base)è F=0.0094*(1+8%/2)/(1+4%/2) = 0.0096 $/YEN

Exercise 3: i_$ is 4% and i_£ is 2%. S is $1.5/£ and F is $2/£. Does IRP hold? How can you arbitrage? What is the forward rate in equilibrium?

Answer: 

S = $1.5/£, so $ is the quoted currency, £ is the base currency.

F = S *(1+ interest rate of quoted currency) / (1+ interest rate of base)è F=(1.04/1.02)*1.5 = $1.529/£, F at $2/£ is too high.

When F=$2/£, what can US investors do to make arbitrage profits?

For example, US investor

· can borrow 1,000 $, and pay back $1,040 a year later.

· Convert to £ now at spot rate and get $1,000/1.5_$/£ = 666.67 £

· deposit in UK @ 2%

· so one year later, get back 666.67 £*(1+2%)=680£

· convert to $ at F rate

· so get back 680 £ * 2_$/£ = $1,360

· So the investor can make a profit of 1,360 -1040 = $320 profit.

The forward rate is set too high. It should be set around $1.529/£, so that the arbitrage opportunity will be eliminated.

Exercise 4:  i_$  is 2% and  i_£  is 4%. S is $1.5/£ and F is $1.1/£. Does IRP hold? How can you arbitrage? What is the forward rate in equilibrium?

Answer:

S = $1.5/£, so $ is the quoted currency, £ is the base currency.

F = S *(1+ interest rate of quoted currency) / (1+ interest rate of base)è F=(1.02/1.04)*1.5 = $1.471/£, so F at $1.1/£ is too low.

When F=$1.1/£, what can US investors do to make arbitrage profits?

For example, US investor

· can borrow 1,000 $, and pay back $1,040 a year later.

· Convert to £ now at spot rate and get $1,000/1.5_$/£ = 666.67 £

· deposit in UK @ 4%

· so one year later, get back 666.67 £*(1+4%)=693.33£

· convert to $ at F rate

· so get back 680 £ * 1.1_$/£ = $762.67

· So the investor will lose money: $762.67 -1040 = -247.33, a loss.

The forward rate is set too low. It should be set around $1.471/£.

SO US investors should let this CIA (covered interest rate arbitrage) go, but UK investor could consider borrow money in UK to generate risk free profits. So the trade by UK investors will force forward rate to drop to its equilibrium price based on IRP.

Rule of Thumb:

· All that is required to make a covered interest arbitrage profit is for interest rate parity not to hold.

· The key to determining whether to start CIA is to compare the differences in interest rate to the forward premium

(= F/S-1, or =forward rate / spot rate -1).

Spot exchange rate	S($/£)	=	$2.0000/£
360-day forward rate	F360($/£)	=	$2.0100/£
U.S. discount rate	i$	=	3.00%
British discount rate	i£	=	2.5%

1. With above information and $1,000 in hand, any opportunities?

2. When  F₃₆₀($/£) = $2.50/£?

3. When  F₃₆₀($/£) = $1.90/£

Answer:

1. Either CIA make 3% or deposit in US also 3%. F is priced correctly.

2. F is too high for US residents. So US investors can take advantage of this high Forward rate; borrow at local rate and trade in FX market

3. F is too low. So UK investors can borrow at local rate and trade in FX market.

Homework chapter 7-2 (due with final)

1. Suppose that the one-year interest rate is 5.0 percent in the United States and 3.5 percent in Germany, and the one-year forward exchange rate is $1.3/€. What must the spot exchange rate be? (Hint: the question is asking for the spot rate, given forward rate. ~~ $1.2814/€ ~~)

2. Imagine that can borrow either $1,000,000 or €800,000 for one year. The one-year interest rate in the U.S. is i_$ = 2% and in the euro zone the one-year interest rate is i_€ = 6%. The one-year forward exchange rate is $1.20 = €1.00; what must the spot rate be to eliminate arbitrage opportunities? (1.2471$/€. It does not matter whether you borrow $ or euro)

3. Image that the future contracts with a value of  €10,000 are available. The information of one year interest rates, spot rate and forward rate available are as follows. 

Question: profits that you can make with one contract at maturity? 

          Exchange rate                            Interest rate                   APR

  So($/€)    $1.45=€1.00                           Interest rate of $          4%

F₃₆₀($/€)    $1.48=€1.00                           Interest rate of €         3%

Hint: The future contract is available, so you can buy 10,000 euro in the future to buy the futures contract. So at present, you can

borrow €9,708.3 (=10,000 euro / 1.03) euro and use the money 360 days later to purchase the future contract of €10,000, since € interest rate is 3%. Let’s see you can make money or not.

Convert €9,708.3 to $ at spot rateè get back €9,708.3 *1.45 $/€= $14,077.67 è deposit at US @4% interest rate, and get back $14,077.67 *(1+4%) = $14,640.78 è convert at F rate, and get back $14,640.78 / 1.48 $/€ =9,892.417 euro , less than 10,000 euro è so this round of trading is not a good idea.

However, if the F rate is $1.46/euro or even less, then you can get back $14,640.78 / 1.46 $/€ > 10,000 euro, so you can do better by doing so than simply depositing money in euro with 3% interest rate.

4. Image that you find that interest rate per year is 3% in Italy. You also realize that the spot rate is $1.2/€ and forward rate (one year maturity) is $1.18/€.

Question: Use IRP to calculate the interest rate per year in US. (1.28%)

5. Suppose the current bid-ask prices for the US dollar (USD) and the British pound (GBP) are as follows:

New York foreign exchange market: Bid = 1 USD = 0.7485 GBP, Ask = 1 USD = 0.7495 GBP

London foreign exchange market: Bid = 1 USD = 0.7950 GBP, Ask = 1 USD = 0.7960 GBP

Assume that there are no transaction costs or other barriers to arbitrage.

Questions:

· What is the potential profit from a locational arbitrage transaction, and how would you execute it?

· What effect would this arbitrage have on the bid-ask spreads in the two markets?

Hint: a) To execute the arbitrage, an investor would buy USD in New York with GBP at the ask price, and then sell the USD for GBP in London at the bid price. Specifically, the investor would do the following:

· Buy 1 USD in New York at the ask price of 0.7495 GBP.

· Convert the 1 USD to GBP in London at the bid price of 0.7950 GBP.

· Sell the GBP for USD in New York at the bid price of 0.7485 GBP.

· Pocket the difference.

b) The effect of this arbitrage would be to increase the demand for USD in New York and the supply of USD in London, which would push up the bid price and push down the ask price in New York, and push down the bid price and push up the ask price in London. This process would continue until the bid-ask spreads in the two markets converge to eliminate the profit opportunity from the arbitrage.

6) Suppose the exchange rates for three currencies - US dollars (USD), Euros (EUR), and British pounds (GBP) - are as follows:

· 1 USD = 0.85 EUR

· 1 EUR = 0.75 GBP

· 1 USD = 0.63 GBP

Assume that there are no transaction costs or other barriers to arbitrage.

Questions: a) Is there an opportunity for triangular arbitrage starting with US dollars (USD)? If so, what is the potential profit and how would you execute it?

b) What effect would this arbitrage have on the exchange rates between the three currencies?

Hint: a) There is an opportunity for triangular arbitrage starting with USD. To execute the arbitrage, an investor would use the three exchange rates to create a triangular loop that begins and ends with the same currency. The investor would do the following:

Buy EUR with USD: Convert 1 USD to EUR at the rate of 1 USD = 0.85 EUR.

Buy GBP with EUR: Convert the €0.85 to GBP at the rate of 1 EUR = 0.75 GBP.

Buy USD with GBP: Convert the £0.6375 to USD at the rate of 1 USD = 0.63 GBP

Calculate the profit: The profit from this transaction is the difference between the initial and final USD amounts, which is …

b) This arbitrage would have the effect of increasing the demand for GBP and decreasing the demand for USD and EUR in the London market, while increasing the demand for USD and EUR and decreasing the demand for GBP in the New York and Frankfurt markets. This would cause the exchange rates to adjust until the profit opportunity from the arbitrage is eliminated. Specifically, the USD/EUR rate in New York would decrease, the EUR/GBP rate in London would increase, and the USD/GBP rate in Frankfurt would decrease.

7) Question: Suppose the exchange rates for US$/GBP, GBP/JPY, and JPY/US$ are 1.25, 150, and 0.008, respectively. Is there an opportunity for triangular arbitrage? Why or why no?

Hint: Try convert US$1 into GBP, then into JPY, and finally back into US$.

Starting with US$1, we can buy 0.8 GBP by exchanging it at the rate of 1 US$/1.25 GBP. Then, we can use the 0.8 GBP to buy JPY at the rate of 1 GBP/150 JPY, which gives us 120 JPY. Finally, we can convert the 120 JPY back into US$ by exchanging it at the rate of 1 JPY/0.008 US$, which gives us US$,,,,,

The followings are useful websites

Exchange rate forecast

http://exchangerateforecast.com/

Daily FX News(has news, technical analysis and live rates):http://www.dailyfx.com/

Technical analysis _ chart example book

http://www.forex-charts-book.com/

Forex Trend lines

http://www.forextrendline.com/

Historical currency rate 

http://www.xe.com/currencytables/

Historical currency chart 

http://www.xe.com/currencycharts/

Forex trading demo

http://www.fxcm.com/forex-trading-demo/

Purchasing power parity (cartoon)

http://www.youtube.com/watch?v=i0icL5zlQww

Uncovered Interest Rate Parity (FYI)

Uncovered interest rate parity (UIP) states that the difference in interest rates between two countries equals the expected change in exchange rates between those two countries. Theoretically, if the interest rate differential between two countries is 3%, then the currency of the nation with the higher interest rate would be expected to depreciate 3% against the other currency.

In reality, however, it is a different story. Since the introduction of floating exchange rates in the early 1970s, currencies of countries with high interest rates have tended to appreciate, rather than depreciate, as the UIP equation states. This well-known conundrum, also termed the “forward premium puzzle,” has been the subject of several academic research papers.

The anomaly may be partly explained by the “carry trade,” whereby speculators borrow in low-interest currencies such as the Japanese yen, sell the borrowed amount and invest the proceeds in higher-yielding currencies and instruments. The Japanese yen was a favorite target for this activity until mid-2007, with an estimated $1 trillion tied up in the yen carry trade by that year.

Relentless selling of the borrowed currency has the effect of weakening it in the foreign exchange markets. From the beginning of 2005 to mid-2007, the Japanese yen depreciated almost 21% against the U.S. dollar. The Bank of Japan’s target rate over that period ranged from 0 to 0.50%; if the UIP theory had held, the yen should have appreciated against the U.S. dollar on the basis of Japan’s lower interest rates alone.

The Difference Between Covered Interest Rate Parity and Uncovered Interest Rate Parity (FYI)

Covered interest parity (CIP) involves using forward or futures contracts to cover exchange rates, which can thus be hedged in the market. Meanwhile, uncovered interest rate parity involves forecasting rates and not covering exposure to foreign exchange risk – that is, there are no forward rate contracts, and it uses only the expected spot rate.

There is no theoretical difference between covered and uncovered interest rate parity when the forward and expected spot rates are the same.

Implications of IRP Theory

If IRP theory holds, then it can negate the possibility of arbitrage. It means that even if investors invest in domestic or foreign currency, the ROI will be the same as if the investor had originally invested in the domestic currency.

When domestic interest rate is below foreign interest rates, the foreign currency must trade at a forward discount. This is applicable for prevention of foreign currency arbitrage.

If a foreign currency does not have a forward discount or when the forward discount is not large enough to offset the interest rate advantage, arbitrage opportunity is available for the domestic investors. So, domestic investors can sometimes benefit from foreign investment.

When domestic rates exceed foreign interest rates, the foreign currency must trade at a forward premium. This is again to offset prevention of domestic country arbitrage.

When the foreign currency does not have a forward premium or when the forward premium is not large enough to nullify the domestic country advantage, an arbitrage opportunity will be available for the foreign investors. So, the foreign investors can gain profit by investing in the domestic market.

Let’s have some fun with ChatGPT – generate Interest Rate Parity Calculator by ChatGPT

Here are step-by-step instructions:

1. Ask ChatGPT to generate an interest rate parity calculator using JavaScript in HTML format. You can ask something like: "Hey ChatGPT, could you please generate an interest rate parity calculator using JavaScript in HTML format to calculate the forward exchange rate, given the spot rate and current interest rates?"

2. ChatGPT should respond with the code for the calculator. Copy the code to your clipboard.

3. Open Notepad or any other text editor and paste the code into a new document.

4. Save the file as an HTML file. You can name it anything you like, but make sure the file extension is ".html". For example, you can name it "interest_rate_parity_calculator.html".

5. Open the saved HTML file in your web browser (e.g. Chrome, Firefox, etc.) by double-clicking on the file or right-clicking and selecting "Open with". The interest rate parity calculator should load and be ready to use.

6. Test the calculator by entering different values for the domestic and foreign interest rates, spot exchange rate, and days to maturity. Make sure the calculated forward exchange rate is correct and matches your expectations.

7. If you find any issues with the calculator, you can ask ChatGPT to generate it again with the desired changes.

Or use the code from my experiment with ChatGPT earlier this week

<!DOCTYPE html>

<html>

<head>

<title>Interest Rate Parity Calculator</title>

</head>

<body>

<h1>Interest Rate Parity Calculator</h1>

<p>Enter the following information:</p>

<form>

<label for="domestic-rate">Domestic interest rate:</label>

<input type="number" id="domestic-rate" name="domestic-rate" step="0.01"><br>

<label for="foreign-rate">Foreign interest rate:</label>

<input type="number" id="foreign-rate" name="foreign-rate" step="0.01"><br>

<label for="spot-rate">Spot exchange rate:</label>

<input type="number" id="spot-rate" name="spot-rate" step="0.0001"><br>

<label for="days-to-maturity">Days to maturity:</label>

<input type="number" id="days-to-maturity" name="days-to-maturity"><br>

<button type="button" onclick="calculate()">Calculate</button>

</form>

<p id="result"></p>

<script>

function calculate() {

// Get the values entered in the form fields

var domesticRate = parseFloat(document.getElementById("domestic-rate").value);

var foreignRate = parseFloat(document.getElementById("foreign-rate").value);

var spotRate = parseFloat(document.getElementById("spot-rate").value);

var daysToMaturity = parseInt(document.getElementById("days-to-maturity").value);

// Calculate the forward exchange rate using the interest rate parity formula

var forwardRate = spotRate * Math.pow((1 + (domesticRate/100)), (daysToMaturity/365)) / Math.pow((1 + (foreignRate/100)), (daysToMaturity/365));

// Display the forward exchange rate on the page

document.getElementById("result").innerHTML = "The forward exchange rate is " + forwardRate.toFixed(4);

}

</script>

</body>

</html>

Try this Triangular Arbitrage Calculator for your homework

<!DOCTYPE html>

<html>

<head>

<title>Triangular Arbitrage</title>

<script>

function checkArbitrage() {

// Get exchange rates from user input

var usdjpy = parseFloat(document.getElementById("usdjpy").value);

var jpyeur = parseFloat(document.getElementById("jpyeur").value);

var eurusd = parseFloat(document.getElementById("eurusd").value);

// Calculate implied exchange rates

var usdeur = 1 / eurusd;

var jpyusd = 1 / usdjpy;

var eurjpy = 1 / jpyeur;

// Calculate cross rates

var crossRate1 = usdjpy * jpyeur;

var crossRate2 = eurusd * jpyusd;

var crossRate3 = eurjpy * eurusd;

// Check for arbitrage opportunity

if (crossRate1 > crossRate2 * crossRate3) {

var startingUSD = 1;

var startingEUR = startingUSD * usdjpy;

var startingJPY = startingEUR * jpyeur;

var endingUSD = startingJPY * eurusd;

var profit = endingUSD - startingUSD;

document.getElementById("result").innerHTML = "Arbitrage opportunity exists! Starting with " + startingUSD.toFixed(2) + " USD, you can make a profit of " + profit.toFixed(2) + " USD.";

} else {

document.getElementById("result").innerHTML = "No arbitrage opportunity.";

}

}

</script>

</head>

<body>

<h1>Triangular Arbitrage Checker</h1>

<p>Enter exchange rates for three currency pairs:</p>

<p>US$/JPY: <input type="text" id="usdjpy" /></p>

<p>JPY/EUR: <input type="text" id="jpyeur" /></p>

<p>EUR/US$: <input type="text" id="eurusd" /></p>

<button onclick="checkArbitrage()">Check Arbitrage</button>

<p id="result"></p>

</body>

</html>

For example:

Second Mid-term exam (3.29)

Review Video in Class (Must watch)

Second Midterm Exam Study Guide

(close book close notes, in class)

Chapter 5

2. What is a forward contract?

3. What is a future contract?

4. Is it necessary to deliver the underlying asset in a futures contract?

5. What are the differences between forward and futures contracts?

6. When should you consider purchasing a futures contract?

7. When should you consider selling a futures contract?

8. Can you explain what a put option is? When is it advisable to purchase a put option?

9. What is a call option and when is it appropriate to buy one?

10. Under what circumstances can you make a profit by exercising a put option?

11. Under what circumstances can you make a profit by exercising a call option?

12. What is a forward premium or discount?

13. Can you define spot rate? What is the settlement rate in a futures contract?

14. Ask to draw call and put option (long position) payoff diagram, given strike price

Chapter 7

15. What is the definition of Interest Rate Parity (IRP)?

16. What are the consequences when IRP does not hold?

17. What factors can cause IRP to not hold?

18. If IRP holds, what is the best investment strategy?

19. Can you earn more from IRP or CIA? What distinguishes them?

20. Questions on currency carry trade.

Covered interest arbitrage is a financial strategy that involves taking advantage of differences in interest rates between two countries to make a profit. The goal of covered interest arbitrage is to exploit the difference between the interest rate in the country where the investor borrows funds and the interest rate in the country where the investor will invest those funds.

Here's how it works:

· The investor borrows money in a country where interest rates are lower than in another country.

· The investor then converts the borrowed funds into the currency of the country where they want to invest.

· The investor then invests the borrowed funds in that country's financial markets, such as buying bonds or depositing the funds in a bank account.

· The investor also enters into a forward contract to sell the invested funds at a predetermined exchange rate and date, which will cover the borrowed funds plus interest.

· When the forward contract matures, the investor repays the borrowed funds plus interest and receives the proceeds from the investment.

The profit comes from the difference between the interest rate earned on the invested funds and the interest rate paid on the borrowed funds, minus any costs associated with the transaction. This strategy is called "covered" because the investor has hedged their foreign exchange risk by entering into a forward contract.

Uncovered interest arbitrage, also known as speculative arbitrage, is a financial strategy that involves taking advantage of differences in interest rates between two countries to make a profit without hedging against foreign exchange risk.

Unlike covered interest arbitrage, where an investor hedges their foreign exchange risk through a forward contract, uncovered interest arbitrage involves borrowing money in one country with a lower interest rate and investing it in another country with a higher interest rate, without hedging the exchange rate risk.

Here's how it works:

The investor borrows money in a country where interest rates are lower than in another country.

The investor then converts the borrowed funds into the currency of the country where they want to invest.

The investor then invests the borrowed funds in that country's financial markets, such as buying bonds or depositing the funds in a bank account.

When the investment matures, the investor converts the proceeds back into their original currency, hoping that the exchange rate has not moved against them.

If the exchange rate has moved in their favor, the investor repays the borrowed funds plus interest and pockets the profit from the difference between the interest rates and the exchange rate.

However, if the exchange rate has moved against the investor, the profit may be reduced or eliminated, and the investor may even incur a loss. Uncovered interest arbitrage is considered riskier than covered interest arbitrage since it exposes the investor to foreign exchange risk.

Chapter 8 Purchasing Power Parity, International Fisher Effect

Part I: PPP

Chapter 8 PPT

1) Purchasing power parity (PPP)  

Purchasing power parity (cartoon) https://www.youtube.com/watch?v=i0icL5zlQww

What is Purchasing Power Parity?

· A theory which states that exchange rates between currencies are in equilibrium when their purchasing power is the same in each of the two countries.

· This means that the exchange rate between two countries should equal the ratio of the two countries' price level of a fixed basket of goods and services.

· When a country's domestic price level is increasing (i.e., a country experiences inflation), that country's exchange rate must depreciated in order to return to PPP.

· The basis for PPP is the "law of one price": In the absence of transportation and other transaction costs, competitive markets will equalize the price of an identical good in two countries when the prices are expressed in the same currency.

· There are some caveats with this law of one price (for class discussion)

· (1) transportation costs, barriers to trade, and other transaction costs, can be significant.

· (2) there must be competitive markets for the goods and services in both countries.

· (3) tradable goods; immobile goods such as houses, and many services that are local, are of course not traded between countries.

What else? Your opinion?

2) The Law of one price THEORY:

 All else being equal (no transaction costs), a product’s price should be the same in all markets

So price in $ sold in US = price in $ sold in Japan after conversion to $ from ¥

P^$  = P ^¥ * Spot Rate _$/¥

Where the price of the product in US dollars (P^$), multiplied by the spot exchange rate (S,  dollar per yen), equals the price of the product in Japanese yen (P^¥)

        Or,  S =  P^$/   P ^¥

PPP Calculator

3) Does PPP determine exchange rates in the short term? (for class discussion)

· No.

· Exchange rate movements in the short term are news-driven.

· Announcements about interest rate changes, changes in perception of the growth path of economies and the like are all factors that drive exchange rates in the short run.

· PPP, by comparison, describes the long run behaviour of exchange rates.

· The economic forces behind PPP will eventually equalize the purchasing power of currencies. This can take many years, however. A time horizon of 4-10 years would be typical.

· What else? Your opinion?

4) How to calculate PPP? ---- Use big mac index

· PPP states that the spot exchange rate is determined by the relative prices of similar basket of goods.

· The simplest way to calculate purchasing power parity between two countries is to compare the price of a "standard" good that is in fact identical across countries.

· Every year The Economist magazine publishes a light-hearted version of PPP: its "Hamburger Index" that compares the price of a McDonald's hamburger around the world. More sophisticated versions of PPP look at a large number of goods and services.

· One of the key problems is that people in different countries consumer very different sets of goods and services, making it difficult to compare the purchasing power between countries.

· For class discussion: can we use bitcoin as another goods to calculate PPP?

Using Hamburgers to Compare Wealth - Big mac index explained video

https://www.economist.com/graphic-detail/2020/01/15/what-can-burgers-tell-us-about-foreign-exchange-markets

Question: Can you use Big Mac Index as evidence to determine whether or not a currency is under-valued? Or over-valued? Market Edge: Peso 'undervalued' vs dollar based on 'Big Mac Index,' says The Economist (video)

5) According to PPP, by how much are currencies overvalued or undervalued?

The currencies listed below are compared to the US Dollar. A green bar indicated that the local currency is overvalued by the percentage figure shown on the axis; the currency is thus expected to depreciate against the US Dollar in the long run. A red bar indicates undervaluation of the local currency; the currency is thus expected to appreciate against the US Dollar in the long run (based on old data)

The currencies listed below are compared to the Euro.

6) Where can I get more information?

• OECD National Accounts: The OECD publishes PPPs for all OECD countries. You can retrieve a table with the OECD's 1950-2015 PPP rates. This is a comma-seprated file that can be easily imported into a spreadsheet program. 

• From The Economist magazine: The Big Mac Index - as they put it "The world's most accurate financial indicator (to be based on a fast food item), with a ten-year retrospective on burgernomics" 

(The above information is collected from http://fx.sauder.ubc.ca/PPP.html)

Time	2012	2013	2014	2015	2016	2017	2018	2019	2020	2021
Unit	National currency per US dollar
Country
Australia	1.54	1.45	1.45	1.47	1.45	1.48	1.47	1.48	1.45	1.46
Austria	0.814	0.797	0.799	0.799	0.777	0.775	0.765	0.771	0.764	0.746
Belgium	0.822	0.806	0.8	0.8	0.781	0.776	0.766	0.767	0.745	0.741
Canada	1.24	1.22	1.23	1.25	1.21	1.21	1.21	1.25	1.25	1.29
Chile	347	350	367	391	397	398	396	408	418	435
Colombia	1 216	1 219	1 233	1 289	1 298	1 328	1 322	1 344	1 320	1 362
Czech Republic	13.3	12.8	12.7	12.9	12.6	12.4	12.4	12.7	12.8	12.9
Denmark	7.56	7.35	7.33	7.31	7.08	6.87	6.77	6.79	6.63	6.47
Estonia	0.521	0.522	0.527	0.538	0.528	0.535	0.539	0.552	0.536	0.525
Finland	0.908	0.905	0.907	0.908	0.881	0.864	0.854	0.863	0.845	0.834
France	0.844	0.812	0.808	0.809	0.78	0.77	0.756	0.739	0.727	0.705
Germany	0.787	0.775	0.769	0.778	0.753	0.745	0.735	0.751	0.738	0.732
Greece	0.685	0.631	0.611	0.609	0.589	0.575	0.565	0.563	0.553	0.546
Hungary	126	125	129	133	132	136	139	145	149	153
Iceland	137	137	139	142	140	138	141	145	150	150
Ireland	0.823	0.811	0.819	0.81	0.794	0.794	0.792	0.827	0.801	0.766
Israel	3.96	3.84	3.94	3.92	3.79	3.75	3.78	3.92	3.85	3.79
Italy	0.748	0.737	0.74	0.739	0.701	0.69	0.681	0.678	0.664	0.648
Japan	104	101	103	103	106	105	104	104	101	96.8
Korea	855	869	872	857	859	873	855	865	825	808
Latvia	0.506	0.499	0.498	0.498	0.485	0.485	0.49	0.502	0.493	0.5
Lithuania	0.453	0.443	0.443	0.446	0.438	0.443	0.447	0.454	0.456	0.458
Luxembourg	0.907	0.895	0.884	0.881	0.852	0.848	0.849	0.862	0.864	0.87
Mexico	7.86	7.88	8.05	8.33	8.45	8.91	9.28	9.65	9.7	9.9
Netherlands	0.824	0.798	0.809	0.81	0.795	0.782	0.777	0.794	0.774	0.762
New Zealand	1.5	1.45	1.44	1.48	1.44	1.43	1.47	1.43	1.44	1.43
Norway	9.04	9.03	9.28	9.93	10	9.75	9.58	9.98	10.1	11.2
Poland	1.8	1.76	1.77	1.77	1.73	1.74	1.75	1.79	1.79	1.79
Portugal	0.605	0.584	0.579	0.585	0.571	0.576	0.571	0.576	0.569	0.552
Slovak Republic	0.505	0.491	0.485	0.492	0.503	0.516	0.526	0.539	0.538	0.529
Slovenia	0.607	0.59	0.591	0.595	0.577	0.57	0.568	0.57	0.562	0.553
Spain	0.695	0.675	0.662	0.665	0.643	0.631	0.632	0.633	0.627	0.613
Sweden	8.65	8.6	8.73	8.85	8.82	8.85	8.87	9	8.75	8.67
Switzerland	1.35	1.31	1.28	1.24	1.2	1.19	1.18	1.18	1.14	1.11
Turkey	1.02	1.07	1.1	1.16	1.24	1.38	1.63	1.93	2.2	2.61
United Kingdom	0.702	0.695	0.698	0.693	0.689	0.685	0.688	0.688	0.689	0.668
United States	1	1	1	1	1	1	1	1	1	1
Euro area (18 countries)	0.774	0.756	0.752	0.755	0.73	0.721	0.713	0.717	0.706	0.69

https://stats.oecd.org/Index.aspx?DataSetCode=PPPGDP

from https://www.oecd.org/fr/sdd/purchasingpowerparities-frequentlyaskedquestionsfaqs.htm

1. What are PPPs?

PPPs are the rates of currency conversion that equalize the purchasing power of different currencies by eliminating the differences in price levels between countries. In their simplest form, PPPs are simply price relatives that show the ratio of the prices in national currencies of the same good or service in different countries. PPPs are also calculated for product groups and for each of the various levels of aggregation up to and including GDP.

2. How PPPs are calculated?

The calculation is undertaken in three stages.

· The first stage is at the product level, where price relatives are calculated for individual goods and services. A simple example would be a litre of Coca-Cola. If it costs 2.3 euros in France and 2.00$ in the United States then the PPP for Coca-Cola between France and the USA is 2.3/2.00, or 1.15. This means that for every dollar spent on a litre of Coca-Cola in the USA, 1.15 euros would have to be spent in France to obtain the same quantity and quality - or, in other words, the same volume - of Coca-Cola.

· The second stage is at the product group level, where the price relatives calculated for the products in the group are averaged to obtain unweighted PPPs for the group. Coca-cola is for example included in the product group “Softdrinks and Concentrates”.

· And the third stage is at the aggregation levels, where the PPPs for the product groups covered by the aggregation level are weighted and averaged to obtain weighted PPPs for the aggregation level up to GDP (in our example, aggregated levels are Non-alcoholic beverages, Food…). The weights used to aggregate the PPPs in the third stage are the expenditures on the product groups as established in the national accounts. You will find detailed information on the calculation in the “EUROSTAT-OECD Methodological manual on purchasing power parities (PPPs)”, Chapter 12.

3. What are the major uses of PPPs?

The major use of PPPs is as a first step in making inter-country comparisons in real terms of gross domestic product (GDP) and its component expenditures. GDP is the aggregate used most frequently to represent the economic size of countries and, on a per capita basis, the economic well-being of their residents. Calculating PPPs is the first step in the process of converting the level of GDP and its major aggregates, expressed in national currencies, into a common currency to enable these comparisons to be made. There are also other uses and recommendations that can be find in details in the EUROSTAT-OECD Methodological manual on purchasing power parities (PPPs)” Chapter 1, box 1.5

Uses of Purchasing Power Parities (PPPs)

4. What are the products included in the basket of goods and services used for the calculation of PPPs and how many are they?

The basket of goods and services priced for the PPP exercise is a sample of all goods and services covered by GDP. The final product list covers around 3,000 consumer goods and services, 30 occupations in government, 200 types of equipment goods and about 15 construction projects. The large number of products is to enable countries to identify goods and services which are representative of their domestic expenditures.

Relative purchasing power parity: Calculate changes in exchange rate based on inflation in two countries

· the relative change in prices between countries over a period of time determines the change in exchange rates

· if the spot rate between 2 countries starts in equilibrium, any change in the differential rate of inflation between them tends to be offset over the long run by an equal but opposite change in the spot rate

Example 1: 1£=1.6$. US inflation rate is 9%. UK inflation is 5%. What will happen? Calculate the new exchange rate using the following equation.

(US inflation is 4% higher than UK US products are 4% higher than UK US customers convert $ to £ to purchase cheap UK products This buying pressuring of £ and selling pressure of $  will force £ to appreciate until the prices in UK are the same as in US   No benefits for US customers to buy from UK market.)

Math equation: e_f= I_h- I_f or ((1+ I_h)/(1+I_f) -1= e_f;      e_f: change in exchange rate

Answer:

(1+ 9%) /(1+5%) -1 = e_{f =} 4% , and 1£=1.6$, so the new rate of £ =1.6*(1+4%) = 1.66 £/$.

Example 2: 1£=1.6$. US inflation rate is 5%. UK inflation is 9%. What will happen? Calculate the new exchange rate using the PPP equation.

Answer:

e_f = I_h – I_f, I_h= 5%, I_f =9%, so e_f = 5%-9% = -4%, so the old rate is that 1£=1.6$. The new rate should be 4% lower. So new rate is that  1£=1.6*(1-4%) = 1.536$

Example 3: 1£=1.2€. Inflation rate in Germany is 4%. UK inflation is 9%. What will happen? Calculate the new exchange rate using the PPP equation.

Answer:

Home currency is euro and foreign currency is pound. e_f = I_h – I_f, I_h= 4%, I_f =9%, so e_f = 4%-9% = -5%, so the old rate is that 1£=1.2€. The new rate should be 5% lower. So new rate is that  1£=1.2*(1-5%) = 1.14€

HOW TO CALCUALTE PPP 

Step 1

Determine which two currencies you would like to compare for purchasing power parity. The formula for purchasing power parity requires two prices in different currencies to calculate the price ratio:

S (purchase power parity ratio) = Price 1/Price 2

In this case, P1 refers to one price in a specific currency, and P2 refers to another price in a different currency.

For instance, suppose you want to calculate the purchasing price parity between the United States and Mexico. Your comparison prices will be in U.S. dollars and Mexican pesos.

Step 2

Determine which product is commonly available in both the United States and Mexico. For simplicity, we'll compare the price of Coca Cola in both countries. Although comparing one common product is one strategy, economic analysts may also select a group of common products to calculate a more broad measure of purchasing power parity. This group of products is commonly called a basket of goods and may include food staples such as bread, milk and other related items. Although the basket approach may be broader, the single item method helps illustrate the calculation in simpler terms.

Step 3

Research the prices of Coca Cola in Mexico and the United States. The purchasing power parity formula requires you to know the price of the item you are comparing. Assume for this example that a 12-ounce can of Coca Cola costs $1.50 in U.S. dollars and $9 Mexican pesos. Divide the $9 pesos by $1.50. The result is the price ratio for purchasing power parity. To illustrate the calculation refer to the following:

S = P1/P2

S = 9/1.50

S = 6

Step 4

Compare the result of the purchasing power parity to the currency exchange rate between the United States and Mexico. Assume that the exchange rate between the Mexican peso and U.S. dollar is 5.7 pesos for every dollar. Recall that for purchasing power parity to exist, the exchange rate and the purchasing power parity ratio must be equal. The purchasing power parity ratio of 6 and a $5.7 peso per dollar exchange rate between the currencies in Mexico and the United States indicates that the purchasing power of the peso and the dollar are similar but not exact. This means that Mexican and U.S. consumers have similar purchasing power with their respective currencies.

However, if the exchange rate between the dollar and the peso suddenly changed to $17 pesos per dollar and the purchasing power parity ratio remained at 6, the purchasing power parity calculation shows a loss of purchasing power for Mexican consumers relative to the U.S. consumers. ?

----- FROM WWW.SAMPLING.COM

February 11, 2022

The Big Mac Index in 2022

Entertaining

https://fxssi.com/big-mac-index

Price of a Big Mac - Ranked by Country - 2022 (video)

Who hasn't tried or at least heard of a famous Big Mac at McDonald's fast-food restaurants? However, few people know that it gave rise to the so-called Big Mac Index, which compares the value of currencies of different countries.

What is the Big Mac Index?

The Big Mac Index is the price of the burger in various countries that are converted to one currency (such as the US dollar) and used to measure purchasing power parity.

It all started in 1986 when The Economist magazine decided to estimate the currencies' value by country based on the prices of Big Mac at McDonald's fast-food restaurants.

Thus, The Economist introduced a simple indicator of the fundamental value of currencies globally.

What does the Big Mac Index show, and why exactly was it taken as an indicator?

It's pretty simple. Big Mac is the most well-known product in McDonald's' fast-food chain. Besides, the same ingredients are used for Big Mac in any country: meat, bread, cheese, lettuce, onions, etc. Therefore, The Economist experts use Big Mac alone instead of determining the cost of a consumer basket (more complex method) for each country.

Big Mac Index Table as of Q1 2022

The most relevant Big Mac Index so far (as of January 2022) is presented in the table below.

Let's analyze these data a bit.

The Russian ruble exchange rate expressed in the Big Mac Index in January 2022 is 23.24 ruble per dollar.

Considering that the current market rate of the Russian currency is about 77.42 ruble, rather than 23.24 per US dollar, the ruble is undervalued by approximately 70%.

Thus, the Russian ruble is the world’s most undervalued (cheapest) currency according to the Big Mac Index.

In 2019, the Russian ruble was the most undervalued (by 64.5%) currency worldwide.

Big Mac costs $1.86 in Turkish. While the price of the burger in the United States is $5.81, the Turkish currency exchange rate is 4.30 lira per dollar in terms of the Big Mac Index.

However, the lira is cheaper in Forex – about 13.42 lira per US dollar (as of January 2022). Therefore, we can conclude that the market undervalues the Turkish currency by almost 68%.

In the list of the world’s most undervalued currencies, the Russian ruble and the Lebanese pound are accompanied by the Malaysian ringgit (undervalued by 58.92%), Indonesian rupian (undervalued by 59.31%), and the Romanian leu (undervalued by 58.65%). Notably, the currencies of India, Pakistan, the Philippines, and other low-income countries are not in the top five most undervalued currencies in 2022.

As for the most highly valued currencies, the statistics by countries show that the world’s most overvalued (expensive) currency is the francs in Switzerland.

Considering that Big Mac costs 6.98 francs in Switzerland, the USD/CHF rate expressed in the Big Mac Index terms should be 1.12 francs per dollar. However, the value of this pair is currently quoted around 0.93 in Forex, which makes the Swiss currency overvalued by the market by 20.16%.

Norwegian krone overvalued by the market by 10.03%.

According to the Big Mac Index authors, Euro is also undervalued by the market. The average Big Mac price in the Eurozone is $4.95, meaning the currency is undervalued by 14.72%.

Notably, according to the Big Mac Index, all major currency pairs, except the Swiss franc and Norwegian krone, are undervalued against the US dollar.

Can We Use This Knowledge in Trading?

We can hardly do it in the short and medium terms, but the Big Mac Index can serve as a helpful assistant while long-term trading.

For example, it can be used as a filter when opening positions in the Forex market. After all, if the Japanese yen is significantly oversold against the US dollar, traders should refrain from opening long positions on USD/JPY.

We can draw similar conclusions for other Forex currency pairs.

The key thing to remember is that the Big Mac Index is an accurate indicator of the fundamental value of currencies, and traders can benefit from its use in trading.

Big Mac's price is up 40%, and it isn’t a good sign

This famous American burger price is outpacing cost of living, and it’s not a good sign.

Updated Thu, Feb 17 2022

https://www.cnbc.com/select/big-mac-index-what-you-need-to-know/

There are few things that are as synonymous with American culture as the iconic Big Mac burger from McDonald’s. Invented in 1957 by an early McDonald’s franchisee, the Big Mac remains a very popular fast-food item.

And because of its global popularity, The Economist invented the “Big Mac index” in 1986 as a unique way to track the price of the famous sandwich against other currencies. The index incorporates the concept of purchasing-power parity, which is the way to track the strength of an individual currency, and what ‘purchasing power’ it has.

So why does this matter to you? Well the price of a Big Mac has risen a staggering 40% over the last 10 years. And because the price of a Big Mac embodies multiple economic factors including the cost of labor, transportation, food and overall inflation — it leads some to believe the sandwich is one way to understand current inflation rates and purchasing power of the U.S. dollar.

Select analyzed the Big Mac index, what it means for consumers and how you can fight back against the rising costs of everyday items.

The Big Mac index, and what it means for you

The index has been studied by many, including the St. Louis Federal Reserve. It describes the ‘burgernomics’ as “a convenient market basket of goods through which the purchasing power of different currencies can be compared.” The sandwich itself contains several goods and services between the two buns, such as: food prices (obviously), labor, power, transportation and more. And because the sandwich exists in so many places around the world, some look at the burger as a way to gauge purchasing power of different currencies.

While the Big Mac is a tasty sandwich, the index is not a foolproof economic indicator of purchasing-power parity. Diana Furchtgott-Roth, adjunct professor of Economics at George Washington University told Select it’s “junk food economics” for several reasons, because “in a lot of the world Big Macs are not the cheapest food and not aimed at lowest-income residents.” And in some countries, Big Macs are not available at all due to cultural reasons.

Without diving deep into economic theory, the Big Mac index is noteworthy as it demonstrates the staggering inflation we’re experiencing. And in some cases, the sandwich is rising in price faster than several economic measurements. The burger now costs an average of $6.05 in the U.S., a 40% increase over the last 10 years. Here’s how other items and economic factors have fared during the last decade:

The Consumer Price Index has gone up 22%

The cost of living index is up 37%

A barrel of oil is down -21%

Raw coffee is up 12%

The U.S. raw food price index is up a modest 7%

And this trend of consumer goods skyrocketing in price is not only a Big Mac trend. Other goods and services have mirrored the same trend over the last decade, including:

Rent prices are up 40%

Home prices have soared 107%.

Used car prices are up 39%

So what does all of this data mean to you? Well it’s no surprise, life has become increasingly expensive. From Dec. 2020 to Dec. 2021, inflation was at a staggering 7%. And in the last year, the Big Mac sandwich is up an identical 7%. For context, a ‘healthy’ rate of inflation is generally 2-3% year-over-year.

Unfortunately, there’s nothing we can do to control inflation. So if you’re craving a Big Mac, fries and soda, you’ll now be paying between $8-10, depending on where you live. However, there are steps everyone can take to control how inflation impacts your wallet.

Simple ways you can battle inflation of goods

Thomas Racca, manager on the Personal Finance Team at Navy Federal Credit Union told Select a few ways on how everyone can easily fight against inflation on daily purchases, and how to stay on track to accomplish larger financial goals.

Evaluate your budget. If you haven’t adjusted your budget recently, you may have noticed common expenses like fuel and groceries going up. Even if it’s only by a few dollars, adjusting your budget can help you keep track where each dollar is going.

Try a new budgeting technique. There are ample ways to track your spending with a budget. It could be as simple as writing everything down, using an automated budgeting app, or even adjusting how you budget can help you save during inflation.

Reroute some money for a period of time. This suggestion is a bit more risky as it can throw off your monthly budget and should be done in moderation. Racca told Select, “if you created an emergency savings fund before the pandemic, consider using some of that money towards your expenses.” So for the time being, you may consider taking some money out of your emergency fund or not making the same monthly contributions. It may be better to invest this money instead, in index funds for example, where you may get a better return over the long run. But with rising inflation, you may be pressed to unfortunately spend more on the same purchases you’d normally make.

Consider changing your grocery list. If you regularly shop at a higher-end grocery store, it may be helpful to transition to a more budget-conscious store, or even consider buying in bulk. Additionally, take a look at what you buy normally and analyze what has risen in price the most, and consider cutting back on those items. Notably, beef and dairy products have soared by over 13%, according to the Bureau of Labor Statistics.

Bottom line

The Big Mac is just one sign among many that life is getting expensive, fast. And whether you’re buying the iconic sandwich, grocery shopping or even looking for a new home, you’ve likely had some sticker shock. However, there may be light at the end of the tunnel as the Federal Reserve is planning on raising interest rates to quell inflation rates that haven’t been seen in over 40 years.

Part II: International Fisher Effect

7)      International Fisher Effect

Fisher Effect: Nominal interest rate (R) = real interest rate (r) + inflation (I)

By assuming real interest rates in two countries are the same, we conclude that inflation moves along with the nominal interest rate which is observable and reported.

The international Fisher effect (sometimes referred to as Fisher's open hypothesis) is a hypothesis in international finance that suggests differences in nominal interest rates reflect expected changes in the spot exchange rate between countries. The hypothesis specifically states that a spot exchange rate is expected to change equally in the opposite direction of the interest rate differential; thus, the currency of the country with the higher nominal interest rate is expected to depreciate against the currency of the country with the lower nominal interest rate, as higher nominal interest rates reflect an expectation of inflation.

Example

Suppose the current spot exchange rate between the United States and the United Kingdom is 1.4339 GBP/USD. Also suppose the current interest rates are 5 percent in the U.S. and 7 percent in the U.K. What is the expected spot exchange rate 12 months from now according to the international Fisher effect?

Solution: The effect estimates future exchange rates based on the relationship between nominal interest rates. Multiplying the current spot exchange rate by the nominal annual U.S. interest rate and dividing by the nominal annual U.K. interest rate yields the estimate of the spot exchange rate 12 months from now.

$1.4339*(1+5%)/(1+7%) = $1.4071

The expected percentage change in the exchange rate is a depreciation of 1.87% for the GBP (it now only costs $1.4071 to purchase 1 GBP rather than $1.4339), which is consistent with the expectation that the value of the currency in the country with a higher interest rate will depreciate.

https://en.wikipedia.org/wiki/International_Fisher_effect

Equation: International fisher effect: e_f= R_h- R_f or  ((1+ R_h)/(1+R_f) -1= e_f)

Calculator for IFE and relative PPP

Example 4: If the interest rate of US is 10% and that of UK is 5%,  which country’s currency will appreciate, by how much? Imagine 1£=1.6$.

Answer:  

Home currency is $ and foreign currency is €. e_f = R_h – R_f, R_h= 10%, R_f =5%, so e_f = 10%-5% = 5%, so the old rate is that 1£=1.6$. The new rate should be 5% higher. So new rate is that  1£=1.6*(1+5%) = 1.68$

Example 5: If the interest rate of US is 5% and that of UK is 10%, which country’s currency will appreciate, by how much? Imagine 1£=1.6$.

Answer:  

Home currency is $ and foreign currency is £. e_f = R_h – R_f, R_h= 5%, R_f =10%, so e_f = 5%-10% = -5%, so the old rate is that 1£=1.6$. The new rate should be 5% lower. So new rate is that  1£=1.6*(1-5%)  

Homework chapter 8 (due with the Final)

1. If a Big Mac costs $2 in the United States and 300 yen in Japan, what is the estimated exchange rate of yen/ $ as hypothesized by the Big Mac index? (Answer: 150 yen /$)

2. Interest rates are currently 2% in the US and 3% in Germany.  The current spot rate between the € and $ is $1.5/€. What is the expected spot rate in one year if the international Fisher effect holds? (Answer:1.4854$/€)

3. You find that inflation in Japan just reduced to 1.3%, while in US, the inflation rate just increased to 3%. You also observed that the spot rate for yen was $0.0075 before the adjustment by economists. With new inflation released, the demand and supply for currencies will drive the exchange rate to a new equilibrium price.

Question: Use PPP to estimate the new exchange rate for yen.  (Answer:0.0076$/yen)

4. You observed the nominal interest rate (annual) just increased to 6% in China, while the nominal annual interest rate is 3% in US. The spot rate for Chinese Yuan is $6.8 before the adjustment.

Question: Use IFE to estimate the new spot rate for Chinese Yuan after the interest rate changes. (Answer:6.6075$/RMB. Note: Dollar is more valuable. In this example, RMB becomes the more valuable currency. Sorry for the mistake)

5. How would you define the Big Mac Index and what is the reasoning behind using the Big Mac as a metric for determining currency value?

6. According to OECD, What are the products included in the basket of goods and services used for the calculation of PPPs and how many are they?

https://www.oecd.org/fr/sdd/purchasingpowerparities-frequentlyaskedquestionsfaqs.htm

ChatGPT is Popular. How AI and Web3 are Combined? (FYI)

https://medium.com/oneblock-community/chatgpt-is-popular-how-ai-and-web3-are-combined-444cff31e870

The Combination of AI+Web3

PWC predicts that AI will contribute $15.7 trillion to the global economy by 2030, resulting in a 14% increase in global GDP. With the development of AI technology, AI will not only be noticed as a separate technology, the combination of AI and other technologies is gradually becoming a general trend. It is constantly influencing other existing technologies and industries, and Web3 is no exception. What role will AI play in the Web3 decentralized world?

Why Should AI be Combined with Web3?

From the perspective of the development of AI technology, the decentralized nature of Web3 provides a guarantee for its long-term development. The generation of AI models requires a large database, and most users who provide data not only fail to get paid for AI products, but are ignored. Web giants have monopolized AI-generated content and profited from it.

In Web3, creators can have full control over their data, AI models and digital assets. Users can repurpose or share data as they wish. AI models can be trained according to the personal knowledge and experience of the creator.

Application of AI in Combination with Web3

In the long term, the future of Web3 is to combine it with AI technologies, including Machine Learning (ML), which can be applied to different stacks of Web3. In particular:

AI + Public Chain

The public chain mainly includes different components such as consensus layer, data layer, incentive layer and contract. In the consensus mechanism layer, AI can increase blockchain security by quickly mining data and predicting behavior to detect fraud and stop attacks, increasing blockchain security. In addition, ML predictions can be used to trade to create a scalable consensus protocol. At the same time, the chain quickly aggregates global data, allowing AI to perform machine learning at a faster speed and larger data scale, and allowing AI models to grow rapidly.

2. AI + Protocol

Web3 can integrate ML capabilities by using smart contracts and protocols. For example, AI can determine your DeFi credit score by browsing your online data, which will be able to predict as accurately as possible how likely you are to repay your debt. If such AI is successfully deployed as a protocol, it has the potential to double the scale of DeFi. Because it will solve two major problems with traditional financing: intermediaries and collateral.

3. AI + DApp

This application trend is more prominent in NFT. For example, by adding ML functionality to NFTs, NFTs will transform from static images into artefacts with intelligent behavior. These NFTs are able to dynamically adjust based on their owner’s profile. In addition, AI is used to build games that can change the scene, difficulty level and tasks depending on the player’s mood.

Admittedly, we also need to face the current problem of AI. That is, how to achieve meaningful AI and Web3 integration? It effectively cleans up the centralization issues in AI and creates a more secure and fair network, which requires the joint efforts of developers in Web3.

AI Empowers Metaverse

AI can greatly expand the boundaries of existing Web3 in many aspects such as on-chain data analysis, security auditing, and privacy protection. Among them, the current hot Metaverse is an application example supported by the development of AI technology. For example, Sony recently entered the Metaverse field with a new wearable motion tracking system called Mocopi. The system will allow users to use full-body movement to create videos of their avatars. The development of AI allows us to see more possibilities of the decentralized Metaverse.

AI + Virtual Man

At present, many companies use the method to make extreme expressions on light field equipment and film them for K-frames, which is a very time-consuming and labor-intensive step, but it is the only way to avoid the “Valley of Terror” effect. However, AI can use machine learning to achieve complex simulation and deformation, refining 3D facial models and motion simulation to help character creation in time. Digital humans in the Metaverse world can transform from static images to intelligent figures with dialogue, real-time reactions and feedback.

2. AI + Virtual Scenes

With the advent of the digital era, the demand for virtual scenes is increasing. It is no longer possible to design every inch of the virtual world in a purely manual way, as thousands of square kilometres of virtual worlds need to be created. The AI-driven art tools don’t need to manually adjust parameters. They can quickly develop virtual scenes and simulate scene dynamics in real time, facilitating the creation of the vibrant Metaverse world.

3. AI + Virtual Items

With AI-driven functions, complex processes such as modeling and replicating are no longer required. Real-world objects are reconstructed in three dimensions using visualization and 3D scanning. The simple operation can not only release the creative potential of designers and creators, but also become a good helper for users in the Metaverse world. For example, scan objects such as ornaments, books and other objects in life into 3D models.

Chapter 11: Managing Transaction Exposure

Chapter 11 PPT

What Is Transaction Exposure?

Transaction exposure is the level of uncertainty businesses involved in international trade face. Specifically, it is the risk that currency exchange rates will fluctuate after a firm has already undertaken a financial obligation. A high level of vulnerability to shifting exchange rates can lead to major capital losses for these international businesses. One way that firms can limit their exposure to changes in the exchange rate is to implement a hedging strategy. Through hedging using forward rates, they may lock in a favorable rate of currency exchange and avoid exposure to risk.

Risks of Transaction Exposure

The danger of transaction exposure is typically one-sided. Only the business that completes a transaction in a foreign currency may feel the vulnerability. The entity that is receiving or paying a bill using its home currency is not subjected to the same risk. Usually, the buyer agrees to buy the product using foreign money. If this is the case, the hazard comes it that foreign currency should appreciate, costing the buyer to spend more than they had budgeted for the goods.

Key Takeaways

• The level of risk companies involved in international trade face.
• A high level of exposure to fluctuating exchange rates can lead to major losses for firms.
• The risk of transaction exposure is typically one-sided.

Real World Example of Transaction Exposure

Suppose that a United States-based company is looking to purchase a product from a company in Germany. The American company agrees to negotiate the deal and pay for the goods using the German company's currency, the euro. Assume that when the U.S. firm begins the process of negotiation, the value of the euro/dollar exchange is a 1-to-1.5 ratio. This rate of exchange equates to one euro being equivalent to 1.50 U.S. dollars (USD).

Once the agreement is complete, the sale might not take place immediately. Meanwhile, the exchange rate may change before the sale is final. This risk of change is transaction exposure. While it is possible that the values of the dollar and the euro may not change, it is also possible that the rates could become more or less favorable for the U.S. company, depending on factors affecting the currency marketplace. More or less favorable rates could result in changes to the exchange rate ratio, such as a more favorable 1-to-1.25 rate or a less favorable 1-to-2 rate.

Regardless of the change in the value of the dollar relative to the euro, the Belgian company experiences no transaction exposure because the deal took place in its local currency. The Belgian company is not affected if it costs the U.S. company more dollars to complete the transaction because the price was set as an amount in euros as dictated by the sales agreement.

(https://www.investopedia.com/terms/t/transactionexposure.asp)

Types of foreign exchange exposure

Transaction Exposure – measures changes in the value of outstanding financial obligations incurred prior to a change in exchange rates but not to be settled until after the exchange rate changes

Operating (Economic)Exposure – also called economic exposure, measures the change in the present value of the firm resulting from any change in expected future operating cash flows caused by an unexpected change in exchange rates

Translation Exposure – also called accounting exposure, is the potential for accounting derived changes in owner’s equity to occur because of the need to “translate” financial statements of foreign subsidiaries into a single reporting currency for consolidated financial statements

Tax Exposure – the tax consequence of foreign exchange exposure varies by country, however as a general rule only realized foreign losses are deductible for purposes of calculating income taxes

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What is transaction exposure

Example of transaction exposure

— Purchasing or selling on credit goods or services when prices are stated in foreign currencies

— Borrowing or lending funds when repayment is to be made in a foreign currency

— Being a party to an unperformed forward contract and

— Otherwise acquiring assets or incurring liabilities denominated in foreign currencies

How to reduce the transaction exposure risk?

1. 1. Forward (Future) Market Hedge

2.      2. Money Market Hedge

3.      3. Options Market Hedge: call and put

·         To hedge a foreign currency payable buy calls on the currency.

·         To hedge a foreign currency receivable buy puts on the currency.

Exercise 1:  Hedging currency payable 

A U.S.–based importer of Italian bicycles

·         In one year owes €100,000 to an Italian supplier.

·         The spot exchange rate is $1.18 = €1.00

·         The one year forward rate is $1.20 = €1.00

·         The one-year interest rate in Italy is i_€ = 5%

·         The one-year interest rate in US is i_$ = 8%

—  Call option exercise price is $1.2/ € with premium of $0.03.

How to hedge the currency payable risk

a.       With forward contract?

b.      With money market?

c.       With call option? Can we use put option?

Answer: Need €100,000 one year from now to pay the payable and plan to hedge the risk of overpaying for the payable one year from now.

1)      With forward contract:

Buy the one year forward contract @$1.20 = €1.00. So need 100,000€*1.2$/€ = $120,000 one year from now. So the company needs to come up with $120k for this payable obligation.

2)      With money market:

Need €100,000 one year from now, and the rate is 5% in Italy, so can deposit €100,000/(1+5%) = €95238.10 now.

For this purpose, need to convert from € to $:  €95238.10*$1.18 /€=$112380.98.

Imagine the company does not have that much of cash and it borrows @8%. So one year from now, the total $ required to pay back to the banks is: $112380.98 *(1+8%) = $121371.43.  So the company needs to come up with $121371.43for this payable obligation.

Summary: Borrow $112380.98 @8% and convert to €95238.10 at present; One year later, the company can get the €100,000 and needs to pay back to the bank a total of $121371.43.

3)      With call option:

Imagine the rate one year later is $1.25/€. So should exercise the call option and the cost one year later should be

€100,000 *(1.2+0.03) $/€ = $123000, lower than the actual cost without the call option. So $123k is the most that the company needs to prepare for this payable obligation. USING CALL OPTION, THE ACTAUL PAYMENT COULD BE A LOT LESS, DEPENDING ON THE ACTAUL EXCHANGE RATE ONE YEAT LATER.

Exercise 2:  Hedging currency receivable (refer to the PPT of chapter 11 for answers)

·         A U.S.–based exporter of US bicycles to Swiss distributors

·         In 6 months receive SF200,000 from an Swiss distributor

·         The spot exchange rate is $0.71 = SF1.00

·         The 6 month forward rate is $0.71 = SF1.00

·         The one-year interest rate in Swiss is i_SF = 5%

·         The one-year interest rate in US is i_$ = 8%

·         Put option exercise price is $0.72/ SF with premium of $0.02.

How to hedge the currency payable risk

a.       With forward contract?

b.      With money market?

c.       With call option? Can we use put option?

Answer: Will receive SF200000 six month from now as receivable and plan to hedge the risk of losing value in the receivable six month from now.

1)      With forward contract:

Sell the one year forward contract @$0.71 = €1.00. So get 200,000SF * 0.71$/SF = $142,000 six month from now. So the company could receive $142k with forward contract.

2)      With money market:

Get SF200000 six month from now, and the rate is 5% in Swiss (or 2.5% for six months), so can borrow SF 200,000/(1+2.5%) = SF195121.95 now.

And can convert @ spot rate to SF195121.95 * 0.71$/SF = $138536.59. This is the money you have now.

So six month from now, the total you have in the bank is: $138536.59*(1+4%) = $144078.05. And you can use the SF200000 receivable to pay back the loan.  So the company could receive $144078.05 with money market.

Summary: Borrow SF195121.95 @5% at present; six month later, the company can get the SF200,000 receivable and payback the loan. Meanwhile, convert the borrowed SF to $ and deposit in US banks @ 8%. 

3)      With put option: With SF200000 received six month later, need to converting it back to $. So can buy put option which allows to sell SF for $ at the exercise price $0.72/ SF.

Imagine the rate one year later is $0.66/ SF. So should exercise the put option and the  total amount of $ six month later should be SF 200,000 *(0.72-0.02) $/ SF = $140000.  So $140k is the LEAST that the company CAN OBTAIN. USING PUT OPTION, THE ACTAUL INCOME COULD BE A LOT MORE, DEPENDING ON THE ACTAUL EXCHANGE RATE ONE YEAT LATER.

Homework of Chapter 11 (due with final)

1. Suppose that your company will be billed £10 million payable in one year.  The money market interest rates and foreign exchange rates are given as follows. How to hedge the risk for parable using forward contract. How to hedge the risk using money market? How to hedge risk using call option?

Call option exercise price The U.S. one-year interest rate:	$1.46/ € with  premium of $0.03 6.10% per annum
The U.K. one-year interest rate:	9.00% per annum
The spot exchange rate:	$1.50/£
The one-year forward exchange rate	$1.46/£

(Answer: With forward contract: $14.6 million; Money market: $14.6million; Call option: $14.9million)

2. Suppose that your company will be billed £10 million receivable in one year.  The money market interest rates and foreign exchange rates are given as follows. How to hedge the risk for parable using forward contract. How to hedge the risk using money market? How to hedge risk using put option?

put option exercise price The U.S. one-year interest rate:	$1.46/ € with  premium of $0.03 6.10% per annum
The U.K. one-year interest rate:	9.00% per annum
The spot exchange rate:	$1.50/£
The one-year forward exchange rate	$1.46/£

(Answer: With forward contract: $14.6 million; Money market: $14.6million; Put option: $14.3million)

Question 3: Multiple Choice Questions (hint: each question has a hidden answer)

1. What is the primary purpose of hedging receivables and payables?

a) To eliminate exchange rate risk

b) To eliminate interest rate risk

c) To generate profits

d) To reduce tax liabilities

Answer: a) To eliminate exchange rate risk

2. Which of the following is NOT a method of hedging receivables and payables?

a) Forward contracts

b) Options contracts

c) Future contacts

d) Money market

wer: c) Spot contracts

3. What is a receivable?

a) A payment that is owed to a company by its customers

b) A payment that a company owes to its suppliers

c) A payment that a company makes to its shareholders

d) A payment that a company makes to its employees

Answer: a) A payment that is owed to a company by its customers

4. What is the primary risk associated with receivables in international finance?

a) Credit risk

b) Exchange rate risk

c) Interest rate risk

d) Regulatory risk

Answer: b) Exchange rate risk

5. What is a payable?

a) A payment that a company owes to its suppliers

b) A payment that is owed to a company by its customers

c) A payment that a company makes to its shareholders

d) A payment that a company makes to its employees

Answer: a) A payment that a company owes to its suppliers

6. Which of the following is a method of hedging payables in international finance using call options?

a) Buying a call option to sell the underlying currency

b) Buying a call option to buy the underlying currency

c) Buying a put option to sell the underlying currency

d) Buying a put option to buy the underlying currency

Answer: b) Buying a call option to buy the underlying currency

7. Which of the following is a benefit of using call options to hedge payables?

a) Unlimited potential gains

b) Limited potential losses

c) Guaranteed fixed exchange rate

d) No premium payment required

Answer: b) Limited potential losses.

8. Which of the following is a method of hedging receivables in international finance using put options?

a) Buying a call option to sell the underlying currency

b) Buying a call option to buy the underlying currency

c) Buying a put option to sell the underlying currency

d) Buying a put option to buy the underlying currency

Answer: d) Buying a put option to buy the underlying currency

9. Which of the following is a benefit of using put options to hedge receivables?

a) Unlimited upside potential

b) Limited downside risk

c) Fixed exchange rate

d) No premium payment required

Answer: b) Limited downside risk

10. Which of the following is a method of hedging payables in international finance using a forward contract?

a) Selling the underlying currency forward

b) Buying the underlying currency forward

c) Buying a put option on the underlying currency

d) Selling a call option on the underlying currency

Answer: b) Buying the underlying currency forward

11. Which of the following is a benefit of using a forward contract to hedge payables?

a) No premium payment required

b) Unlimited upside potential

c) Fixed exchange rate

d) Limited downside risk

Answer: c) Fixed exchange rate

12. Which of the following is a disadvantage of using a forward contract to hedge payables?

a) Requires payment of a premium

b) Limited upside potential

c) Unlimited downside risk

d) Exposure to counterparty risk

Answer: d) Exposure to counterparty risk

Gold prices could notch an all-time high soon — and stay there

PUBLISHED WED, MAR 22 202312:33 AM EDTUPDATED THU, MAR 23 20235:01 AM EDT

Lee Ying Shan @LEEYINGSHAN

https://www.cnbc.com/2023/03/22/gold-price-could-hit-high-amid-svb-credit-suisse-bank-problems.html

KEY POINTS

· Gold prices have more room to rise and could go as high as $2,600 per ounce.

· Investors have been turning to gold and Treasurys after the collapse of Silicon Valley Bank and Credit Suisse’s struggles.

· Gold’s all-time high was $2,075 in August 2020, according to Refinitiv data.

Gold prices have more room to run as global banks struggle and the U.S. Federal Reserve renders another interest rate decision, potentially breaking all-time highs — and staying there.

“A sooner Fed pivot on rate hikes will likely cause another gold price surge due to a potential further decline in the U.S. dollar and bond yields,” said Tina Teng from financial services company CMC Markets. She expects gold will trade between $2,500 to $2,600 an ounce.

Gold is trading at $1,940.68 per ounce. On Monday, it breached $2,000 to strike its highest since March 2022. Gold has risen around 10% since early March when SVB was hit by a bank run.

Gold’s all-time high was $2,075 in August 2020, according to Refinitiv data. Demand from central banks will likely keep wind in its sails.

“Continued central bank buying of gold bodes well for long-term prices,” said CEO Randy Smallwood of Wheaton Precious Metals, a precious metals streaming company.

I think it’s very plausible that we see a strong performance in gold over the coming months. The stars appear to be aligning for gold which could see it break new highs before long.

Demand for gold skyrocketed to an 11-year high in 2022, owing to “colossal central bank purchases,” according to the World Gold Council. Central banks bought a 55-year high of 1,136 tons of gold last year.

Fitch: Gold prices will stay at highs

In late March, Fitch Solutions predicted that gold would notch a high of $2,075 “in the coming weeks.” The firm based that outlook on “global financial instability,” adding that it expects gold to “remain elevated in the coming years compared to pre-Covid levels.”

Gold prices soar amid banking turmoil

Craig Erlam, a senior market analyst at foreign exchange company Oanda, agrees with Fitch’s buoyant outlook.

“I think it’s very plausible that we see a strong performance in gold over the coming months. The stars appear to be aligning for gold which could see it break new highs before long,” he said.

“Interest rates are at or near their peak, cuts are now being priced in sooner than anticipated on the back of recent developments in the banking sector,” said Erlam, who added that he thinks that dynamic will boost gold demand, even if it coincides with a softer dollar.

Fed’s next moves

Investors are closely watching the Federal Reserve’s next moves and their impact on gold prices.

The Fed began their two-day meeting on Tuesday, where it’s widely expected to approve a 25 basis point rate hike Wednesday, though predictions vary among analysts.

“Overall, the Fed will have to choose between higher inflation or a recession, and either outcome is bullish for gold,” said Nicky Shiels, head of metals strategy at precious metals firm MKS Pamp. She forecasts gold to extend to $2,200 per ounce.

A weakening of the dollar may support gold prices, according to HSBC’s chief precious metals analyst James Steel, who expects a 25 basis point hike from the Fed.

Gold and the greenback

“What we saw earlier [last] week was the simultaneous events of both gold and the dollar. And that’s quite unusual,” Steel said, referring to the rise in gold prices and the dollar last week.

There’s usually an inverse relationship between gold prices and the U.S. dollar. But investors tend to like the perceived safety of U.S. Treasurys and gold simultaneously during periods of financial stress.

“This scenario does not happen often but when it does — it is always a sign of elevated investor concerns,” Steel said.

Term Project Review on 4/10/2023

Class Video Word Session

Class Video Excel Session Part I (Thanks, Maggie)

Class Video Excel Session Part II (Thanks, Maggie)

Chapter 16 – Country Risk Analysis

Ppt

Example of Countries with Low Political Risk

Country	Continent	Population	Political Risk Level	Reasons for Low Political Risk
Iceland	Europe	387,758	Very Low	· Stable democratic institutions · strong rule of law and protection of property right · low corruption levels · high respect for human rights · low risk of armed conflicts or terrorism · high economic development and social welfare · peaceful political environment with low levels of political instability or social unrest.
Switzerland	Europe	8.8 million	Very Low	Same as above
Norway	Europe	5.5 million	Very Low	Same as above
Finland	Europe	5.5 million	Very Low	Same as above
Sweden	Europe	10.3 million	Very Low	Same as above
New Zealand	Oceania	4.9 million	Very Low	Same as above
Denmark	Europe	5.85 million	Very Low	Same as above
Canada	North America	38.66 million	Very Low	Same as above
Australia	Oceania	26.3 million	Very Low	Same as above
Luxembourg	Europe	654,328	Very Low	Same as above

https://www.theglobaleconomy.com/rankings/political_risk_short_term/

https://willistowerswatson.turtl.co/story/political-risk-index-winter-2022-2023-gated/page/12/1

Examples of Countries with High Political Risk

Country	Continent	Population	Political Risk Level	Reasons for High Political Risk
Afghanistan	Asia	41 million	High	· Ongoing armed conflicts with various insurgent groups · political instability due to frequent changes in government · terrorism by extremist groups, widespread corruption and bribery · weak governance with lack of effective law enforcement and judicial system · lack of rule of law and protection of property rights · challenges in implementing reforms and maintaining social stability.
Syria	Asia	18.6 million	High	o Ongoing civil war with multiple factions and foreign interventions o political instability due to the complex and protracted conflict o terrorism by various extremist groups o widespread human rights violations o sanctions imposed by the international community o challenges in rebuilding and stabilizing the country
Yemen	Asia	31.6 million	High	Ø Ongoing armed conflicts between government forces and rebel groups Ø political instability with multiple factions vying for power Ø humanitarian crisis with widespread poverty and lack of basic services Ø terrorism by extremist groups Ø lack of rule of law and weak governance Ø challenges in achieving political reconciliation and peace building.
Venezuela	South America	28.2 million	High	v Economic crisis with hyperinflation and severe shortages of basic goods v political instability with the ongoing power struggle between the government and opposition v corruption and embezzlement of state funds, erosion of democratic institutions and rule of law v social unrest and protests, sanctions imposed by the international community v challenges in achieving economic and political stability.
Democratic Republic of Congo	Africa	97.1 million	High	ü Ongoing armed conflicts with various rebel groups and militias ü political instability with frequent changes in government ü widespread corruption and embezzlement of state funds ü human rights violations ü weak governance with lack of effective law enforcement and judicial system ü challenges in achieving peace, stability, and development.
Somalia	Africa	17.1 million	High	· Ongoing armed conflicts between government forces and various insurgent groups · political instability with lack of effective central government · terrorism and piracy in the coastal regions · lack of effective law enforcement and judicial system · lack of basic infrastructure and services, including education and healthcare · challenges in achieving political reconciliation and state-building.
South Sudan	Africa	11.6 million	High	o Ongoing armed conflicts between government forces and rebel groups o political instability with multiple factions vying for power o humanitarian crisis with widespread displacement and food insecurity o lack of effective governance and state institutions o human rights violations o challenges in achieving political stability, peace, and development.
Libya	Africa	7.1 million	High	Political instability with multiple competing governments and armed factions armed conflicts and terrorism by various groups lack of effective government institutions and rule of law security challenges with widespread violence and lawlessness economic challenges with dependence on oil revenues challenges in achieving political reconciliation and stability.
Zimbabwe	Africa	15.5 million	High	Ø Economic challenges with hyperinflation and unemployment Ø political instability with lack of effective governance Ø corruption and embezzlement of state funds Ø erosion of democratic institutions and human rights Ø lack of rule of law and protection of property rights Ø social unrest and protests Ø challenges in achieving economic recovery

https://www.theglobaleconomy.com/rankings/political_risk_short_term/

https://willistowerswatson.turtl.co/story/political-risk-index-winter-2022-2023-gated/page/12/1

Chapter 18 Long Term Debt Financing - Interest rate swap, currency swap

ppt

Intro:

•         All firms—domestic or multinational, small or large, leveraged, or unleveraged—are sensitive to interest rate movements in one way or another.

•         The single largest interest rate risk of the nonfinancial firm (our focus in this discussion) is debt service

–        The multicurrency dimension of interest rate risk for the MNE is a complicating concern.

•         The second most prevalent source of interest rate risk for the MNE lies in its portfolio holdings of interest-sensitive securities

 Interest Rate Swap Explained

https://www.youtube.com/watch?v=JIdcips9vPU

Interest rate swap 1 | Finance & Capital Markets | Khan Academy

Interest rate swap 2 | Finance & Capital Markets | Khan Academy

Example:  Consider a firm facing three debt strategies

– Strategy #1: Borrow $1 million for 3 years at a fixed rate

– Strategy #2: Borrow $1 million for 3 years at a floating rate, LIBOR + 2% to be reset annually (LIBOR: London Interbank Offered Rate,)

– Strategy #3: Borrow $1 million for 1 year at a fixed rate, then renew the credit annually

– Although the lowest cost of funds is always a major criterion, it is not the only one

• Strategy #1 assures itself of funding at a known rate for the three years

– Sacrifices the ability to enjoy a fall in future interest rates for the security of a fixed rate of interest should future interest rates rise

• Strategy #2 offers what #1 didn’t, flexibility (and, therefore, repricing risk)

– It too assures funding for the three years but offersrepricing risk when LIBOR changes

– Eliminates credit risk as its spread remains fixed

• Strategy #3 offers more flexibility but more risk;

– In the second year the firm faces repricing and credit risk, thus the funds are not guaranteed for the three years and neither is the price

– Also, firm is borrowing on the “short-end” of the yield curve which is typically upward sloping—hence, the firm likely borrows at a lower rate than in Strategy #1

Volatility, however, is far greater on the short-end than on the long-end of the yield curve.

What is interest rate swap?

Swaps are contractual agreements to exchange or swap a series of cash flows

– Whereas a forward rate agreement or currency forward leads to the exchange of cash flows on just one future date, swaps lead to cash flow exchanges on several future dates

• If the agreement is to swap interest payments—say, fixed for a floating—it is termed an interest rate swap

– Most commonly, interest rate swaps are associated with a debt service, such as the floating-rate loan described earlier

– An agreement between two parties to exchange fixed-rate for floating-rate financial obligations is often termed a plain vanilla swap

– This type of swap forms the largest single financial derivative market in the world.

Why Interest-rate Swaps Exist

• If company A (B) wants a floating- (fixed-) rate loan, why doesn’t it just do it from the start? An explanation commonly put forward is comparative advantage!

• Example: Suppose that two companies, A and B, both wish to borrow $10MM for 5 years and have been offered the following rates: 

Fixed         Floating

Company A      10%       6 month LIBOR+0.3%

Company B      11.2%     6month LIBOR+1.0%

Note:

· Company A anticipates the interest rates to fall in the future and prefers a floating rate loan. However, company A can get a better deal in a fixed rate loan.

· On the contrary, company B anticipates the interest rates to rise and therefore prefers a fixed rate loan. Company B’s comparative advantage is in getting a floating rate loan.

· So both companies could be better off with a interest rate swap contract.

– The difference between the two fixed rates (1.2%) is greater than the difference between the two floating rates (0.7%)

• Company B has a comparative advantage in floating-rate markets

• Company A has a comparative advantage in fixed-rate markets

• In fact, the combined savings for both firms is 1.2% - 0.70% = 0.50%

In class exercise

Solution:

A: Receive fixed rate 10.5% from B, pay LIBOR + 0.55% to B, and pay 10% to bank

è Final outcome: A could pay the debt at 10% interest rate to the bank with the10.5% interest received from Bè leaving A with 0.5% under A’s control.

è Since A needs to pay B at LIBOR + 0.55% and A has kept 0.5% previously

è A’s net result = LIBOR + 0.55% - 0.5% = LIBOR + 0.05% = LIBOR + 0.05%

è A anticipates the rates to go down and prefers to pay at a flexible rate.

è Eventually, A gets LIBOR + 0.05%, better than the rate A could obtain from the bank directly which is LIBOR + 0.3%, so A would benefit from this interest rate swap deal.

 B: Receive LIBOR + 0.55% from A, pay 10.5% to A, and pay LIBOR + 1% to bank

è Final outcome: B could pay the debt at LIBOR + 1% interest rate to the bank with the LIBOR + 0.55% interest received from Aè leaving B with -0.45%.

è Since B needs to pay A at 10.5% and B still have -0.45% debt previously

è B’s net result = 10.5% + 0.45% = 10.95%

è B anticipates the rates to go up and prefers to pay at a fixed rate.

è Eventually, B gets 10.95%, better than the rate B could obtain from the bank directly which is 11.2%, so B would benefit from this interest rate swap deal.

Plain vanilla swap: An agreement between two parties to exchange fixed-rate for floating-rate financial obligations 

How Do Currency Swaps Work?

By CORY MITCHELL Updated September 22, 2021, Reviewed by GORDON SCOTT

https://www.investopedia.com/ask/answers/042315/how-do-currency-swaps-work.asp

What Is a Currency Swap?

A currency swap is a transaction in which two parties exchange an equivalent amount of money with each other but in different currencies. The parties are essentially loaning each other money and will repay the amounts at a specified date and exchange rate. The purpose could be to hedge exposure to exchange-rate risk, to speculate on the direction of a currency, or to reduce the cost of borrowing in a foreign currency.

The parties involved in currency swaps are usually financial institutions, trading on their own or on behalf of a non-financial corporation. Currency swaps and FX forwards now account for a majority of the daily transactions in global currency markets, according to the Bank for International Settlements.

KEY TAKEAWAYS

· Two parties exchange equivalent amounts of two different currencies and trade back at a later specified date.

· Currency swaps are often offsetting loans, and the two sides often pay each other interest on amounts exchanged.

· Financial institutions conduct most of the FX swaps, often on behalf of a non-financial corporation.

· Swaps can be used to hedge against exchange-rate risk, speculate on currency moves, and borrow foreign exchange at lower interest rates.

How a Currency Swap Works

In a currency swap, or FX swap, the counter-parties exchange given amounts in the two currencies. For example, one party might receive 100 million British pounds (GBP), while the other receives $125 million. This implies a GBP/USD exchange rate of 1.25. At the end of the agreement, they will swap again at either the original exchange rate or another pre-agreed rate, closing out the deal.

FX Swaps and Exchange Rates

Swaps can last for years, depending on the individual agreement, so the spot market's exchange rate between the two currencies in question can change dramatically during the life of the trade. This is one of the reasons institutions use currency swaps. They know exactly how much money they will receive and have to pay back in the future. If they need to borrow money in a particular currency, and they expect that currency to strengthen significantly in the coming years, a swap will help limit their cost in repaying that borrowed currency.

FX Swaps and Cross Currency Swaps

A currency swap is often referred to as a cross-currency swap, and for all practical purposes, the two are basically the same. But there can be slight differences. Technically, a cross-currency swap is the same as an FX swap, except the two parties also exchange interest payments on the loans during the life of the swap, as well as the principal amounts at the beginning and end. FX swaps can also involve interest payments, but not all do.

There are a number of ways interest can be paid. Both parties can pay a fixed or floating rate, or one party may pay a floating rate while the other pays a fixed.

In addition to hedging exchange-rate risk, this type of swap often helps borrowers obtain lower interest rates than they could get if they needed to borrow directly in a foreign market.

Real-World Example

Consider a company that is holding U.S. dollars and needs British pounds to fund a new operation in Britain. Meanwhile, a British company needs U.S. dollars for an investment in the U.S. The two seek each other out through their banks and come to an agreement where they both get the cash they want without having to go to a foreign bank to get a loan, which would likely involve higher interest rates and increase their debt loads. Currency swaps don't need to appear on a company's balance sheet, while a loan would.

What Are the Pros and Cons of a Currency Swap?

Peter Hann, Last Modified Date: March 06, 2022

https://www.smartcapitalmind.com/what-are-the-pros-and-cons-of-a-currency-swap.htm#:~:text=In%20the%20longer%20term%2C%20where,might%20default%20on%20the%20arrangement.

A currency swap occurs when two parties agree to exchange the principal and interest of a loan in one currency for the principal and interest of a loan in another currency. The intention of the swap is to hedge against currency fluctuations by reducing the exposure to the other currency and increasing the certainty of future cash flows. An enterprise might also achieve a lower rate of interest by looking for a low-interest loan in another currency and engaging in a currency swap. The costs involved in arranging the transaction might be a disadvantage, and as with other similar transactions, there also is a risk that the other party to the swap might default.

A structure often used in a currency swap is including only the principal of the loan in the arrangement. The parties agree to swap the principal of their loans at a specified time in the future at a specified rate. Alternatively, the exchange of the principal of the loans might be combined with an interest rate swap, whereby the parties would also swap the streams of interest on the loans.

In some cases, the currency swap would relate only to the interest on the loans and not the principal. The two interest streams would be swapped over the life of the agreement. These interest streams are in different currencies, so the payments generally would be made by each party in full, rather than being netted off into one payment as might occur if only one currency is involved.

The advantage of currency swaps is that they bring together two parties who each have an advantage in a particular market. The arrangement enables each party to exploit a comparative advantage. For example, a domestic company might be able to borrow on more favorable terms than a foreign company in a particular country. It therefore would make sense for the foreign company entering that market to look for a currency swap.

Costs that might arise for an enterprise looking for a foreign currency swap include the expense of finding a willing counterparty. This might be done through the services of an intermediary or by direct negotiation with the other party. The process might be expensive in terms of fees charged by an intermediary or the cost of management time in negotiation. There also will be legal fees for drawing up the currency swap agreement.

The expenses of setting up a currency swap might make it unattractive as a hedging mechanism against currency movements in the short term. In the longer term, where there is increased risk, the swap might be cost effective in comparison with other types of derivative. A disadvantage is that, in any such arrangement, there is a risk that the other party to the contract might default on the arrangement.

Homework of chapter 18 (due with final)

1. How did Goldman Sacks help Greece to cover its debt using currency swap? (Hint: Goldman Sachs helped the Greek government to mask the true extent of its deficit with the help of a derivatives deal (Goldman Sachs arranged a secret loan of 2.8 billion euros for Greece, disguised as an off-the-books “cross-currency swap”.—a complicated transaction in which Greece's foreign-currency debt was converted into a domestic-currency obligation using a fictitious market exchange rate.) that legally circumvented the EU Maastricht deficit rules. At some point the so-called cross currency swaps will mature, and swell the country's already bloated deficit https://www.thenation.com/article/archive/goldmans-greek-gambit/)

2. What are the pros and cons associated with establishing a currency swap?

3. Explain what is an interest rate swap using an example.

4. Company AAA will borrow $1,000,000 for ten years at a floating rate. Company BBB will borrow for ten years at a fixed rate for $1,000,000. Refer to the following for details.

		Fixed-Rate Borrowing Cost	Floating-Rate Borrowing Cost
	Company AAA	10%	LIBOR
	Company BBB	12%	LIBOR + 1.5%
Note: · Company AAA anticipates the interest rates to fall in the future and prefers a floating rate loan. However, company AAA can get a better deal in a fixed rate loan. · On the contrary, company BBB anticipates the interest rates to rise and therefore prefers a fixed rate loan. Company BBB’s comparative advantage is in getting a floating rate loan. · So both companies could be better off with a interest rate swap contract. Assume that a swap bank help the two parties. 1 According to the swap contract, Firm BBB will pay the swap bank on $1,000,000 at a fixed rate of 10.30% 2 The swap bank will pay firm BBB on $1,000,000 at the floating rate of (LIBOR - 0.15%). 3 Firm AAA needs to pay the swap bank on $1,000,000 at the floating rate of (LIBOR - 0.15%); 4 The swap bank will pay firm AAA on $10,000,000 at a fixed rate of 9.90%. Please answer the following questions. · Show the value of this swap to firm AAA? (answer: Firm AAA can save $500 each year) · Show the value of this swap to firm BBB? ( answer: Firm BBB will save $500 per year) · Show the value of the swap to the swap bank. (answer: The swap bank can earn $4,000 each year)

Hint: Just write down all relevant transactions for each player, and sum them up. For example, AAA pays 10% and LIBOR-0.15%, and receive 9.9% è net result: 10% - 9.9% + LIBOR-0.15% = LIBOR -0.05%, a saving of 0.05%, since if AAA gets the debt from the bank, AAA’s interest rate would be LIBOR. Similarly, for BBB, pay LIBOR + 1.5% - (LIBOR -0.15%) + 10.3% = 11.95%, a saving of 0.5%, since BBB could get 12% interest rate if BBB gets the loan from the bank directly; To the SWAP Bank, its net result = Receive 10.3% from BBB, and pays 9.9% to AAA, and receive LIBOR-0.15% from AAA and pays LIBOR-0.15% to BBB, so net result = 10.3% - 9.9% +(LIBOR -0.15%) – (LIBOR=0.15%) = 0.4%, the profit of the SWAP bank.)

Goldman Sachs and Greece's decline - VPRO documentary – 2012 (FYI)

How Goldman Sachs Helped Mask Greece's Debt

Goldman Sachs details 2001 Greek derivative trades

By Reuters Staff

https://www.reuters.com/article/goldman-sachs-greece-derivatives/goldman-sachs-details-2001-greek-derivative-trades-idUSLDE61L1KH20100222

LONDON, Feb 22, 2010 (Reuters) - Goldman Sachs GS.N has defended the cross-currency derivatives it conducted for Greece in 2001 which reduced the country's debt as a common currency risk management procedure consistent with EU debt reporting rules. The US bank said that it did the deals to reduce foreign denominated liabilities of Greece, which had become a priority following the nation's entry into the single European currency.

“The Greek government has stated (and we agree) that these transactions were consistent with the Eurostat principles governing their use and application at the time,” said Goldman Sachs in a statement on its website on Sunday.

Details on the nine-year old swaps have re-emerged after several months of concern about Greece‘s budget and debt levels.

The country has battled to establish credibility over reducing its budget deficit, which at just under 13 percent is more than four times the 3 percent level stipulated by Maastrict.

Goldman has explained the derivatives in the context of EU rules on unhedged foreign currency debt which stated that these had to be converted into euros using the year-end currency rate.

Therefore a rise in the dollar or yen, currencies in which Greece had frequently issued debt, increased the country’s reported debt.

To mitigate this currency risk, in December 2000 and in June 2001, Greece conducted cross-currency swaps and restructured its cross-currency swap portfolio with Goldman Sachs at a historical implied foreign exchange rate, the U.S. investment bank said.

This was a practice commonly undertaken by European sovereigns, Goldman Sachs said.

These transactions reduced Greece’s foreign denominated debt in euro terms by 2.367 billion euros and, in turn, decreased Greece’s debt as a percentage of GDP by just 1.6%, from 105.3% to 103.7%.

To offset a fall in the value of the swap portfolio Greece and Goldman Sachs entered into a long-dated interest rate swap.

The new interest rate swap was on the back of a newly issued Greek bond, where Goldman Sachs paid the bond coupon for the life of the trade and received the cash flows based on variable interest rates.

In total the currency and interest rate hedges reduced the Greece’s debt by a total of 2.3 billion euros.

Greek debt crisis: How easy is it to swap currencies?

Published July 2015

https://www.bbc.com/news/world-europe-33462294

The euro was meant to cast the Greek drachma into the book of obsolete currencies, a note somewhere between the Rhodesian dollar and the brass dupondius coins used in ancient Rome.

Yet as the Greek government battles to satisfy its creditors, and avoid exiting the single currency, its citizens face the very real possibility that the drachma - or an alternative - could return.

While there have been high-profile cases of countries switching currencies, in many ways Greece's situation is unique. Here are some things Athens has to consider.

We do not know what plans, if any, Greece has to replace the euro. But nor would we expect to.

A mere hint from any government that the money in their citizen's pockets will soon become worthless would send people rushing to the banks.

If the Syriza-led government is preparing an alternative currency, such plans will have been worked out in secret. This might involve a foreign firm creating the new notes.

A precedent is post-war Germany. In 1948, confidence in the currency had collapsed.

The allies, keen to restore economic stability, printed billions of Deutsche marks, as the new currency was called, and in a matter of days distributed it around the country. It was quickly accepted.

Whether Greece has the capacity for such a dramatic move is unclear, but the German case shows how decisive action can work.

Greece already has capital controls in place - which can be a precursor to a new currency

Another example of a successful currency switch came in 1993 after Czechoslovakia spilt.

A currency union between the new Czech and Slovak nations lasted just 38 days, when it became clear the faltering Slovakian economy could not keep pace with its neighbour.

As in Germany, notes were printed in secret and distributed around the country with the help of the army.

But also important were the capital controls and bans on cross-border transfers, which kept money in state banks and prevented speculative flows between the two nations.

Greece already has capital controls, and its banks are closed, so in theory it has a head start, were it to introduce a new currency.

After the "Velvet Revolution" of 1989, Czechoslovakia had an amicable "Velvet Divorce", including a currency split

So you have printed wads of new notes and have your bank system on a tight leash. You now need to find a way to introduce the new currency, and phase out the old.

This is where it gets tricky. It took years of planning and careful transition to introduce the euro, yet Greece would have to bring a new currency in days.

Greece might run its new money side-by-side with the old, meaning shops for a period would accept both.

Citizens could only be allowed to swap a set amount of euros for cash, and be forced to deposit the rest, as the Czechs and Slovaks were compelled too.

The government would have to decide on an exchange rate to convert balances into the new currency. But would foreign buyers of Greek goods want to be paid in drachma?

In an interview with Britain's the Daily Telegraph, former Greek finance minister Yanis Varoufakis suggested his country could issue "California-style IOUs" as a way of introducing liquidity into a system thirsty for cash.

He was referring to California in 2009, when the US state, reeling from the financial crisis and unable to meet its bills, gave IOUs to contractors in lieu of payments.

This is not as outlandish as it sounds - the European Central Bank reportedly examined a scenario where the Greek state paid civil servants in IOUs.

The move would buy Greece time, and could ease the way to a formal new currency.

But unless such notes can easily be exchanged for goods, this would not help ordinary Greeks such as pensioners who rely on cash.

Greece already has the means to print more euros at its press in Holargos, a suburb of Athens, which once pumped out drachma.

Developing new banknotes is expensive, and difficult - the notes must be secure and be able to be recognised by cash machines - so such a scenario has appeal.

But this would not be the euro, but rather a "euro" - a parallel Greek version of the currency that is likely to devalue rapidly.

Greece could also look to its Balkan neighbours Kosovo and Montenegro if it fails to reach a deal. Despite the objections of the European authorities, both have unilaterally adopted the euro.

Such a move would give Greece a stable, internationally-recognised currency - but one in which they had no say.

Slovakia's economy may have been struggling when it abandoned its currency union with the Czech Republic, but it bounced back and later qualified for eurozone membership.

Estonia was the first to leave the Soviet rouble. Although the new currency was unstable at first, its adoption helped the country towards a successful free-market economy.

And having your own currency is not just a financial decision, but a point of national pride.

South Sudan introduced a new currency after it split from the north four years ago. Inflation has been a problem ever since, but for many in South Sudan it was an important way of asserting their new sovereignty.

Long-term damage

East Germany is arguably still paying the price for adopting the Deutsche mark after reunification.

East Germans were able to exchange their eastern marks one to one - great for individuals, but industry was unable to compete with the advanced West German economy.

Introducing a new currency is possible - former Czech Republic President Vaclav Klaus called it "a simple administrative thing to do" but its success depends on more than technical considerations.

Anything can be used as money, so long as there is confidence in it - it seems bizarre to think that Chinese traders once used cowrie shells, but imagine what they would make of Bitcoins.

A Greek break with the euro is unlikely to be clean, as its former currency will remain in circulation. It is unclear how readily a Greek society already divided over the euro would take to something new.

Greek Debt Crisis

How Goldman Sachs Helped Greece to Mask its True Debt

https://www.spiegel.de/international/europe/greek-debt-crisis-how-goldman-sachs-helped-greece-to-mask-its-true-debt-a-676634.html

Goldman Sachs helped the Greek government to mask the true extent of its deficit with the help of a derivatives deal that legally circumvented the EU Maastricht deficit rules. At some point the so-called cross currency swaps will mature, and swell the country's already bloated deficit.

Von Beat Balzli, 08.02.2010, 18.55 Uhr, Zur Merkliste hinzufügen

Greeks aren't very welcome in the Rue Alphones Weicker in Luxembourg. It's home to Eurostat, the European Union's statistical office. The number crunchers there are deeply annoyed with Athens. Investigative reports state that important data "cannot be confirmed" or has been requested but "not received."

Creative accounting took priority when it came to totting up government debt. Since 1999, the Maastricht rules threaten to slap hefty fines on euro member countries that exceed the budget deficit limit of three percent of gross domestic product. Total government debt mustn't exceed 60 percent.

The Greeks have never managed to stick to the 60 percent debt limit, and they only adhered to the three percent deficit ceiling with the help of blatant balance sheet cosmetics. One time, gigantic military expenditures were left out, and another time billions in hospital debt. After recalculating the figures, the experts at Eurostat consistently came up with the same results: In truth, the deficit each year has been far greater than the three percent limit. In 2009, it exploded to over 12 percent.

Now, though, it looks like the Greek figure jugglers have been even more brazen than was previously thought. "Around 2002 in particular, various investment banks offered complex financial products with which governments could push part of their liabilities into the future," one insider recalled, adding that Mediterranean countries had snapped up such products.

Greece's debt managers agreed a huge deal with the savvy bankers of US investment bank Goldman Sachs at the start of 2002. The deal involved so-called cross-currency swaps in which government debt issued in dollars and yen was swapped for euro debt for a certain period -- to be exchanged back into the original currencies at a later date.

Fictional Exchange Rates

Such transactions are part of normal government refinancing. Europe's governments obtain funds from investors around the world by issuing bonds in yen, dollar or Swiss francs. But they need euros to pay their daily bills. Years later the bonds are repaid in the original foreign denominations.

But in the Greek case the US bankers devised a special kind of swap with fictional exchange rates. That enabled Greece to receive a far higher sum than the actual euro market value of 10 billion dollars or yen. In that way Goldman Sachs secretly arranged additional credit of up to $1 billion for the Greeks.

This credit disguised as a swap didn't show up in the Greek debt statistics. Eurostat's reporting rules don't comprehensively record transactions involving financial derivatives. "The Maastricht rules can be circumvented quite legally through swaps," says a German derivatives dealer.

In previous years, Italy used a similar trick to mask its true debt with the help of a different US bank. In 2002 the Greek deficit amounted to 1.2 percent of GDP. After Eurostat reviewed the data in September 2004, the ratio had to be revised up to 3.7 percent. According to today's records, it stands at 5.2 percent.

At some point Greece will have to pay up for its swap transactions, and that will impact its deficit. The bond maturities range between 10 and 15 years. Goldman Sachs charged a hefty commission for the deal and sold the swaps on to a Greek bank in 2005.

The bank declined to comment on the controversial deal. The Greek Finance Ministry did not respond to a written request for comment.

4/26 (3-5:30 PM) Final Exam (in class, non-cumulative, multiple choice, two calculation questions)

Study guide (chapters 8, 11, 18)

Final Review Video (in class 4/20/2023)

Video explaining the Interest rate swap question

Part I - Multiple choice and true/false questions (2 points each; 2*40=80 points; only chapters 8, 11 and 18; close book close notes)

Chapter 8

1. What is the theory of purchasing power parity (PPP)?

2. How does PPP affect exchange rates?

3. How can PPP be used to compare the standard of living in different countries?

4. What is interest rate parity?

5. How does Interest Rate Parity affect the exchange rate between two currencies?

6. How does the law of one price relate to purchasing power parity?

7. How can investors take advantage of deviations from interest rate parity through carry trades?

8. What is Currency Carry Trades?

Chapter 11

9. How to hedge transaction exposure? (hint: option, forward contract, money market)

10. How to hedge with options (hint: receivable and payable use either put or call options)

11. Explain the concept of forward contracts as a hedging strategy.

12. Discuss the advantages and disadvantages of using forward contracts as a hedging strategy.

13. Explain how forward contracts differ from other hedging strategies, such as options

14. Explain how a company can use the money market to hedge its payables.

15. Explain how a company can use the money market to hedge its receivables.

16. How can a put option be used to hedge a receivable transaction, and what are the potential benefits and drawbacks of this strategy?

17. What are the main differences between hedging a receivable transaction with a put option versus using a forward contract?

18. How can a call option be used to hedge a payable transaction, and what are the potential benefits and drawbacks of this strategy?

Chapter 18

19. Define an interest rate swap and explain its purpose.

20. Explain the fixed-for-floating interest rate swap

21. Discuss the benefits and risks of using interest rate swaps to manage interest rate risk.

22. Define a currency swap and explain its purpose.

23. Discuss the benefits and risks of using currency swaps to manage foreign exchange risk.

24. Explain the concept of counterparty risk and how it applies to currency swaps.

25. Explain the concept of plain vanilla swap?

1.

Part II - Calculation part (Total 20 points, two questions, no need of calculator; Show works to earn partial credits)

1. Big Mac Index question: Given the price of Big Mac in US and in Japan, calculate the exchange rate based on the Big Mac Index (no need of calculator)

2. Interest rate swap: calculate the net outcome of each party involved, including two multinational firms and the swap bank (similar to the homework question, as below)

FYI

Company AAA will borrow $1,000,000 for ten years at a floating rate. Company BBB will borrow for ten years at a fixed rate for $1,000,000. Refer to the following for details.

		Fixed-Rate Borrowing Cost	Floating-Rate Borrowing Cost
	Company AAA	10%	LIBOR
	Company  BBB	12%	LIBOR + 1.5%
Note: · Company AAA anticipates the interest rates to fall in the future and prefers a floating rate loan. However, company AAA can get a better deal in a fixed rate loan. · On the contrary, company BBB anticipates the interest rates to rise and therefore prefers a fixed rate loan. Company BBB’s comparative advantage is in getting a floating rate loan. · So both companies could be better off with a interest rate swap contract. Assume that a swap bank help the two parties. 1 According to the swap contract, Firm BBB will pay the swap bank on $1,000,000 at a fixed rate of 10.30% 2 The swap bank will pay firm BBB on $1,000,000 at the floating rate of (LIBOR - 0.15%). 3 Firm AAA needs to pay the swap bank on $1,000,000 at the floating rate of (LIBOR - 0.15%); 4 The swap bank will pay firm AAA on $10,000,000 at a fixed rate of 9.90%. Please answer the following questions. • Show the value of this swap to firm AAA? (answer: Firm AAA can save $500 each year) • Show the value of this swap to firm BBB? ( answer: Firm BBB will save $500 per year)

Solution

Just write down all relevant transactions for each player, and sum them up. For example, AAA pays 10% and LIBOR-0.15%, and receive 9.9% è net result: 10% - 9.9% + LIBOR-0.15% = LIBOR -0.05%, a saving of 0.05%, since if AAA gets the debt from the bank, AAA’s interest rate would be LIBOR. Similarly, for BBB, pay LIBOR + 1.5% - (LIBOR -0.15%) + 10.3% = 11.95%, a saving of 0.5%, since BBB could get 12% interest rate if BBB gets the loan from the bank directly; To the SWAP Bank, its net result = Receive 10.3% from BBB, and pays 9.9% to AAA, and receive LIBOR-0.15% from AAA and pays LIBOR-0.15% to BBB, so net result = 10.3% - 9.9% +(LIBOR -0.15%) – (LIBOR=0.15%) = 0.4%, the profit of the SWAP bank.)

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