FIN415 Class Web
Page, Spring '25
Jacksonville
University
Instructor:
Maggie Foley
The
Syllabus                             Overall Grade Calculator (FYI)
Term Project Part I
(due with final)               
Term
project part II (excel questions) (due
with final)     
Weekly SCHEDULE,
LINKS, FILES and Questions  
| Week | Coverage, HW, Supplements -       
  Required | Supplemental Reaching Materials | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Marketwatch Stock Trading Game (Pass
  code: havefun) 1.     URL for your game:  2.   Password for this private game: havefun. ·      
  Click on the 'Join Now' button to get started. ·      
  If you are an existing MarketWatch member, login. If
  you are a new user, follow the link for a Free account - it's easy! ·      
  Follow the instructions and start trading! 3.   Game will be over
  on 4/25/2025 5.    Game
   ·      
  Mutual Fund
  Selection Game (FYI) ·      
  Order Type Explained
  Game (FYI) 6.    Youtube Instructions ·       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) |   | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| The Implications of Trump's Return on U.S.
  Trade Policy: Will Tariffs and Trade Wars Resurface? Background Trump's
  presidency (2017-2021) featured aggressive trade policies, including
  significant tariffs on China and other trading partners, renegotiations of
  trade agreements, and discussions about protecting American manufacturing
  through quotas and tariffs. Discussion Topics ·      
  U.S.-China
  Trade Relations:
  What would a potential second Trump presidency mean for the ongoing
  U.S.-China trade war and the tariffs imposed during his first term? ·      
  Impact
  on Global Supply Chains:
  How would renewed tariffs or quotas affect global supply chains, especially
  in key sectors like technology, agriculture, and automotive manufacturing? ·      
  Trade
  Protectionism vs. Free Trade: Analyzing the economic and political implications of shifting
  back toward protectionist policies. ·      
  Geopolitical Strategies: How might Trump's trade
  policies impact relations with allies and adversaries in a changing global
  landscape? 
 
     
 Key
  Insights1.    
  Jobs: 
 2.    
  Cost of Living: ·      
  Prices rise for everyday goods (e.g.,
  food, clothes, electronics) when tariffs increase import costs. ·      
  Higher energy costs can have widespread
  effects across industries. 3.    
  Availability of Goods: ·      
  Imported goods (e.g., seasonal produce,
  luxury cars, and tech gadgets) may become limited or delayed. ·      
  Domestic alternatives might not match
  global competition in terms of quality, price, or innovation. Now,
  let’s work on this survey about tariffs. Tariff Survey Game: Tariff Trade Simulation  
  A simple game   No Homework on the topic of Tariff  | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Chapter 1 – Part
  1 - World Economy Review of 2024 
 
 https://www.imf.org/en/Publications/WEO/weo-database/2024/October/select-country-group Currency Performance Analysis: Changes
  from January 1, 2024, to December 31, 2024 
 https://www.exchange-rates.org/exchange-rate-history/eur-usd-2024 In Class
  Discussion Questions    Curency_jigsaw_game       Self-Produced
  Video       
     Quiz 
 Homework - Chapter 1-1 (due with the
  first midterm exam):  
 1)    
  How
  tariffs affect trade balances (exports vs. imports) 2)    
  The
  impact of reduced imports on foreign demand for the dollar 3)    
  How
  tariffs might influence global investor confidence in the U.S. economy. 2       Do you prefer a strong dollar or a
  weak dollar? Why?  ·       
  Advantages
  of a strong dollar:                                                                   
  I.         
  Cheaper imports for consumers.                                                                  
  II.         
  Increased purchasing power for U.S. travelers abroad. ·       
  Advantages of a weak dollar:                                                                   
  I.         
  Boosts U.S. exports by making them more competitive globally.                                                                  
  II.         
  Supports domestic manufacturing and job creation. ·       
  Discuss which groups (e.g., consumers, exporters, travelers) benefit
  from each scenario and why you hold your preference. Submission Requirements: Write a 250-300 word response addressing both
  parts of the assignment. Hint: 
 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Part 2 - In class exercise – practice of
  converting currencies   1.     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 $1800. What
  about the exchange
  rate set at  1£ = 1.2$?     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.                  1.     If the Euro (EUR) to US Dollar
  (USD) exchange rate is 1.18, and the US Dollar to Japanese Yen (JPY) exchange
  rate is 110, what is the implied exchange rate between Euro and Japanese Yen?
   Answer: The implied exchange rate
  between Euro and Japanese Yen is approximately 129.80 (110 * 1.18). Explanation:   ·      
  1
  EUR = 1.18 USD; 1 USD = 110 JPY. So 
  1.18 USD/EUR * 110 JPY/USD = 1.18 * 110 = 129.80 JPY/EUR (one EUR =
  129.80 JPY) ·      
  Or,
  1 EUR = 1.18 USD è 1 USD = (1/1.18) EUR; 1USD
  = 110 JPY, so è (1/1.18)EUR = 110 JPY è 1 EUR = 110/(1/1.18) =
  129.80 JPY 2.     If the Euro to the British
  Pound (GBP) exchange rate is 0.85, and the Swiss Franc (CHF) to Euro exchange
  rate is 1.10, what is the implied exchange rate between British Pound and
  Swiss Franc? Answer: The implied exchange rate
  between British Pound and Swiss Franc is approximately  (1/0.85)/1.1 = 1.07 CHF/GBP è one GBP is worth 1.07 CHF Explanation:   ·      
  1
  EUR = 0.85 GBPè 1 GBP = (1/0.85) EUR, 1
  CHF = 1.10 EUR, so (1/0.85) EUR/ GBP / 1.1 EUR/CHF = (1/0.85)/1.1 CHF/EUR =
  1.07 CHF/GBP ·      
  Or
  1 EUR = 0.85 GBP, 1 CHF=1.1 EUR è 1 EUR = (1/1.1) CHF, so 1
  EUR = 0.85 GBP = (1/1.1) CHF è 1 GBP = (1/1.1)/0.85 =
  1.07 CHF 3.     If the Australian Dollar
  (AUD) to US Dollar exchange rate is 0.75, and the Canadian Dollar (CAD) to US
  Dollar exchange rate is 1.25, what is the implied exchange rate between
  Australian Dollar and Canadian Dollar? Answer: The implied exchange rate
  between Australian Dollar and Canadian Dollar is 0.60 (0.75 / 1.25). Explanation:  ·      
  1
  AUD = 0.75 USD, 1 CAD = 1.25 USD, So 1 AUD can get 0.75 USD, and since 1 USD
  can get (1/1.25=0.8) 0.8 CAD, so 1 AUD = 0.75 *(1/1.25) = 0.6 CAD. So one AUD
  is worth 0.6 CAD.  ·      
  Or,
  0.75USD/AUD * (1/1.25) CAD/USD = 0.75 * 0.8 CAD/AUD = 0.6 CAD/AUD 4.    
  Are there any arbitrage opportunities based
  on the information provided below? Why or why not?  
   Homework chapter1-2 (due with the 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.    
  If USD to the Chinese Yuan (CNY)
  exchange rate is 7.35, and USD to the Indian Rupee (INR) exchange rate is
  94.20, what is the implied exchange rate between Chinese Yuan and Indian
  Rupee, eg 1 CNY = ? INR? (answer: 1
  CNY = 12.816 INR) 3.    
  If the New Zealand Dollar (NZD) to
  Australian Dollar (AUD) exchange rate is 1.05, and the Singapore Dollar (SGD)
  to New Zealand Dollar exchange rate is 0.94, what is the implied exchange
  rate between Singapore Dollar and Australian Dollar? (answer: 1 AUD = 1.013 SGD, or 1 SGD = 0.987 AUD) | Swiss franc carry trade
  comes fraught with safe-haven rally risk (FYI) By Harry Robertson September 2, 20241:03 AM EDTUpdated 5 months ago LONDON, Sept 2 (Reuters) - As investors turn to the Swiss
  franc as an alternative to Japan's yen to fund carry trades, the risk of the
  currency staging one of its rapid rallies remains ever present. The Swiss franc has long been used in the popular strategy
  where traders borrow currencies with low interest rates then swap them into
  others to buy higher-yielding assets. Its appeal has brightened further as the yen's has dimmed. Yen
  carry trades imploded in August after the currency rallied hard on weak U.S.
  economic data and a surprise Bank of Japan rate hike, helping spark global
  market turmoil. The Swiss National Bank (SNB) was the first major central bank
  to kick off an easing cycle earlier this year and its key interest rate
  stands at 1.25%, allowing investors to borrow francs cheaply to invest
  elsewhere. By comparison, interest rates are in a 5.25%-5.50% range in
  the United States, 5% in Britain, and 3.75% in the euro zone. "The Swiss franc is back as a funding currency,"
  said Benjamin Dubois, global head of overlay management at Edmond de
  Rothschild  STABILITY The franc is near its highest in eight months against the
  dollar and in nine years against the euro , reflecting its status as a
  safe-haven currency and expectations for European and U.S. rate cuts. But investors hope for a gradual decline in the currency's
  value that could boost the returns on carry trades. Speculators have held on to a $3.8 billion short position
  against the Swiss franc even as they have abruptly moved to a $2 billion long
  position on the yen , U.S. Commodity Futures Trading Commission data shows. "There is more two-way risk now in the yen than there has
  been for quite some time," said Bank of America senior G10 FX strategist
  Kamal Sharma. "The Swiss franc looks the more logical funding currency
  of choice." BofA recommends investors buy sterling against the franc ,
  arguing the pound can rally due to the large interest rate gap between
  Switzerland and Britain, in a call echoed by Goldman Sachs. The SNB appears set to cut rates further in the coming months
  as inflation dwindles. That would lower franc borrowing costs and could weigh
  on the currency, making it cheaper to pay back for those already borrowing
  it. Central bankers also appear reluctant to see the currency
  strengthen further, partly because of the pain it can cause exporters. BofA
  and Goldman Sachs say they believe the SNB stepped in to weaken the currency
  in August. "The SNB will likely guard against currency appreciation
  through intervention or rate cuts as required," said Goldman's G10
  currency strategist Michael Cahill. 'INHERENTLY RISKY' Yet the Swissie, as it is known in currency markets, can be an
  unreliable friend. Investors are prone to pile into the currency when they get
  nervous, thanks to its long-standing safe-haven reputation. Cahill said the franc is best used as a funding currency at
  moments when investors are feeling optimistic. A quick rally in the currency used to fund carry trades can
  wipe out gains and cause investors to rapidly unwind their positions, as the
  yen drama showed. High levels of volatility or a drop in the higher-yielding
  currency can have the same effect. The SNB and Swiss regulator Finma declined to comment when
  asked by Reuters about the impact of carry trades on the Swiss currency. As stock markets tumbled in early August, the Swiss franc
  jumped as much as 3.5% over two days. The franc-dollar pair has proven sensitive
  to the U.S. economy, often rallying hard on weak data that causes U.S.
  Treasury yields to fall. "Any carry trade
  is inherently risky and this is particularly true for those funded with
  safe-haven currencies," said Michael Puempel, FX strategist at
  Deutsche Bank. "The main risk is that when yields move lower in a
  risk-off environment, yield differentials compress and the Swiss franc can
  rally," Puempel added. A gauge of how much investors expect the Swiss currency to
  move , derived from options prices, is currently at around its highest since
  March 2023. "Considering the central banks, you can see how there may
  be more sentiment for some carry players to prefer the franc over the
  yen," said Nathan Vurgest, head of trading at Record Currency Management. "The ultimate success of this carry trade might still be
  dependent on how quickly it can be closed in a risk-off scenario,"
  Vurgest said, referring to a moment where investors cut their riskier trades
  to focus on protecting their cash. Get the latest news and expert analysis about the state of the
  global economy with the Reuters Econ World newsletter. Sign up here. Reporting by Harry Robertson; Editing by Dhara Ranasinghe and
  Alexander Smith   Key Insights from the
  Article:1.    
  Swiss Franc as a Funding
  Currency: 
 2.    
  Carry Trade Dynamics: 
 3.    
  Safe-Haven Risks: 
 4.    
  Central Bank Influence: 
 5.    
  Strategist Views: 
 6.    
  Risks of Swiss Franc
  Carry Trades: 
 7.    
  Investor Sentiment: 
 This
  analysis highlights the opportunities | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Part III: Multilateral
  Trade vs. Bilateral Trade   Multilateralism Explained
  | Model Diplomacy (youtube)             
  Game            quiz  
 Key Takeaways:1.     
  Multilateral Trade
  Agreements: 
 2.     
  Bilateral Trade
  Agreements: 
 Homework chapter1-3 (due with first
  midterm exam) 1)    
  What is bilateralism? What is Multilateralism?  2)     Do you advocate
  for bilateralism or multilateralism as being more suitable for the U.S.
  economy? Why     Chapter 2 : International Trade   Let’s watch this video together. Imports, Exports, and Exchange Rates: Crash Course Economics
  #15 (youtube) 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.    Summary: Current Account: ·      
  Definition: The current
  account represents the country's transactions in goods, services, income, and
  current transfers with the rest of the world. ·      
  Components: A.    Trade Balance: The difference between exports and imports
  of goods. B.    Services: Transactions related to services (e.g.,
  tourism, transportation). C.    Income: Receipts and payments of interest, dividends, and
  wages. D.    Current Transfers: Gifts, aids, and remittances. Capital Account: ·      
  Definition: The
  capital account tracks capital transfers and the acquisition or disposal of non-financial
  assets. Now includes financial account.  ·      
  Components: A.    Capital Transfers: Non-financial transfers (e.g., debt
  forgiveness) and financial transfers.  B.    Acquisition/Disposal of Non-Financial Assets: Sale or purchase
  of non-financial assets, such as patents, goodwill, copy rights, etc, and
  financial assets, such as FDI, changes in reserves, portfolio investment, and
  financial derivative.  Balance of Payments (BoP): ·      
  Definition: The BoP
  is a comprehensive record of a country's economic transactions with the rest
  of the world over a specific period. ·      
  Equation: BoP = Current Account + Capital Account ·      
  Significance: It
  indicates whether a country has a surplus or deficit in its transactions with
  the rest of the world. Summary: ·      
  Current Account:
  Records day-to-day transactions, including trade, services, income, and
  transfers. ·      
  Capital Account:
  Deals with transfers of non-financial and financial assets and capital
  transfers. ·      
  Balance of Payments:
  The overall record combining the Current and Capital Accounts, reflecting a
  country's economic relationship with the world. | 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 
 Cons 
 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.    | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Part I -  What is the current
  account? Current vs. Capital Accounts: What's the
  Difference?   Interactive Game on Current
  Account and Capital Account 
   Balance of payments:
  Current account (video, Khan academy)              Quiz
  1       Quiz
  2   https://www.bea.gov/data/intl-trade-investment/international-transactions 
 The U.S. current-account deficit widened by $35.9 billion, or 13.1 percent, to $310.9 billion in the third quarter of 2024, according to statistics released today by the U.S. Bureau of Economic Analysis. The revised second-quarter deficit was $275.0 billion. The third-quarter deficit was 4.2 percent of current-dollar gross domestic product, up from 3.7 percent in the second quarter.   
   Capital-Account
  Transactions   ·      
  Capital-transfer receipts were $1.6 billion in the third
  quarter. The transactions reflected receipts from foreign insurance companies
  for losses resulting from Hurricane Helene. For information on transactions
  associated with hurricanes and other disasters, see “How do losses recovered from foreign insurance companies
  following natural or man-made disasters affect foreign transactions, the
  current account balance, and net lending or net borrowing?”.
  Capital-transfer payments increased $1.8 billion to $3.3 billion, reflecting
  an increase in infrastructure grants. Financial-Account
  Transactions   ·      
  Net
  financial-account transactions were −$493.6
  billion in the third quarter, reflecting net U.S. borrowing from foreign
  residents. https://www.bea.gov/news/2024/us-international-transactions-3rd-quarter-2024 Part II - What
  is the Capital AccountBalance of payments: Capital account (video,
  Khan Academy)        Quiz 3 https://fred.stlouisfed.org/tags/series?t=capital+account   Chapter
  2 part 1  (Due with the first mid term exam) 1.    
  Can a trade war
  help reduce current account deficit? Why or why not? 2.    
  How do tariffs impact the current account deficit in the context of
  ongoing trade disputes? 3.    
  Below are examples of various
  economic activities. Based on each example, determine whether the factor increases
  or decreases the current account balance. Write your answers in the
  blank space provided. 1)    
  A local
  factory sells more goods overseas, creating jobs and income locally. Effect
  on Current Account: ___________ 2)    
  Workers
  abroad send more money back to their families at home. Effect on Current
  Account: ___________ 3)    
  Paying
  less interest on loans taken from international lenders. Effect on Current
  Account: ___________ 4)    
  Buying
  fewer foreign-made products, such as cars or electronics. Effect on
  Current Account: ___________ 5)    
  More
  tourists visit the country and spend money on hotels, food, and services. Effect
  on Current Account: ___________ 6)    
  Buying
  more imported products, such as foreign luxury goods. Effect on Current
  Account: ___________ 7)    
  Exporting
  fewer goods due to higher costs or less demand abroad. Effect on Current
  Account: ___________ 8)    
  Traveling
  abroad and spending more on international vacations. Effect on Current
  Account: ___________ 9)    
  Receiving
  less income from foreign investments due to low returns. Effect on Current
  Account: ___________ 10)
  Paying
  more interest on loans owed to foreign banks or investors. Effect on
  Current Account: ___________ 11)
  Sending
  more money to family members living in other countries. Effect on Current
  Account: ___________ Optional Homework:  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:  https://research.stlouisfed.org/publications/ Balance of Payments statistics:  https://fred.stlouisfed.org/categories/125 | Current vs. Capital Accounts: What's the
  Difference? By
  THE INVESTOPEDIA TEAM,  Updated June
  29, 2021, Reviewed by ROBERT C. KELLY 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.   | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Topic 2 of Chapter 2 --- Evolution
  of international monetary system 1.   Finance:
  The History of Money (combined) (video, fan to watch)               Quiz  2.   Timeline of the history of Money:     ·       Quiz
  on Gold Standard           ·       Quiz
  on Bretton Woods System  ·       Quiz
  on Exchange Rate RegimeHISTORY OF EXCHANGE RATE SYSTEMS 
 Videos ·      
  The Gold Standard Explained in One
  Minute (video)·      
  The Bretton Woods Monetary System (1944 - 1971) Explained
  in One Minute (video) ·      
  FLOATING AND FIXED EXCHANGE RATE (video)  3.    
  Bretton Woods Agreement
  and System 
 U.S. Perspective: A Comparison of the Bretton Woods
  System and the Post-Bretton Woods System  
 For class discussion:  Why was the Bretton Woods System created
  after World War II, and what factors led to its collapse in 1973? (Why the World Abandoned
  the Gold Standard, FYI) (Bretton Woods system,
  FYI) | Bretton Woods Agreement and System By
  JAMES CHEN Updated April 28, 2021, Reviewed by SOMER ANDERSON 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. | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Topic 3: Shall we go back to Gold
  Standard for its currency?    Play  the “Gold Standard Adventure Game” to learn Video:  The US should not return
  to the gold standard for its currency: Jerome Powell (youtube)       (refer to: https://www.forbes.com/sites/nathanlewis/2020/03/27/what-if-we-had-a-gold-standard-right-now/?sh=1bfba3313e58)Homework of chapter 2 part ii (due with the first midterm
  exam) ·              
  Do you support returning to gold standard? Why or why not? Hint:  
 ·              
  What is the Bretton Woods agreement? Why is the Bretton Woods Agreement a
  significant event in world financial history? ·              
  What are
  some alternative currencies that have emerged as potential contenders to
  challenge the dollar's supremacy? Chinese Yuan? Euro? Yen? Bitcoin?... And
  why? (Hint:
  according to Why The U.S. Dollar May Be In
  Danger (youtube),  the three necessary conditions for
  a currency to be perceived as a global reserve currency are: An independent
  central bank; Strong military backing; A large and liquid debt market).     | 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. | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Why Cryptocurrency Will Never Become
  the World’s Primary Currency ·      
  Economist explains the two
  futures of crypto | Tyler Cowen ·      
  Self produced video: Crypto Cannot Be Cash  ·      
  Self
  produced video: The Crypto
  Hustle: Easy Money or Easy Mistake?·       Quiz 
 For class discussion: The
  Role of Cryptocurrency in the Future Financial System 1)     Will cryptocurrency remain just an investment asset, or
  can it become mainstream for daily purchases? 2)     What are the biggest technological and social barriers
  preventing crypto from replacing cash? 3)     What role will blockchain innovation play in shaping the
  future of finance? For your information on Blockchain Technology: ·      
  Private key vs. Public Key: https://www.jufinance.com/game/crypto_wallet.html   https://www.youtube.com/watch?v=izwkoczLj3w
  (self-produced video) ·      
  Create your private key at https://www.bitaddress.org/bitaddress.org-v3.3.0-SHA256-dec17c07685e1870960903d8f58090475b25af946fe95a734f88408cef4aa194.html ·      
  What is Bitcoin Mining?: https://www.jufinance.com/game/bitcoin_mining.html    https://www.youtube.com/watch?v=649Jh6-_WdA
  (self-produced video) ·      
  Blockscout: An open-source
  block explorer that allows users to search transactions, verify smart
  contracts, and analyze addresse https://eth.blockscout.com/?utm_source=chatgpt.com
   Homework of chapter 2 part iii (due with the first midterm
  exam)       Will cryptocurrency ever replace traditional national
  currencies? Why or why not? 
 | By
  Nathan Reiff Updated April 19, 2024 
  Reviewed by Somer Anderson https://www.investopedia.com/tech/bitcoin-or-altcoin-can-one-them-replace-fiat/   Can Cryptocurrency Replace Fiat? Cryptocurrencies
  are treated as a store of value and as money by many people, but to replace
  fiat currency, they must overtake fiat's use and acceptance in most
  geographies. Between 2020 and 2022, cryptocurrency adoption rates increased
  globally. However, rates have since decreased, except in certain geographies. Lower and middle-income (LMI) countries are
  where cryptocurrency use is more likely to replace fiat use—coincidentally, according to research, LMIs are where crypto
  adoption rates are still increasing. This is most likely because many people
  in these areas do not have access to financial services, or the existing
  systems suffer from inefficiencies or corruption. Key
  Takeaways ·       
  Developed countries are less likely to adopt cryptocurrencies over
  existing fiat currencies. ·       
  Some people expect cryptocurrency to replace fiat worldwide, but
  others are skeptical. ·       
  Cryptocurrency addresses many issues faced by those in lower and
  middle-income countries. ·       
  The most likely scenario is similar to now, where cryptocurrency
  remains convertible with fiat currencies while some countries ban it
  altogether. Fiat Currency Issues That Crypto Addresses Many
  agencies and regulators define money as anything that is a widely accepted
  means of exchange, a store of value, and a unit of account. Fiat currency,
  sometimes called real or physical money, has met all three requirements for
  over a millennium. However, advancements have already begun to reduce the
  need for physical currency in most developed countries. Cryptocurrency
  removes many of the requirements in today's financial systems. Here are a
  few. The Need to Trust Our
  current systems need third parties to issue debit and credit cards or conduct
  electronic transfers. Governments, banks, businesses, and people transfer
  funds by having a third party, usually a bank, change numbers on the
  equivalent of an electronic ledger. These third parties are necessary to
  ensure transactions are valid, and the costs of maintaining these financial
  systems are high. These
  third parties also bring the necessity of trusting someone else with your
  money. This trust has been violated on many occasions, and unethical
  practices by third parties have even contributed to global financial crises. Cryptocurrency
  reduces the need to involve another person to verify transactions and ensure
  accuracy. Each party is credited or debited correctly because blockchain
  technology and automated consensus mechanisms verify transactions and store
  the information in an unalterable way. Decentralization of Control One of
  the more significant issues many believe cryptocurrencies address is control
  of financial services. Undoubtedly, many people have problems accessing
  necessary financial services, with many being denied access for
  discriminatory reasons, lack of collateral, or not meeting other requirements
  set by lenders. Some
  may not have services available in their jurisdictions. However, since even
  those considered "unbanked" generally have access to the internet,
  decentralized finance applications that use cryptocurrencies can solve many
  of these problems. Another
  issue many people debate is centralized control of the supply of money. The
  argument is that central banks use the amount of circulating money to
  influence demand, which messes with exchange rates and purchasing power.
  Central banks also control interest rates to attempt to increase or decrease
  spending, depending on the inflationary environment. The
  belief is that if control is taken away from these central banks, people will
  be the ones to influence demand and supply, which will help the currency
  maintain a more stable value. Additionally, if money and financial services
  become peer-to-peer, it is believed that inflation will be tempered
  automatically by the people who are lending to each other. What Would Happen If Cryptocurrency Replaces
  Fiat? Cryptocurrencies,
  in their current form, transcend borders and regulations, which has both
  positive and negative effects. They are not controlled or influenced by
  central banks like fiat currencies. Central banks use monetary policy tools
  to influence inflation and employment through interest rates and open market
  operations. Decentralization, one of the fundamental principles behind
  cryptocurrency, removes these tools. Consumers
  may not have financial recourse or protections if cryptocurrency, in its
  current state, replaces fiat currency. The
  effects of completely replacing the tools used by central banks are still
  being explored and evaluated. The change could have significant adverse
  impacts on economic and financial stability or usher in an era of complete
  global stability. The
  International Monetary Fund (IMF) recommends against adopting cryptocurrency
  as a main national currency in its current state due to price volatility.
  Additionally, the organization feels that the risks of macro-financial
  stability and lack of consumer protections should be addressed. However,
  the IMF does acknowledge that adoption is most likely to occur more rapidly
  in countries where cryptocurrency risks are an improvement on the financial system
  in place. For
  example, many Ukrainians turned to cryptocurrency after fleeing the Russian
  invasion in 2022. Without cryptocurrency, many might not have had the money
  to survive. It is
  also being used by many in countries with severe fiat devaluation to preserve
  their savings, send and accept remittances, and conduct business. What Does the Future of Currency Look Like? You can
  already exchange cryptocurrency for fiat through exchanges or trades with
  other cryptocurrency users. Cryptocurrency continues to gain popularity in
  areas that are obviously in need of change, and blockchain use cases,
  popularity, understanding, and acceptance continue to grow. The more each is
  understood and used, the more value cryptocurrency could have as a means of
  exchange. As seen
  from cryptocurrency's use, research, and development, it is very likely that
  cryptocurrency use worldwide will continue to grow. If
  these trends continue, several currency scenarios could emerge. First, a
  society and economy could embrace cryptocurrency to the point that the
  country's fiat currency would be replaced. Its government would be forced to
  recognize it as legal tender and fiat currency would cease to be used. This
  is unlikely to occur in most areas. A
  second scenario might be a hybrid of digital assets and fiat currency.
  Governments could recognize both and be able to collect tax revenues and fund
  their programs and militaries. Consumers and businesses could choose
  whichever they wanted. This seems the most likely scenario to occur, and in
  many areas, it is already the case. Third,
  a society could reject cryptocurrency entirely and keep using its established
  fiat currency. This scenario might occur, at least regarding cryptocurrency.
  However, pressures to address corruption and awareness of blockchain
  advancements are guiding societies toward financial systems where information
  cannot be altered or faked. It is very likely that blockchain technology,
  rather than cryptocurrencies, will become part of existing monetary systems. Lastly,
  there might be a mix of governments worldwide that ban cryptocurrency use
  entirely, while others allow it to exist and be convertible to fiat currency,
  similar to how it is used today.  | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Chapter 3 International Financial Market/ 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 *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:  
 Part II – Interest Rate Benchmarks: LIBOR
  vs. SOFR  
 ·      
  Secured Overnight Financing Rate (SOFR): https://www.newyorkfed.org/markets/reference-rates/sofro   The Secured
  Overnight Financing Rate (SOFR) is a broad measure of the cost of borrowing cash overnight collateralized by Treasury
  securities. o  
  The SOFR includes all trades in the Broad
  General Collateral Rate plus bilateral Treasury repurchase agreement (repo) transactions cleared through the
  Delivery-versus-Payment (DVP) service offered by the Fixed Income Clearing
  Corporation (FICC), which is filtered to remove a portion of transactions
  considered “specials”.  o  
  The SOFR is calculated as a
  volume-weighted median of transaction-level tri-party repo data collected
  from the Bank of New York Mellon as well as GCF Repo transaction data and
  data on bilateral Treasury repo transactions cleared through FICC's DVP
  service, which are obtained from the U.S. Department of the Treasury’s Office
  of Financial Research (OFR). ·       Here's What Went Wrong
  With LIBOR (youtube)·      
  Libor: Bank of England
  implicated in secret recording - BBC News·      
  LIBOR vs. SOFR :
  Introduction, Scandals & Replacement : The Interest-Rate Benchmark·      
  LIBOR VS SOFR (youtube)Comparisons 
 2. Key Differences Table
 
 https://www.forbes.com/advisor/investing/what-is-libor          Timeline of LIBOR’s Phase-Out Here is
  a timeline of LIBOR’s phase-out, showing key
  milestones from the 2012 LIBOR scandal to its official cessation on June 30,
  2023. 
 SOFR Calculation from Repo Transactions 
 
   Homework - Chapter 3 Part I   1.     What does LIBOR stand for, and how
  was it used in financial markets? Explain how LIBOR was calculated and why it
  was considered unreliable. 2.     Describe the role LIBOR played in the
  2008 financial crisis. What was the LIBOR manipulation scandal, and which
  banks were involved? 3.     What is SOFR, and how does it differ
  from LIBOR? How is SOFR calculated, and why is it considered more reliable
  than LIBOR? 4.     A financial institution previously
  used LIBOR + 2% for a loan. If LIBOR was 0.5%, what was the total interest
  rate on the loan? 5.    
  If
  SOFR is currently 0.3% and a bank charges SOFR + 2% for a similar loan, what is the new
  total interest rate? |   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.  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. | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Part II: Forex quote6 Correlated
  Currency Pairs by Investopedia (youtube)                Quiz
 Key
  Summary: Quote Currency in Forex from    
  Quizhttps://www.investopedia.com/terms/q/quotecurrency.asp 1.    
  What is a Quote
  Currency? 
 2.    
  How
  Currency Pairs Work: 
 3.    
  How
  to Read Exchange Rates: 
 4.    
  How
  Buying & Selling Works: 
 5.    
  Example: 
 6.    
  Factors
  Affecting Currency Values: 
 Final Takeaway:
 In Class Exercise  1.    
  What is the current exchange rate for the
  GBP/USD pair?  _________________ 2.    
  What is the current exchange rate for the
  USD/GBP pair?  _________________ 3.    
  What is the current exchange rate for the
  EUR/USD pair?  ________________ 4.    
  What is the current exchange rate for the
  USD/JPY ?  ____________________ 5.    
  What is the current exchange rate for the
  EUR/ JPY?   ___________________ 6.    
  What is the current exchange rate for the
  GBP/NOK?    ____________________ 7.    
  What is the current exchange rate for the
  NOK/USD?    ____________________ Currency Conversion Exercise 1.    
  If 1 USD = 150 JPY and 1 GBP = 1.25 USD, how many
  JPY is 1 GBP worth? 2.     If 1 EUR = 1.10 USD and 1 USD = 10 NOK, how many NOK is 1 EUR? 3.    
  If 1 CHF = 0.90 EUR and 1 EUR =
  1.05 USD, how many USD is 1 CHF? 4.    
  If 1 GBP = 1.20 EUR and 1 USD =
  0.93 EUR, how many USD is 1 GBP? 5.    
  If 1 USD = 140 JPY and 1 NOK =
  0.10 USD, how many JPY is 1 NOK? 6.    
  If 1 EUR = 1.05 CHF and 1 USD =
  1.1 CHF, how many USD is 1 EUR? 7.    
  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) 8.    
  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%) Solution: $100 è £50
  at £1 = $2  è one year later, get back £60 è convert to £60 * 1.75 $/£ = $105. So a
  gain of $5 and a return of 5%.  9.     You observe the following
  exchange rates:1€=1.1$; 1£=1.21$; 1£=1.05€.
  Starting with $1,000,000, how can you make money through
  arbitrage? What is your profit? Solution: $1,000,000 è $1,000,000 / 1.1 $/€ = €909,090.91 è€909,090.91 / 1.05€/£= £865,800.87 è  £865,800.87 *
  1.21 $/£ = 
  $1,047,619.05,  a profit of
  $47,619.05 10.  You observe the following
  exchange rates:1€=1.1$; 1£=1.21$; 1£=1.15€.
  Starting with $1,000,000, how can you make money through arbitrage?
  What is your profit? Solution: $1,000,000 è $1,000,000 / 1.21 $/£ = £826,446.2810 è£826,446.2810 * 1.15€/£ = €950,413.2231 è  €950,413.2231€ *
  1.1 $/€ = $1,045,454.55, a profit of $45,454.55 11.  You observe the following exchange
  rates:1€=1.1$; 1£=1.21$; 1£=1.1€.
  Starting with $1,000,000, how can you make money through arbitrage?
  What is your profit? Solution: No arbitrage
  opportunity. Profits = 0  : In Class Discussion and Homework (due with the first midterm exam):  1.    
  Do you
  think the Chinese Yuan (CNY) will become one of the major global currencies?
  Why or why not? 2.     Do you think the Norwegian
  Krone (NOK) will become one of the major global currencies? Why or why not? Hint:  
 | Quote Currency in Forex: Meaning and Examples https://www.investopedia.com/terms/q/quotecurrency.asp By ADAM HAYES Updated May
  25, 2022 Reviewed by GORDON SCOTT Reviewed by Gordon Scott What
  Is a Quote Currency? In
  foreign exchange (forex), the quote currency, commonly known as the counter
  currency, is the second currency in both a direct and indirect currency pair
  and is used to determine the value of the base currency.   In
  a direct quote, the quote currency is the foreign currency, while in an indirect
  quote, the quote currency is the domestic currency.
  The quote currency is listed after the base currency in the pair when
  currency exchange rates are quoted. One can determine how much of the quote
  currency they need to sell in order to purchase one unit of the first or base
  currency. KEY
  TAKEAWAYS ·      
  The quote currency (counter currency) is
  the second currency in both a direct and indirect currency pair and is used
  to value the base currency. ·      
  Currency quotes show many units of the
  quote currency they will need to exchange for one unit of the first (base)
  currency. ·      
  In a direct quote, the quote currency is
  the foreign currency, while in an indirect quote, the quote currency is the
  domestic currency. ·      
  When somebody buys (goes long) a currency
  pair, they sell the counter currency; if they short a currency pair, they
  would buy the counter currency.  Understanding
  Quote Currency Understanding the quotation
  and pricing structure of currencies is essential for anyone wanting to trade currencies
  in the forex market. Market makers tend to trade specific currency pairs in
  set ways, either direct or indirect, which means understanding the quote
  currency is paramount.  A currency pair's exchange
  rate reflects how much of the quote currency is needed to be sold/bought to
  buy/sell one unit of the base currency. As the rate in a currency pair
  increases, the value of the quote currency falls, whether the pair is direct
  or indirect. Most U.S. dollar (USD) pairs
  hold the USD as the base currency. If the USD is not the base, it is a
  reciprocal currency. For example, the cross rate
  between the U.S. dollar and the Canadian dollar is denoted as USD/CAD and is
  a direct quote. This means that the CAD is the quote currency, while the USD
  is the base currency. The CAD is used as a reference to determine the value
  of one USD. From a U.S.-centric point of view, the CAD is a foreign currency. On the other hand, the
  EUR/USD denotes the cross rate between the euro and the U.S. dollar and is an
  indirect quote. This means that the EUR is the base currency, and the USD is
  the quote currency. Here, the USD is the domestic currency and determines the
  value of one EUR. Special
  Considerations Currency pairs—both base and
  quote currencies—are affected by a number of different factors. Some of these
  include economic activity, the monetary and fiscal policy enacted by central
  banks, and interest rates. Major currencies, such as
  the euro and U.S. dollar, are more likely to be the base currency rather than
  the quote currency in a currency pair, especially when it comes to trades in
  exotic currencies. The most commonly traded
  currency pairs on the market in 2021 were: EUR/GBP EUR/USD GBP/USD USD/CHF USD/JPY As noted above, the first
  currency in these pairings is the base currency while the second one (after
  the slash) is the quote currency. In the GBP/USD pairing, the pound is the
  base currency or the one that is being purchased while the dollar is the
  quote currency. This is the one that is being sold. Example
  of a Quote Currency Let's assume a trader wants
  to purchase £400 using U.S. dollars. This would involve a trade using the
  GBP/USD currency pair. In order to execute the trade, they need to figure out
  how many USD (the quote currency) they need to sell in order to get £400. The exchange rate for the
  pair at the end of the trading day on June 3, 2021, was 1.4103. This means it
  cost the trader $1.4103 to purchase £1. To complete the transaction on that
  day, the trader had to sell 564.12 units of the quote currency in order to
  get 400 units of the base currency or $564.12 for £400 = (400 x 1.4103). | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Chapter
  4 Exchange Rate Determination   Part I: What determines the strength of a
  currency?    Hint: The value of currency is determined
  by demand and supply, unless it is manipulated by the government. What Determines The Strength Of A Currency? | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Currency | Country/Region | Reasons for Strength | 
| Swiss Franc (CHF) | Switzerland | Safe-haven status, strong banking system, low inflation, political
    stability | 
| US Dollar (USD) | United States | Global reserve currency, strong economy, high demand in
    international trade, stable government | 
| Euro (EUR) | Eurozone | Backed by multiple strong economies (Germany, France, etc.),
    widely used in trade, European Central Bank (ECB) monetary policies | 
| British Pound (GBP) | United Kingdom | Historically strong financial sector, independent central bank
    policies, investor confidence | 
| Japanese Yen (JPY) | Japan | Safe-haven currency, trade surplus, government stability, Bank
    of Japan’s monetary policies | 
| Singapore Dollar (SGD) | Singapore | Strong financial hub, stable economy, sound fiscal policies,
    low debt | 
| Norwegian Krone (NOK) | Norway | Backed by strong oil and gas reserves, sovereign wealth fund,
    stable economic policies | 
| Canadian Dollar (CAD) | Canada | Resource-rich economy (oil, minerals), stable government,
    close trade ties with the US | 
Examples of weak currencies and the
  reasons behind their weakness
| Currency | Country/Region | Reasons for Weakness | 
| Venezuelan Bolívar (VES) | Venezuela | Hyperinflation, economic mismanagement, political instability,
    reliance on oil exports | 
| Iranian Rial (IRR) | Iran | Economic sanctions, high inflation, restricted access to
    global financial systems | 
| Lebanese Pound (LBP) | Lebanon | Banking crisis, political instability, debt defaults | 
| Argentine Peso (ARS) | Argentina | High inflation, frequent debt crises, weak investor confidence | 
| Turkish Lira (TRY) | Turkey | High inflation, political interference in central bank
    decisions, currency devaluation | 
| Pakistani Rupee (PKR) | Pakistan | Trade deficits, external debt, political instability | 
| Zimbabwean Dollar (ZWL) | Zimbabwe | History of hyperinflation, weak economic fundamentals,
    unstable government policies | 
| Nigerian Naira (NGN) | Nigeria | Oil dependency, inflation, foreign exchange shortages | 
| Egyptian Pound (EGP) | Egypt | High inflation, reliance on imports, foreign exchange
    shortages | 
| Russian Ruble (RUB) | Russia | Economic sanctions, reliance on oil exports, geopolitical
    risks | 
 
| Key Insight | Description | 
| Foreign Exchange Market Participants | Firms, households, and investors trade currencies through banks
    and key foreign exchange dealers. | 
| Exchange Rate Determination | Exchange rates are set at equilibrium where currency demand
    and supply meet; exchange rates between two currencies are inversely
    related. | 
| Factors Influencing Exchange Rates | Increased demand or decreased supply strengthens a currency
    (appreciation), while decreased demand or increased supply weakens it
    (depreciation). | 
| Role of Expectations | Future appreciation expectations increase demand and reduce
    supply, raising the exchange rate, while depreciation expectations lower
    demand and increase supply, reducing the exchange rate. | 
| Simultaneous Demand and Supply Shifts | In currency markets, demand and supply typically shift
    together, influenced by global events and investor sentiment. | 
| Self-Reinforcing Exchange Rate Movements | Exchange rate trends are amplified by investor behavior,
    leading to rapid fluctuations and speculative trading. | 
| Impact on Global Trade and Policy | Exchange rate volatility affects international trade and
    economic stability, prompting potential government or central bank
    intervention. | 
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.
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?

2) Real
  interest rate goes up   è currency demand high or low? è currency value up or down?

3)    Public debt goes up è currency demand high or low? è currency value up or down?

4)    Recession or crisis è currency demand high or low? è currency value up or down?

 
| 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 | 
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. 
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. 
| Economic Factor         |  Increase  | Impact on Demand for Peso | Impact on Supply of Peso | Impact on Peso  | 
|  Economic Growth        |      ↑     |            ↑                   |             ↓                  |       Appreciation        | 
|  Interest Rate             |      ↑     |            ↑                   |             ↓                  |       Appreciation        | 
|  Inflation                   |      ↑     |            ↓                   |             ↑                  |       Depreciation       | 
|  Political Uncertainty  |      ↑     |            ↓                   |          May ↑              |       Depreciation       | 
|  Public Debt               |      ↑     |            ↓                   |          May ↑              |       Depreciation       | 
|  Current Account        |      ↑     |            ↓                   |          May ↑              |       Depreciation       | 
|  Recession                 |      ↑     |            ↓                   |             ↑                  |       Depreciation       | 
  
  
| Economic Factor         |  Decrease  | Impact on Demand for Peso | Impact on Supply of Peso |  Impact on Peso  | 
|  Economic Growth        |      ↓     |            ↓                   |            ↑                   |       Depreciation       | 
|  Interest Rate             |      ↓     |            ↓                   |            ↑                   |       Depreciation       | 
|  Inflation                   |      ↓     |            ↑                   |             ↓                  |       Appreciation        | 
|  Political Uncertainty  |      ↓     |            ↑                   |             ↓                  |       Appreciation        | 
|  Public Debt               |      ↓     |            ↑                   |             ↓                  |       Appreciation        | 
|  Current Account        |      ↓     |            ↑                   |             ↓                  |       Appreciation        | 
Part II: Fixed
  exchange rate vs. floating exchange rate
 
 
How Are International
  Exchange Rates Set?               
https://www.investopedia.com/ask/answers/forex/how-forex-exchange-rates-set.asp
Comparison
  of Fixed vs. Floating Exchange Rates
| Exchange Rate System | Pros (Advantages) | Cons (Disadvantages) | 
| Fixed Exchange Rate | Provides stability in trade and investment, reducing uncertainty
    for businesses and investors. | Requires large foreign reserves to maintain the peg, which can
    strain the economy. | 
|   | Helps control inflation by preventing rapid currency
    depreciation. | Limits the ability of a country to use monetary policy to
    respond to economic changes. | 
|   | Reduces currency speculation, making financial markets more
    stable. | Can lead to an overvalued or undervalued currency, causing
    trade imbalances. | 
|   | Attracts foreign investment by providing a predictable
    exchange rate environment. | If the fixed rate becomes unsustainable, the country may face
    a currency crisis and forced devaluation. | 
| Floating Exchange Rate | Automatically adjusts to market conditions, correcting trade
    imbalances and inflation naturally. | Can be highly volatile, making international trade and
    investment riskier. | 
|   | Allows central banks to use monetary policy freely to manage
    the economy. | Speculative trading can cause rapid and unpredictable currency
    fluctuations. | 
|   | Reduces the need for large foreign currency reserves. | Exchange rate instability can negatively impact trade
    relationships and economic planning. | 
|   | Reflects real economic conditions, ensuring that the currency
    value aligns with market fundamentals. | A weak currency can lead to inflation, while a strong currency
    may hurt exports. | 
Homework
  (due with the first midterm exam):
Refer to the above table. In your
  view, should China adopt a floating exchange rate while Norway implements a
  fixed exchange rate? 
Explain your reasoning based on
  economic stability, trade dependencies, and government intervention.
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.
The Impossible Trinity
  or "The Trilemma" 
– can a country controls its interest rates, exchange
  rates, and capital flow simultaneously? 
Imagine you are running a country, and you
  have to make a tough choice between three powerful economic goals. But here’s the catch—you can only pick two at any given
  time. The three goals are:
The
  Problem? You Can’t Have All Three at the Same Time! 
| Choice | What You Get | What You Sacrifice | Real-World Example | 
| A. Fixed Exchange Rate + Free Capital Flows | Stable currency + Money moves freely | No control over interest rates (must match global rates) | Denmark (DKK pegged to EUR), Hong Kong (HKD pegged to USD) * ·       Both have a
    fixed exchange rate and free capital movement but must follow the interest
    rates of the ECB (Denmark) or the Fed (Hong Kong). | 
| B. Free Capital Flows + Independent Monetary Policy | Control over interest rates + Free money movement | Currency value fluctuates (no fixed exchange rate) | U.S., UK, Japan, Norway  ·       Money moves
    freely, and they set their own interest rates, but exchange rates float and
    fluctuate. | 
| C. Fixed Exchange Rate + Independent Monetary Policy | Stable currency + Control over interest rates | No free capital flows (capital controls restrict money
    movement) | China (before 2005), Bretton Woods system (1944–1971) ·      
    China restricted capital movement while keeping its currency
    pegged.  ·       Under Bretton
    Woods, countries maintained exchange rate pegs but used capital controls to
    prevent excessive flows. | 
1)     Denmark
  must align its interest rates
  with those of the European
  Central Bank (ECB).
2)     If
  the ECB raises rates, Denmark must follow; otherwise, speculative capital
  flows could destabilize the peg.
1)     Hong
  Kong must match U.S. interest
  rates set by the Federal
  Reserve to maintain the peg.
2) If the Fed hikes rates, Hong Kong must follow, even if it’s bad for the local economy.
Let’s say you try:
·      
  Every country makes a trade-off. The U.S. picks free capital flow and independent monetary policy
  (floating exchange rate), while Eurozone countries pick free
  capital flow and a fixed exchange rate (but give up control
  over interest rates).
·      
  
·      
  This is why some economists, like Dani Rodrik, argue that
  limiting capital flows (Option C) can sometimes be a better choice to avoid
  frequent financial crises.
  Homework (due with the first midterm exam):
Based on the Impossible Trinity,
  should China transition to a floating exchange rate, and should Norway adopt
  a fixed exchange rate? Explain your reasoning by considering each country's
  economic structure, capital flow policies, and monetary policy objectives.
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 (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:
·         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.
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.
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)
First Midterm Exam          
·      
  Date:
  February 20, 2025 
·      
  In-Class,
  Closed-Book, Closed-Notes
·      
  50
  T/F questions similar to quizzes
·       
  Tariff
·       
  Quota
·       
  Trade War
·       
  Sanction
·       
  Bilateral Trade
·       
  Multilateral
  Trade
·       
  Balance of
  Payments (BOP)
·       
  Current Account
·       
  Capital Account
·       
  Bretton Woods
  System
·       
  Floating Exchange
  Rate System
·       
  Fixed Exchange
  Rate System
·       
  Pros and Cons of
  Floating vs. Fixed Exchange Rate
·       
  Gold Standard
·       
  Cryptocurrency
·       
  LIBOR (London
  Interbank Offered Rate)
·       
  SOFR (Secured
  Overnight Financing Rate)
·       
  Direct Quote
·       
  Indirect Quote
·       
  Base Currency
·       
  Quote Currency
·       
  7 Major Currency
  Pairs
·       
  Factors That
  Determine Currency Values
·       
  Demand and Supply
  Curves for Currency Values
·       
  Impossible Trinity 
  
Chapter
  5  - Part I
What is
  SWIFT? How could banning Russia from the banking system impact the country?
https://www.usatoday.com/story/money/2022/02/24/swift-russia-banki
·  What is SWIFT?
·  SWIFT's Role in Global Finance
·  SWIFT and International Sanctions
·  Alternatives to SWIFT
·  Impact of Being Cut Off from SWIFT
·  The U.S. Influence on SWIFT
·  Misconceptions About SWIFT
·  Cryptocurrency as an Alternative
·  Current Status of Russia and SWIFT
| Country | Year Removed from SWIFT | Reason for Removal | Immediate Impact | Long-Term Impact | Year Allowed Back | Reason for Reconnection | 
| Russia | 2022 | Invasion of Ukraine | Severe disruption to financial transactions, loss of foreign
    trade revenue | Development of alternative payment systems like SPFS, deeper
    financial ties with China | ? | Economic necessity, shifting geopolitical alliances | 
| Iran | 2012 | Nuclear program sanctions | 50% loss in oil export revenue, 30% drop in foreign trade | Reconnected in 2016, but economy remained strained due to
    other sanctions | 2016 | Nuclear deal agreement and partial sanction relief | 
| Argument | Why Allow Russia Back into SWIFT | Why Russia Should Not Be Allowed Back into SWIFT | 
| Economic Stability | Reconnecting Russia could stabilize global financial markets
    and reduce transaction inefficiencies. | Keeping Russia excluded maintains pressure on its economy,
    restricting its ability to finance military actions. | 
| Energy Trade | Facilitating Russian energy exports through SWIFT would help
    maintain steady global oil and gas supplies. | Preventing Russia from using SWIFT limits its ability to
    profit from energy exports, weakening its war financing. | 
| Diplomatic Leverage | Allowing Russia back could be used as a negotiation tool to
    de-escalate tensions and foster diplomatic solutions. | Exclusion signals a strong stance against aggression,
    reinforcing international norms and deterring similar actions in the
    future. | 
| Sanctions Enforcement | Some argue that cutting Russia off has not stopped its
    actions, making SWIFT sanctions less effective than expected. | Russia's disconnection has been one of the most significant
    financial penalties imposed, and reintroducing it could weaken the
    credibility of future sanctions. | 
| Geopolitical Consequences | Blocking Russia could push it closer to adversarial alliances,
    strengthening economic and military ties with China, Iran, and others. | Reconnecting Russia too soon might be seen as appeasement,
    emboldening further geopolitical instability. | 
| Alternative Systems | Russia has developed its own alternative system (SPFS), and
    prolonged exclusion may weaken SWIFT’s dominance in global finance. | Keeping Russia out forces other nations to rely on SWIFT
    rather than alternative financial systems, preserving its dominance. | 
For Discussion and
  Homework (due with the second midterm exam):
Read the following
  article and discuss: How long should the sanctions last? Should they be
  lifted when the war is over?
Trump hands Russian economy a
  lifeline after three years of war           
  Quiz         Game
By Alexander Marrow
  and Darya Korsunskaya February 24, 20251:24 PM  
Summary
•                 
  US push for Ukraine deal could benefit Russia's economy
•                 
  Russia's inflation remains stubbornly high
•                 
  Russia's overheated economy set to cool
•                 
  Some winners, losers in Russia's war economy
LONDON, Feb 24 (Reuters) - Russia's overheating economy is
  on the cusp of serious cooling, as huge fiscal stimulus, soaring interest
  rates, stubbornly high inflation and Western sanctions take their toll, but
  after three years of war, Washington may just have thrown Moscow a lifeline.
U.S. President Donald Trump is pushing for a quick deal to
  end the war in Ukraine, alarming Washington's European allies by leaving them
  and Ukraine out of initial talks with Russia and blaming Ukraine for Russia's
  2022 invasion, political gifts for Moscow that could also bring strong
  economic benefits.
Washington's push comes as Moscow faces two undesirable
  options, according to Oleg Vyugin, former deputy chairman of Russia's central
  bank.
Russia can either stop inflating military spending as it
  presses to gain territory in Ukraine, he said, or maintain it and pay the
  price with years of slow growth, high inflation and falling living standards,
  all of which carry political risks.
Key Insights from the Reuters Article: "After Three
  Years of War, Trump Hands Russian Economy a Lifeline"
| Key Topics | Insights | 
| Russia's Economy is
    Overheating | Military spending keeps Russia’s economy afloat but causes
    high inflation and economic strain. Interest rates at 21% are slowing corporate
    investment and increasing financial pressure. | 
| Trump’s Push for a
    Peace Deal | Trump is pushing for a quick resolution to the Ukraine war,
    excluding European allies and Ukraine from early talks while favoring
    direct discussions with Russia. | 
| Potential Economic
    Relief for Russia | A peace deal could ease sanctions and potentially allow
    Western companies to return to Russia. The Russian ruble has already
    strengthened due to speculation of future economic relief. | 
| Russia's Dilemma: Guns
    vs. Butter | Russia must choose between reducing military spending to
    stabilize the economy or continuing high defense spending, leading to
    long-term stagnation and inflation. | 
| Labor Shortages and
    Inflation Risks | War-driven recruitment and emigration have pushed unemployment
    to a record low of 2.3%. High demand and labor shortages are keeping
    inflation high, adding economic pressure. | 
| The U.S. Strategy:
    Carrot & Stick | The U.S. offers possible sanctions relief if Russia cooperates
    but threatens tougher sanctions if no progress is made. | 
| No Mention of SWIFT
    Reconnection | While the article discusses potential sanctions relief, it
    does not explicitly mention Russia being reconnected to SWIFT. | 
  
What
  is SWIFT? How could banning Russia from the banking system impact the
  country?
Marina Pitofsky, USA TODAY
https://www.usatoday.com/story/money/2022/02/24/swift-russia-banking-system-sanctions/6930931001/
The White House announced Saturday that the United States and allies agreed
  to block select Russian banks from SWIFT, the global financial messaging
  system.
In a joint statement with leaders of the European
  Commission, France, Germany, Italy, the United Kingdom, Canada, the officials
  said Russia being excluded from SWIFT ensures “that these banks are disconnected from the international financial system
  and harm their ability to operate globally.”
The announcement comes after President Joe Biden on
  Thursday told reporters that the penalties from the latest round of sanctions
  against Russia are “maybe more consequence than SWIFT.”  
What does it mean for Russia to be kicked out of the
  SWIFT banking system? Here’s what you need to know: 
What is the SWIFT financial system?
SWIFT
  stands for the Society for Worldwide Interbank Financial Telecommunication.
  It is a global messaging system connecting thousands of financial
  institutions around the world.  
SWIFT was formed in 1973, and it is headquartered in
  Belgium. It is overseen by the National Bank of Belgium, in addition to the
  U.S. Federal Reserve System, the European Central Bank and others. It connects more than 11,000 financial
  institutions in more than 200 countries and territories worldwide so banks
  can be informed about transactions. 
Alexandra Vacroux, executive director of the Davis
  Center for Russian and Eurasian Studies at Harvard University, told NPR,
  "It doesn't move the money, but
  it moves the information about the money." 
SWIFT said it recorded 42 million messages a day on
  average in 2021 and 82 million messages overall this month. That includes
  currency exchanges, trades and more.
How would a removal from SWIFT affect Russia?
Barring
  Russia from SWIFT would damage the country’s economy right away and, in the
  long term, cut Russia off from a swath of international financial
  transactions. That includes international profits from oil and gas
  production, which make up more than 40% of Russia’s revenue. 
Iran lost access to SWIFT in 2012 as part of
  sanctions over its nuclear program, though many of the country's banks were
  reconnected to the system in 2016. Vacroux told NPR that when Iran was kicked
  off, "they lost half of their oil export revenues and 30% of their
  foreign trade."
What have other leaders said about removing Russia
  from SWIFT?  
Ukrainian President Volodymyr Zelenskyy urged the
  U.S. and other countries to cut Russia from the system. Some nations resisted
  the move out of concerns for the broader economy, but as the invasion wore on
  more European Union nations got on board.
Early Saturday morning, Italian Prime Minister Mario
  Draghi told Zelenskyy that Italy supported "Russia's disconnection from
  SWIFT, the provision of defense assistance." 
Several hours later, Germany, which had been the
  last European Union nation holding out on the sanctions, offered measured
  support for Russia's disconnection from SWIFT, according to a joint statement
  from German Foreign Minister Annalena Baerbock and German Economics Minister
  Robert Habeck.
“We are working flat out on how to limit the collateral
  damage of a disconnection from #SWIFT, so that it hits the right people,” the
  officials wrote in a statement. "What we need is a targeted and
  functional restriction of SWIFT.”
Trump hands
  Russian economy a lifeline after three years of war
By Alexander
  Marrow and Darya Korsunskaya February 24, 20251:24 PM  
Summary
•           US push for Ukraine deal could
  benefit Russia's economy
•           Russia's inflation remains
  stubbornly high
•           Russia's overheated economy set to
  cool
•           Some winners, losers in Russia's
  war economy
LONDON,
  Feb 24 (Reuters) - Russia's overheating economy is on the cusp of serious
  cooling, as huge fiscal stimulus, soaring interest rates, stubbornly high
  inflation and Western sanctions take their toll, but after three years of
  war, Washington may just have thrown Moscow a lifeline.
U.S.
  President Donald Trump is pushing for a quick deal to end the war in Ukraine,
  alarming Washington's European allies by leaving them and Ukraine out of
  initial talks with Russia and blaming Ukraine for Russia's 2022 invasion,
  political gifts for Moscow that could also bring strong economic benefits.
Washington's
  push comes as Moscow faces two undesirable options, according to Oleg Vyugin,
  former deputy chairman of Russia's central bank.
Russia
  can either stop inflating military spending as it presses to gain territory
  in Ukraine, he said, or maintain it and pay the price with years of slow
  growth, high inflation and falling living standards, all of which carry
  political risks.
Though
  government spending usually stimulates growth, non-regenerative spending on
  missiles at the expense of civilian sectors has caused overheating to the
  extent that interest rates at 21% are slowing corporate investment and
  inflation cannot be tamed.
"For
  economic reasons, Russia is interested in negotiating a diplomatic end to the
  conflict," Vyugin said. "(This) will avoid further increasing the
  redistribution of limited resources for unproductive purposes. It's the only
  way to avoid stagflation."
While
  Russia is unlikely to swiftly reduce defence spending, which accounts for
  about a third of all budget expenditure, the prospect of a deal should ease
  other economic pressures, could bring sanctions relief and eventually the
  return of Western firms.
"The
  Russians will be reluctant to stop spending on arms production overnight,
  afraid of causing a recession, and because they need to restore the
  army," said Alexander Kolyandr, researcher at the Center for European
  Policy Analysis (CEPA).
"But
  by letting some soldiers go, that would take a bit of pressure off the labour
  market."
War-related
  recruitment and emigration have caused widespread labour shortages, pushing
  Russian unemployment to a record low 2.3%.
Inflation
  pressure could also ease, Kolyandr added, as peace prospects may make
  Washington less likely to enforce secondary sanctions on companies from
  countries like China, making imports more straightforward and, therefore,
  cheaper.
NATURAL
  SLOWDOWN
Russian
  markets have already seen a boost. The rouble surged to a near six-month high
  against the dollar on Friday, buoyed by prospects for sanctions relief.
Russia's
  economy has grown strongly since a small contraction in 2022, but authorities
  expect 2024's 4.1% growth to slow to around 1-2% this year and the central
  bank is not yet seeing sustainable grounds to cut rates.
When
  holding rates at 21% on February 14, Central Bank Governor Elvira Nabiullina
  said demand growth has long been faster than production capacity, hence the
  natural slowdown in growth.
The
  bank's challenge in finding a balance between growing the economy and
  lowering inflation is complicated by rampant fiscal stimulus. Russia's fiscal
  deficit ballooned to 1.7 trillion roubles ($19.21 billion) in January alone,
  a 14-fold increase year on year as Moscow frontloads 2025 spending.
"...it
  is very important for us that the budget deficit...remains as the government
  is currently planning," Nabiullina said.
The
  finance ministry, which expects a 1.2-trillion-rouble deficit for 2025 as a
  whole, rejigged its budget plans three times last year.
CARROT
  & STICK
The war
  has brought economic advantages for some Russians but pain for others.
For
  workers in sectors linked to the military, fiscal stimulus has sharply raised
  wages, while others in civilian sectors struggle with soaring prices for
  basic goods.
Some
  businesses have seized opportunities presented by huge shifts in trade flows
  and reduced competition. For example, Melon Fashion Group's revenues have
  steadily risen as it has ridden the consumer demand wave.
Melon's
  brands have significantly expanded over the last two years, the company told
  Reuters, and since 2023, the average size of stores it opens has doubled.
But for
  many others, high rates pose a serious challenge.
"At
  current lending rates, it is difficult for developments to launch new
  projects," said Elena Bondarchuk, founder of warehouse developer
  Orientir. "The once-wide circle of investors has narrowed and those who
  remain are also dependent on banks' terms."
Lower
  oil prices, budget constraints and a rise in bad corporate debt are among the
  top economic risks facing Russia, internal documents seen by Reuters show.
  And Trump, though dangling the carrot of concessions over Ukraine, has
  threatened additional sanctions if no deal is forthcoming.
"The
  United States has significant leverage in terms of the economy and it's why
  the Russians are happy to meet," Chris Weafer, chief executive of
  Macro-Advisory Ltd, told Reuters.
"The
  United States is saying: 'We can ease sanctions if you cooperate, but if you
  don't we can make it a hell of a lot worse'."
  
Part II: 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

Homework (due with the
  second midterm exam): 
Question 1: 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 $5 million. If Baylor
  Bank’s forecast if correct, what will its dollar profit be from speculation
  over the five day period (assuming it does not use any of its existing
  consumer deposits to capitalize on its expectations)? (Answer: 0.44 million NZ$ profits; or $0.88 million)    
  
Question 2: Baylor Bank
  believes the New Zealand dollar will depreciate over the next five days from
  $.52 to $.55. The following annual interest rates apply:
Currency                                            Lending
  Rate                 
           Borrowing Rate
      Dollars                                                     5.50%                                      5.80%
      New
  Zealand dollar
  (NZ$)                        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: $0.288 million, or 0.524 million NZ$
  profits )
0.52 *(1+5.5%/360*5) /0.5 –
  11*(1+5.25%/360*5)
=
  5/0.52*(1+4.8%/360*5)*0.55-5*(1+5.8%/360*5)
 
 
Part
  III -  Currency Derivatives 
| Hedging Strategy    |  Description                                                       
                                                                                                    | 
| Forward Contracts   | Enter into agreements with a bank or financial institution to lock
    in a specific exchange rate for future transactions, protecting against
    adverse exchange rate movements.  | 
| Options Contracts   | Purchase contracts granting the right (but not obligation) to
    exchange currency at a predetermined rate on or before a specified date,
    offering flexibility with limited downside risk.     | 
| Currency Swaps      | Exchange cash flows in different currencies through
    agreements, such as swapping domestic currency for Japanese yen at a fixed
    rate, mitigating exchange rate fluctuations.       | 
| Natural Hedging     | Offset currency exposure by aligning revenue or expenses in
    Japanese yen, naturally hedging against exchange rate risk through matching
    currency inflows and outflows.         
     | 
  Part a - Forward
  market vs. Future market
      Futures vs.
  Forward Contract Game          Futures Trading Simulator           Forward Trading Simulator       
         
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)
| Feature | Forward
     Contract | Futures
     Contract | 
| Definition | A
    customized agreement between two parties to exchange currencies at a future
    date at a predetermined rate. | A
    standardized contract traded on an exchange to buy or sell a currency at a set
    price on a future date. | 
| Trading Venue | Over-the-counter
    (OTC), typically through banks or financial institutions. | Traded
    on organized exchanges (e.g., CME Group). | 
| Customization | Fully
    customizable (amount, maturity date, settlement terms). | Standardized
    (contract size, expiration date, and settlement terms are fixed). | 
| Regulation | Not
    regulated; risk depends on counterparty creditworthiness. | Highly
    regulated by exchanges and clearinghouses. | 
| Margin Requirement | No
    margin required, but a credit line is needed. | Requires
    an initial margin and daily mark-to-market settlements. | 
| Settlement | Delivered
    at contract expiration (physical settlement). | Mostly
    cash-settled daily; delivery is rare. | 
| Flexibility | More
    flexible but less liquid. | Less
    flexible but highly liquid. | 
| Counterparty Risk | High
    (depends on the creditworthiness of the counterparty). | Low
    (exchange acts as an intermediary and guarantees the contract). | 
| Situation | Best
     Choice | 
| Hedging
    an exact amount for a specific future transaction | Forward Contract | 
| Speculating
    on currency price movements | Futures Contract | 
| Avoiding
    counterparty credit risk | Futures Contract | 
| Needing
    a flexible, customized agreement | Forward Contract | 
| Trading
    with high liquidity and transparency | Futures Contract | 
| Business
    importing/exporting goods with long-term contracts | Forward Contract | 
·       
  Forward
  Contracts:
·       
  Futures
  Contracts:
1) Forward Contract
   F = S * ((1
  + iq) / (1 + ib)
A simpler version: F - S = S*(iq - ib)
Where:
Examples: USD/GBP, the US Dollar is the base currency;
  EUR/USD, the EURO is the base currency
GBP/USD = 2 è GBP is the based currency and USD is the quoted currency. 
If interest rate in UK is 10%, interest rate is US is 5% è F = 2*(1+5%) / (1+10%) = 1.9091

https://www.jufinance.com/irp/
For
  example:
A Jacksonville-based seafood company plans to import NOK
  1,000,000 worth of salmon in the summer. Concerned about the potential appreciation
  of the NOK in the coming months due to trade tensions, the company seeks to
  hedge against exchange rate fluctuations. To mitigate this risk, they
  approach Deutsche Bank to establish a forward contract, securing the exchange
  rate at present. As the market maker for this forward contract, you observe
  that the current interest rates are 6% in the U.S. and 2% in Norway. How
  should you determine the forward rate, and what is the reasoning behind your
  calculation?
Answer:
The
  current exchange rate is NOK/USD = 0.1,
  meaning 1 NOK = 0.1 USD, where NOK
  is the base currency and USD is the quoted currency.
To determine the forward rate, we use the
  interest rate parity (IRP) formula:

Since
  there are three months left
  until summer, the three-month interest rates are calculated as:
Applying
  the formula:
Thus,
  the forward rate should be approximately
  0.101 NOK/USD.
A simpler way to estimate the forward rate is:
F - S = S*(iq - ib)
Where:
Thus,
  the forward rate remains
  0.101 NOK/USD, confirming the calculation.

| Term | What It Means   | 
| Margin | Money
    you must deposit to trade futures (like a security deposit). | 
| Initial Margin | The
    minimum
    money you need to open a futures trade (like a down payment). | 
| Maintenance Margin | The
    minimum
    balance required to keep the trade open (like a minimum bank balance). | 
| Margin Call | A
    warning when your balance drops too low; you must add money or close the
    trade (like a teacher telling you to do homework or fail). | 
| Mark-to-Market | Daily
    profit/loss adjustment in your account (like updating your grade every
    day). | 
| Leverage | You
    control a large contract with a small margin (like borrowing a big car with
    a small deposit). | 
| Clearing House | Ensures
    everyone follows margin rules (like a referee in a game). | 
 
·      
  You think oil prices
  will rise from $80
  per barrel to $90
  per barrel next month.
·      
  Instead of buying actual oil, you buy 1 oil futures contract
  (each contract = 1,000 barrels).
·      
  The Initial
  Margin required is $5,000
  (not the full price).
 Advantage: Leverage è
  You controlled $80,000 worth of oil
  with just $5,000.
  Risk: Big losses! If oil crashes
  to $70, you
  owe $10,000 
| Factor | Advantage   | Risk   | 
| Leverage | Small
    money controls big assets. | Can
    lose more than the deposit. | 
| Profit Potential | High
    return if the price moves in your favor. | High
    losses if the price moves against you. | 
| Liquidity | Easy
    to buy & sell. | Market
    moves fast → high volatility. | 
| Margin Calls | Trade
    with less cash upfront. | Must
    add money if the market goes against you. | 
Another
  Example:  Cryptocurrency Futures                Quiz
https://www.investopedia.com/articles/investing/012215/how-invest-bitcoin-exchange-futures.asp
| Topic | Summary | 
| Definition | Cryptocurrency futures are contracts that allow investors to
    speculate on crypto prices without owning the underlying asset. | 
| Trading Venues | Crypto futures trade on regulated exchanges like CME and CBOE,
    as well as unregulated platforms like Binance, ByBit, OKX, and XT.COM. | 
| Key Features | Contracts specify a future price and settlement date, with
    cash-settled and margined options available. | 
| History | First Bitcoin futures launched in Dec 2017 (CBOE, CME); CBOE
    discontinued, while CME expanded offerings. | 
| Popular Exchanges | CME (regulated), Binance, ByBit, OKX, XT.COM (unregulated,
    high leverage). | 
| Regulated vs.
    Unregulated | Regulated exchanges (CME, CBOE): Strict margin rules,
    government oversight (CFTC). Unregulated exchanges: Higher leverage (up to
    125x), greater risk. | 
| Margin Requirements | Regulated: Margin requirements set by exchanges (e.g., CME
    requires 50% for BTC, 60% for ETH). Unregulated: Higher leverage allowed,
    leading to increased risk. | 
| Leverage | CME & brokers: Limited leverage due to regulations.
    Binance (unregulated): Originally up to 125x, reduced to 20x in 2021. | 
| Settlement | Cash-settled (CME, CBOE): No physical crypto transfer. Some
    exchanges allow physical settlement. | 
| Trading Process | Requires broker approval, margin deposit, and futures account
    setup. Positions can be rolled over or expire at settlement. | 
| Volatility &
    Risk | Crypto futures are highly volatile and may trade at a premium
    or discount to spot prices. | 
| SEC Warning | The SEC warned in 2021 that crypto futures are highly
    speculative investments. | 
| Benefits | Regulated exposure to crypto (CME); No need for a crypto
    wallet; Safer than direct ownership (cash settlement, position limits). | 
| Drawbacks | Extreme volatility; High leverage risk (especially on
    unregulated exchanges); Unregulated markets pose security risks (e.g.,
    ByBit hack 2025 - $1.5B lost). | 
Another
  Example: Euro
  FX Futures - Contract Specs                  
  Quiz
https://www.cmegroup.com/markets/fx/g10/euro-fx.contractSpecs.html
| Specification | Details | 
| Contract Unit | 125,000 Euro | 
| Price Quotation | U.S. dollars and cents per Euro increment | 
| Trading Hours (CME
    Globex) | Sunday - Friday 5:00 p.m. - 4:00 p.m. CT with a 60-minute
    break each day beginning at 4:00 p.m. CT | 
| Trading Hours (BTIC) | Sunday - Friday 5:00 p.m. - 4:00 p.m. CT with a trading close
    from 3:40 p.m. - 4:30 p.m. London time (9:40 a.m. - 10:30 a.m. CT) and a
    60-minute break each day beginning at 4:00 p.m. CT | 
| Trading Hours (CME
    ClearPort) | Sunday 5:00 p.m. - Friday 5:45 p.m. CT with no reporting
    Monday - Thursday from 5:45 p.m. - 6:00 p.m. CT | 
| Trading Hours (BTIC
    - ClearPort) | Sunday - Friday 5:00 p.m. - 5:45 p.m. CT with a trading halt
    9:40 a.m. to 11:30 a.m. CT, and with no reporting Monday - Thursday from
    5:45 p.m. - 6:00 p.m. CT | 
| Minimum Price
    Fluctuation (CME Globex) | 0.000050 per Euro increment = $6.25 | 
| Minimum Price
    Fluctuation (BTIC) | 0.000005 per Euro increment = $0.625 | 
| Minimum Price
    Fluctuation (Spreads) | 0.00002 per Euro increment = $2.50 | 
| Minimum Price
    Fluctuation (CME ClearPort) | 0.000010 per Euro increment = $1.25 | 
| Minimum Price
    Fluctuation (BTIC - ClearPort) | 0.000001 per Euro increment = $0.125 | 
| Product Code (CME
    Globex) | 6E | 
| Product Code (CME
    ClearPort) | EC | 
| Product Code
    (Clearing) | EC | 
| Product Code (BTIC) | 6EB | 
| Listed Contracts | Quarterly contracts (Mar, Jun, Sep, Dec) listed for 20
    consecutive quarters and serial contracts listed for 3 months | 
| Settlement Method | Deliverable | 
| Termination of
    Trading | Trading terminates at 9:16 a.m. CT, 2 business days prior to
    the third Wednesday of the contract month. | 
| Termination of
    Trading (BTIC) | Trading terminates at 3:40 p.m. London time (9:40 a.m. CT) one
    business day prior to futures last trade date. | 
| Settlement
    Procedures | Physical Delivery | 
| 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 | 
 
Short and long position
  and payoff (video)
 
Let’s Play the futures trading
  simulator game and learn how PnL is calculated.
Just like in the game:
Assume
  a trader buys one NOK/USD futures
  contract (Long
  Position) with:
This is exactly how futures trading mark-to-market (MTM) settlement
  works in real life.
For a long position, its payoff: 
Value at maturity (long position) = principal * (
  spot exchange rate at maturity  – settlement price)
Value at maturity (short position) = -principal * (
  spot exchange rate at maturity  – settlement price)
Note: In the
  calculator, principal is called contract size
Example: 
Suppose a trader enters into a currency futures
  contract to buy 10,000 euros (contract size) at a specified exchange rate of
  1.2000 USD/EUR. The settlement price at the time of entering the contract is
  also 1.2500 USD/EUR. The maturity date of the contract is in three months.
Long Position:
·       At maturity, the spot exchange rate is
  1.2500 USD/EUR.
·       Using the formula for a long position's
  payoff:
·       Value at maturity (long position) =
  Principal * (Spot exchange rate at maturity - Settlement price)
·       = 10,000 euros * (1.2500 USD/EUR - 1.2000
  USD/EUR)
·       = 10,000 euros * 0.0500 USD/EUR
·       = 500 USD
·       Therefore, the trader receives a payoff of
  500 USD from the long position.
Short Position:
·       At maturity, the spot exchange rate is
  still 1.2500 USD/EUR.
·       Using the formula for a short position's
  payoff:
·       Value at maturity (short position) =
  -Principal * (Spot exchange rate at maturity - Settlement price)
·       = -10,000 euros * (1.2500 USD/EUR - 1.2000
  USD/EUR)
·       = -10,000 euros * 0.0500 USD/EUR
·       = -500 USD
·       Therefore, the trader has to pay 500 USD
  as the payoff for the short position.
In
  summary, for a long position, the trader benefits from a favorable movement
  in the exchange rate, resulting in a positive payoff. Conversely, for a short
  position, the trader incurs losses when the exchange rate moves against their
  position, leading to a negative payoff.
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 5: 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  
 
HW of chapter
  5 part I (Due with the second mid-term)
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?
5.     Watch this video and explain the following
  concepts.  
·       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?
6.    
  A Jacksonville-based seafood company
  plans to import NOK 1,000,000 worth of salmon in the summer. Concerned about
  the potential appreciation of the NOK in the coming months due to trade
  tensions, the company seeks to hedge against exchange rate fluctuations. To
  mitigate this risk, they approach Deutsche Bank to establish a forward
  contract, securing the exchange rate at present. As the market maker for this
  forward contract, you observe that the current interest rates are 2% in the
  U.S. and 6% in Norway. How should you determine the forward rate, and what is
  the reasoning behind your calculation?
Cryptocurrency
  Futures: Definition and How They Work on Exchanges
By
  Prableen Bajpai Updated October 11, 2024
Reviewed
  by Erika Rasure
Fact checked
  by Suzanne Kvilhaug 
https://www.investopedia.com/articles/investing/012215/how-invest-bitcoin-exchange-futures.asp
What Are Cryptocurrency
  Futures?
Cryptocurrency futures are contracts between two investors who
  bet on a cryptocurrency's future price, giving them exposure to
  cryptocurrencies without purchasing them. Crypto futures resemble standard
  futures contracts because they allow traders to bet on the price trajectory
  of an underlying asset.
These contracts specify that one party must deliver a
  cryptocurrency's fiat value to another party at a specific price by a certain
  date.
Crypto futures contracts trade on the Chicago Mercantile Exchange
  (CME) and cryptocurrency exchanges. Margined futures for Bitcoin and Ether
  also trade on the Chicago Board Options Exchange (CBOE).
Key Takeaways
·      
  Cryptocurrency futures
  allow investors to speculate on the future price of cryptocurrencies.
·      
  You can choose from a
  variety of venues to trade monthly cryptocurrency futures. Some are
  regulated; others are not.
·      
  Cryptocurrency is known
  for its volatile price swings, which makes investing in cryptocurrency
  futures risky.
·      
  You can trade
  cryptocurrency futures at brokerages approved for futures and options trading
  and on many decentralized exchanges.
Cryptocurrency Futures
  History
The first Bitcoin futures contracts were listed on the CBOE in
  early December 2017, but were discontinued.
 
 In January 2024, the
  exchange announced that margined Bitcoin and Ether futures began trading.
  According to the exchange, this made it the "first U.S. regulated crypto
  native exchange and clearinghouse to offer both spot and leveraged
  derivatives trading on a single platform."
The CME introduced Bitcoin futures contracts in December 2017.
  The contracts are traded on the Globex electronic trading platform and are
  settled in cash. Bitcoin and Ether futures are based on the CME CF Bitcoin
  Reference Rate and the CME CF Ether Reference Rate.
The CME also has reference rates for many other
  cryptocurrencies, although futures for these cryptos are not available on the
  exchange for trading. These rates are published for traders using other
  exchanges. There are 17 cryptocurrency rates (including bitcoin and ether),
  four DeFi token rates, and three Metaverse token rates.
Cryptocurrency Futures on CME
The table below highlights the contract details for Bitcoin
  and ETH futures offered by the CME:
Popular Exchanges for Cryptocurrency Futures
According to data from crypto aggregation site CoinGecko, some
  prominent crypto derivative trading platforms are:
·      
  Binance: The world’s
  biggest cryptocurrency exchange by trading volume also accounted for $60.30
  billion of the total trading volume in Bitcoin futures.  
·      
  ByBit: While it may not
  be as well-known as Binance to U.S. audiences, ByBit ranks among the world’s
  biggest cryptocurrency exchanges and has 469 cryptocurrency futures
  available. It had a trading volume of $19.98 billion on Oct. 10, 2024. Due to
  regulatory compliance reasons, ByBit is not available to U.S. customers.
·      
  OKX: OKX offers 178
  cryptocurrency futures. Trading volume was $21.15 billion on Oct. 10, 2024.
·      
  XT.COM: Another
  lesser-known exchange, XT.COM was created in 2018 and has 472 crypto futures
  available. Its 24-hour trading volume is $21.15 billion, and open interest is
  $4.74 billion.
·      
  
On Feb. 21, 2025, Bybit CEO Ben Zhou announced that hackers
  infiltrated the exchange’s Ethereum multi-signature
  cold wallet, draining nearly $1.5 billion in crypto. Zhou also went on to
  state that the breach was isolated to Bybit’s Ethereum cold wallet, and that “All withdrawals are NORMAL.” Investopedia will continue to monitor the situation and
  provide updates when conditions warrant it.
Trading on Regulated vs.
  Unregulated Exchanges
Regulated Exchanges
Consider the following example for a CME Group Bitcoin futures
  contract. Suppose an investor purchases two Bitcoin futures contracts
  totaling 10 bitcoin. The price of a single bitcoin when the futures contract
  was purchased was $5,000 each, totaling $50,000 for both futures contracts.
The exchange calls for a 50% margin for Bitcoin (60% for
  Ether) futures trading, so they would need to place $25,000 in their margin
  account. The rest could be funded by leverage. 
 Brokerages offer
  futures products from many companies but can have different margin
  requirements over and above the amount the provider charges.
For example, CME has a base margin requirement for Bitcoin
  futures; brokerages like TD Ameritrade, which offers CME Bitcoin futures
  trading as part of their product suite, can set margin rates on top of the
  base rate set by the exchange.
The contract's value varies based on the underlying asset's
  price (i.e., Bitcoin). CME uses the Bitcoin Reference Rate, which is the
  volume-weighted average price for Bitcoin sourced from multiple exchanges and
  is calculated daily between 3 p.m. and 4 p.m. London time.
To trade futures, you must have an account with a registered
  futures commission merchant or introducing broker.
Depending on Bitcoin’s price fluctuations, you
  can either hold onto the futures contracts or sell them to another party. At
  the end of your contracts’ duration, you have the
  option to roll them over to new ones or let them expire and collect the cash
  settlement due.
The steps to conduct a trade in Bitcoin futures are the same
  as those for a regular futures contract. You begin by setting up an account
  with the brokerage or exchange where you plan to trade. Once your account is
  approved, you will need another approval from the trading service provider to
  start futures trading. Generally, the latter approval is a function of
  funding requirements and the account holder’s experience with derivatives trading. 
The same criteria also play an essential role in determining
  leverage and margin amounts for your trade. Futures trading makes heavy use
  of leverage to execute trades. Government agencies regulate the maximum
  leverage amount allowed at regulated exchanges and trading venues.
Bitcoin’s risky and volatile nature
  means that the margin amounts required for trading their futures are
  generally higher than those for other commodities and assets.
Unregulated Exchanges
The story is different at unregulated exchanges. They have the
  freedom to allow excessive risk-taking for their trades. For example, Binance
  offered leverage of up to 125 times the trading amount when it launched
  futures trading on its platform in 2019. 
  That figure was revised to 20 times the trading amount in July 2021.
  Remember that higher leverage amounts translate to more volatility for your
  trade. Thus, the promise of high profits is offset by the risk of losing
  significant amounts of money.
The amount you can trade depends on the margin amount
  available to you. Margin is the minimum collateral you must have in your
  account to execute trades. The higher the amount of the trade, the greater
  the margin amount required by the broker or exchange to complete the trade.
You can also gain exposure to cryptocurrency futures by
  trading cryptocurrency ETFs. There are several Bitcoin ETFs that are linked
  to Bitcoin futures.
Benefits of Cryptocurrency Futures Trading
The main advantage of trading Bitcoin futures contracts is
  that they offer regulated exposure to cryptocurrencies. That is a significant
  point in a volatile ecosystem with wild price swings. In the U.S., bitcoin
  futures contracts at CME are regulated by the Commodity Futures Trading
  Commission (CFTC). This offers a measure of confidence and recourse to
  institutional investors, who compose the majority of traders in such
  contracts.
Simplicity: Bitcoin futures also simplify the process of
  investing in Bitcoin. You do not need to create a Bitcoin wallet or put money
  into custody solutions for storage and security while trading because there
  is no bitcoin exchange. An added benefit of cash-settled contracts is
  eliminating the risk of physical ownership of a volatile asset.
Safer Than Owning Crypto: Bitcoin futures contracts are
  relatively safer for dabbling in bitcoin without getting burnt because
  futures contracts have positions and price limits that enable you to curtail
  your risk exposure to the asset class.
Position Limits: Position limits differ between exchanges. For
  example, CME allows a maximum of 8,000 front-month futures contracts for
  bitcoin and micro bitcoin and 8,000 for ether and micro ether. Binance, the
  world’s biggest cryptocurrency exchange by
  trading volume, has a position limit adjustment feature that enables manual
  reconfiguration of limits based on past trading history and margin amounts.
  The further out the futures contract expiration date is, the higher the
  account maintenance amount will generally be.
What to Consider When
  Trading Cryptocurrency Futures
The number of venues offering cryptocurrency futures trading
  is growing, as are the numbers of participants and trading volumes compared
  to other commodities. Cryptocurrency futures trading has its own set of
  peculiarities.
Trading Volume
Trading volumes in cryptocurrency futures can mimic those of
  its spot markets counterparts. Price fluctuations can also be high,
  especially during volatile stretches regarding price. During these times,
  cryptocurrency futures may appear to follow spot market prices or trade at a
  significant premium or discount to spot prices.
This means that Bitcoin futures may not offer sufficient
  protection against the volatility of the underlying futures market. The SEC
  warned investors about the pitfalls of trading cryptocurrency futures in June
  2021. "Among other things, investors should understand that [bitcoin],
  including gaining exposure through the [bitcoin] futures market, is a highly
  speculative investment." 
Most Exchanges Are Unregulated
Except for select trading venues, such as CME, cryptocurrency
  futures trading occurs mainly on exchanges outside the purview of regulation.
  Among the world’s biggest platforms for Bitcoin futures,
  only CME is regulated by the CFTC.
 
Class
  Discussion on Russian – Ukraine War
Prepare by using the
  discussion platform on the class website:
https://www.jufinance.com/fin415_25s/russian_ukrain_war_discussion_2025.html
 
Homework (due with the second midterm exam)
When do you think the
  war will end and why? 
Part
  b: Call and Put Option
1.      What is Call and put option?
  Difference between the two?
American call option (video, khan academy)
 
American put option (video, khan academy)
 
Refer to  What is Is Options
  Trading? A Beginner's Overview
Learn the benefits and risks
  of options and how to start trading options
https://www.investopedia.com/options-basics-tutorial-4583012
| Feature | Call Option  | Put Option  | 
| Definition | A
    call option
    gives the right to buy
    an asset at a set price before expiration. | A
    put option
    gives the right to sell
    an asset at a set price before expiration. | 
| Market Outlook | Bullish
    (Expect the asset price to rise) | Bearish
    (Expect the asset price to fall) | 
| Profit Potential | Unlimited
    (As the asset price rises, the value of the call increases) | Limited to the strike
    price (As the asset price falls, the value of
    the put increases) | 
| Maximum Loss | The premium paid
    (If the asset price does not increase above the strike price, the option
    expires worthless) | The premium paid
    (If the asset price does not decrease below the strike price, the option
    expires worthless) | 
| When to BUY (Go Long)? | When you expect the
    price of the asset to increase.
    Example: Buying a Call
    Option on NOK/USD when expecting NOK to strengthen (1 USD =
    11 NOK now, expect 1 USD = 9 NOK). | When you expect the
    price of the asset to decrease.
    Example: Buying a Put
    Option on NOK/USD when expecting NOK to weaken (1 USD = 11
    NOK now, expect 1 USD = 13 NOK). | 
| When to SELL (Go Short)? | When you think the
    asset will NOT rise much or will fall.
    Example: Selling a Call
    Option on Tesla stock if you believe it will stay the same
    or decline. | When you think the
    asset will NOT fall much or will rise.
    Example: Selling a Put
    Option on NOK/USD if you believe NOK will strengthen
    against USD. | 
| Best Used For | Speculation
    (Profiting from a price increase) or hedging
    short positions. | Speculation
    (Profiting from a price decrease) or hedging
    long positions. | 
| Example 1 (Stock) | You
    buy a Call Option
    on Apple stock
    at $150. If the price rises to $180, you profit. | You
    buy a Put Option
    on Apple stock
    at $150. If the price drops to $120, you profit. | 
| Example 2 (Currency) | You
    buy a Call Option on NOK/USD
    (strike price: 11
    NOK per USD). If NOK strengthens (1 USD = 9 NOK), you profit. | You
    buy a Put Option on NOK/USD
    (strike price: 11
    NOK per USD). If NOK weakens (1 USD = 13 NOK), you profit. | 
| Example 3 (Commodities) | You
    buy a Call Option on Oil at
    $80/barrel. If oil rises to $100, you profit. | You
    buy a Put Option on Oil at
    $80/barrel. If oil drops to $60, you profit. | 
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
 
1.    
   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
  $1.41, 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)
2.    
  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
  $1.50, 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.
www.jufinance.com/option_diagram
 
  
 
  
Summary
           
| Strike Price < Current Price  |  Strike Price = Current Price  |  Strike Price > Current Price  | 
|  Call Option: In the Money     |  Call Option: At the Money     |  Call Option: Out of the Money  | 
|  Put Option: Out of the Money  |  Put Option: At the Money      |  Put Option: In the Money      | 
  
  Payoff for Call
  Option (X = Strike, S = Current Price):
·      
  In the Money: S - X
·      
  At the Money: 0
·      
  Out of the Money: 0
    Payoff
  for Put Option (X = Strike, S = Current Price):
·      
  In the Money: X - S
·      
  At the Money: 0
·      
  Out of the Money: 0
Objective:
  This exercise will help you understand how currency options work and how they
  are priced in the market. You will use Investing.com’s EUR/USD Options page to analyze current
  market data.
1.    
  Access
  the Data:
2.    
  Observe
  the Key Elements:
3.    
  Compare
  Different Expiration Dates:
4.    
  Scenario
  Analysis:
5.    
  Discussion
  Questions:
Prepare a short report (1 page)
  summarizing your findings. Include:
What is Is Options
  Trading? A Beginner's Overview
Learn the benefits and
  risks of options and how to start trading options
https://www.investopedia.com/options-basics-tutorial-4583012
By Lucas Downey Updated November 15, 2024; Reviewed by
  Samantha Silberstein; Fact checked by Vikki Velasquez
 
Options are financial contracts that give the holder the
  right to buy or sell a financial instrument at a specific price for a certain
  period of time. Options are available for numerous financial products, such
  as stocks, funds, commodities, and indexes. Like most other asset classes,
  options can be purchased with brokerage investment accounts.
Options trading may seem overwhelming at first, but it’s
  easy to understand if you know a few key points. Investor portfolios are
  usually constructed with several asset classes. These may be stocks, bonds,
  exchange-traded funds (ETFs), and mutual funds. Options are another asset
  class, and when used correctly, they offer many advantages that trading stocks
  and ETFs alone cannot.
There are three key features of options:
·       Strike price: This is the price at which an option can be
  exercised.
·       Expiration date: This is the date at which an option
  expires and becomes worthless.
·       Option premium: This is the price at which an option is
  purchased.
Key Takeaways
·       An option is a contract giving the buyer the right—but not
  the obligation—to buy (in the case of a call) or sell (in the case of a put)
  the underlying asset at a specific price on or before a certain date.
·       People use options for income, to speculate, and to hedge
  risk.
·       Options are known as derivatives because they derive their
  value from an underlying asset.
·       A stock option contract typically represents 100 shares of
  the underlying stock, but options may be written on any sort of underlying
  asset from bonds to currencies to commodities.
Why Trade Options?
Options are powerful because they can enhance an
  individual’s portfolio, adding income, protection, and even leverage.
  Depending on the situation, there is usually an option scenario appropriate
  for an investor’s goal.
Options can be used as a hedge against a declining stock
  market to limit downside losses. In fact, options were really invented for
  hedging purposes. Hedging with options is meant to reduce risk at a
  reasonable cost. Just as you insure your house or car, options can be used to
  insure your investments against a downturn.
Imagine that you want to buy technology stocks, but you
  also want to limit losses. By using put options, you could limit your
  downside risk and cost-effectively enjoy all the upside. For short sellers,
  call options can be used to limit losses if the underlying price moves
  against their trade—especially during a short squeeze.
Options can also be used for speculation. Speculation is a
  wager on future price direction. A speculator might think the price of a
  stock will go up, perhaps based on fundamental analysis or technical
  analysis.
A speculator might buy the stock or buy a call option on
  the stock. Speculating with a call option—instead of buying the stock
  outright—is attractive to some traders because options provide leverage. An
  out-of-the-money call option may only cost a few dollars or even cents
  compared with the full price of a $100 stock.
Options Are Derivatives
Options belong to the larger group of securities known as
  derivatives. A derivative’s price is dependent on or derived from the price
  of something else. Options are derivatives of financial securities—their
  value depends on the price of some other asset. Examples of derivatives
  include calls, puts, futures, forwards, swaps, and mortgage-backed
  securities, among others.
How to Trade Options
Many brokers today allow access to options trading for
  qualified customers. If you want access to options trading, you will have to
  be approved for both margin and options with your broker. 
Once approved, there are four basic things you can do with
  options:
·       Buy (long) calls
·       Sell (short) calls
·       Buy (long) puts
·       Sell (short) puts
Buying stock gives you a long position. Buying a call
  option gives you a potential long position in the underlying stock.
  Short-selling a stock gives you a short position. Selling a naked or
  uncovered call gives you a potential short position in the underlying stock.
Buying a put option gives you a potential short position in
  the underlying stock. Selling a naked or unmarried put gives you a potential
  long position in the underlying stock. Keeping these four scenarios straight
  is crucial.
People who buy options are called holders, and those who
  sell options are called writers of options. Here is the important distinction
  between holders and writers:
Call holders and put holders (buyers) are not obligated to
  buy or sell. They have the choice to exercise their rights. This limits the
  risk of buyers of options to only the premium spent.
Call writers and put writers (sellers), however, are
  obligated to buy or sell if the option expires in the money. This means that
  a seller may be required to make good on a promise to buy or sell. It also
  implies that option sellers have exposure to more—and in some cases,
  unlimited—risks. This means writers can lose much more than the price of the
  options premium.
Options can also generate recurring income. Additionally,
  they are often used for speculative purposes, such as wagering on the
  direction of a stock. 
How Do Options Work?
In terms of valuing option contracts, it is essentially all
  about determining the probabilities of future price events. The more likely
  something is to occur, the more expensive an option that profits from that
  event would be. For instance, a call value goes up as the stock (underlying)
  goes up. This is the key to understanding the relative value of options.
The less time there is until expiry, the less value an
  option will have. This is because the chances of a price move in the
  underlying stock diminish as we draw closer to expiry. This is why an option
  is a wasting asset. If you buy a one-month option that is out of the money,
  and the stock doesn’t move, the option becomes less valuable with each
  passing day.
Because time is a component of the price of an option, a
  one-month option is going to be less valuable than a three-month option. This
  is because with more time available, the probability of a price move in your
  favor increases, and vice versa.
Accordingly, the same option strike that expires in a year
  will cost more than the same strike for one month. This wasting feature of
  options is known as time decay. The same option will be worth less tomorrow
  than it is today if the price of the stock doesn’t move.
Volatility also increases the price of an option. This is
  because uncertainty pushes the odds of an outcome higher. If the volatility
  of the underlying asset increases, larger price swings increase the
  possibility of substantial moves both up and down.
Greater price swings will increase the chances of an event
  occurring. Therefore, the greater the volatility, the greater the price of
  the option. Options trading and volatility are intrinsically linked to each
  other in this way.
On most U.S. exchanges, a stock option contract is the
  option to buy or sell 100 shares; that’s why you must multiply the contract
  premium by 100 to get the total amount you’ll have to spend to buy the call.
 
Call Options
A call option gives the holder the right, but not the
  obligation, to buy the underlying security at the strike price on or before
  expiration. A call option will therefore become more valuable as the
  underlying security rises in price (calls have a positive delta).
A long call can be used to speculate on the price of the
  underlying rising since it has unlimited upside potential, but the maximum
  loss is the premium (price) paid for the option.
Call Option Basics
Call Option Example
A potential homeowner sees a new development going up. That
  person may want the right to purchase a home in the future but will only want
  to exercise that right after certain developments around the area are built.
The potential homebuyer would benefit from the option of
  buying or not. Imagine they can buy a call option from the developer to buy
  the home at, say, $400,000 at any point in the next three years. Well, they
  can—you know it as a non-refundable deposit.
Naturally, the developer wouldn’t grant such an option for
  free. The potential homebuyer needs to contribute a down payment to lock in
  that right.
With respect to an option, this cost is known as the
  premium. It is the price of the option contract. In our home example, the
  deposit might be $20,000 that the buyer pays the developer.
Let’s say two years have passed, and now the developments
  are built and zoning has been approved. The homebuyer exercises the option
  and buys the home for $400,000 because that is the contract purchased.
The market value of that home may have doubled to $800,000.
  But because the down payment locked in a predetermined price, the buyer pays
  $400,000.
Now, in an alternate scenario, say the zoning approval
  doesn’t come through until year four. This is one year past the expiration of
  this option. Now the homebuyer must pay the market price because the contract
  has expired. In either case, the developer keeps the original $20,000
  collected.
Put Options
Opposite to call options, a put gives the holder the right,
  but not the obligation, to instead sell the underlying stock at the strike
  price on or before expiration.
A long put, therefore, is a short position in the
  underlying security, since the put gains value as the underlying price falls
  (they have a negative delta). Protective puts can be purchased as a sort of
  insurance, providing a price floor for investors to hedge their positions.
Put Option Basics
Put Option Example
Now, think of a put option as an insurance policy. If you
  own your home, you are likely familiar with the process of purchasing
  homeowner’s insurance. A homeowner buys a homeowner’s policy to protect their
  home from damage.
They pay an amount called a premium for a certain amount of
  time—let’s say a year. The policy has a face value and gives the insurance
  holder protection in the event the home is damaged.
What if, instead of a home, your asset was a stock or index
  investment? Similarly, if an investor wants insurance on their S&P 500
  index portfolio, they can purchase put options.
An investor may fear that a bear market is near and may be
  unwilling to lose more than 10% of their long position in the S&P 500
  index. If the S&P 500 is currently trading at $2,500, they can purchase a
  put option giving them the right to sell the index at $2,250, for example, at
  any point in the next two years.
If in six months the market crashes by 20% (500 points on
  the index), they have made 250 points by being able to sell the index at
  $2,250 when it is trading at $2,000—a combined loss of just 10%.
In fact, even if the market drops to zero, the loss would
  only be 10% if this put option is held. Again, purchasing the option will
  carry a cost (the premium), and if the market doesn’t drop during that period,
  the maximum loss on the option is just the premium spent.
How To Buy and Sell Bitcoin
  Options 
Learn what it takes to buy
  and sell Bitcoin options
By ALEX LIELACHER
  Updated February 11, 2024, Fact checked by SUZANNE KVILHAUG
https://www.investopedia.com/how-to-buy-and-sell-bitcoin-options-7378233
Bitcoin options are financial derivatives that enable
  investors to speculate on the price of the digital currency with leverage or
  hedge their digital asset portfolios. Available on both
  traditional derivatives exchanges and on crypto trading platforms, Bitcoin
  options have emerged as a popular investment product among advanced crypto
  traders. 
KEY TAKEAWAYS
·       Bitcoin options are financial derivatives contracts
  that allow you to buy or sell Bitcoin at a predetermined price on a specific
  future date.
·       Trading Bitcoin and other cryptocurrency options
  works much the same as other options, except they're typically less liquid.
·       There are some trading platforms and crypto
  exchanges where you can trade Bitcoin options; but you'll need to set up and
  fund an account first.
·       Trading Bitcoin options is riskier and more complex
  than trading spot Bitcoin, which is itself risky and speculative.
·       Traders should conduct as much research as possible
  (including consulting with a financial advisor) before trading Bitcoin
  options, and must select a reputable reputable crypto derivatives exchange
  with strong security for their trades.
·       Understanding Bitcoin Options
Options are financial
  derivatives contracts that give holders the right but not the obligation to
  buy or sell a predetermined amount of an asset at a specified price, and at a
  specific date in the future.
In the case of Bitcoin options, the underlying asset is the
  cryptocurrency Bitcoin (BTC). While the
  cryptocurrency options market is still fairly new, you can already trade
  Bitcoin and Ethereum options on a handful of traditional securities exchanges
  and crypto trading platforms. 
Traders who wish to
  gain exposure to Bitcoin now have additional choices. The 11 recently launched spot Bitcoin exchange-traded funds (ETFs),
  which were approved by the U.S. Securities and Exchange Commission in January
  2024, each offer a basket of cryptocurrency securities and can be traded on
  Cboe BZX, NYSE Arca, and Nasdaq.
From a technical
  point of view, cryptocurrency options and options contracts on assets like
  stocks, indexes, or commodities function in essentially the same way. However,
  crypto options are generally less
  liquid than options on leading stock indexes or commodities like gold.
  That’s a result of the crypto markets still being a lot smaller than
  traditional investment markets. 
European vs. American
There are two main types
  of options contracts: European and American. The key difference between the
  two is that European-style options can only be exercised at expiration, while
  American-style options can be exercised at any time up until the expiry date.
  
ITM vs. ATM vs. OTM
An options position
  can either be in the money, at the money, or out of the money. 
·       An in-the-money (ITM) option refers to the situation
  when the option has intrinsic value. If you exercised an in-the-money option
  you would profit. For call options, this is when the market price is higher
  than the strike price. Put options are in-the-money when the market price is
  below the strike price.
·       An out-of-the-money (OTM) option refers to a
  situation when you would lose money if you exercised the option, meaning the
  option currently has no intrinsic value. In the case of call options, this is
  when the market price is lower than the strike price. For put options, this
  is when the market price is higher than the strike price.
·       An at-the-money (ATM) option is currently trading at
  the strike price. 
Calls vs. Puts
You can either buy a call or a put option. A call gives the
  holder the right to buy the underlying asset, while a put option gives the
  holder the right to sell the underlying asset. 
Whether you buy or
  sell a Bitcoin put option or call option depends on whether you want to
  speculate on a rising or falling price or whether you are looking to hedge
  crypto exposure. 
Physical vs. Cash Settle
Options can either be cash settled or physically settled. For example, if you trade cocoa options, you could—if the options
  contract determines it—receive shipments of cocoa once the options contract
  expires.
When bitcoin options are settled physically, the bitcoin is
  transferred between the two parties. When cash settlement is used, the
  parties would exchange dollars or another currency.
Investing in cryptocurrencies, decentralized finance
  (DeFi), and initial coin offerings (ICOs) is highly risky and speculative, and the markets can be extremely
  volatile. Consult with a qualified professional before making any
  financial decisions.
Options Are Riskier Than Spot Trading
Trading Bitcoin options is generally riskier than buying
  and selling Bitcoin in the spot market.
For example, suppose you buy a call option on Bitcoin with
  a strike price of $35,000 and an expiry date that is three months away. If
  the price of Bitcoin doesn’t surpass $35,000 by the expiration date, you will
  lose the options premium (the price you paid for the option) in full. 
Options Are More Complex Than Spot Trading
When trading Bitcoin
  options, the price of Bitcoin is not the only factor affecting the value of
  options contracts. There are several key factors that affect the value of the
  options you buy or sell, but time decay is by far the most critical. That’s
  because as the time moves closer to the expiry date, the value of an options
  contract decreases because the time remaining to trade or exercise the
  options diminishes.
The Bitcoin Options Market Is Less Established 
While Bitcoin options
  can be found on traditional securities exchanges, like the Chicago Mercantile
  Exchange (CME), and on dedicated crypto trading platforms, the BTC options market is still quite
  young and doesn’t have the deep liquidity found in mature options markets. This
  can affect price slippage, especially in options with longer maturities. 
HW
  Chapter 5 Part II (Due with the
  second midterm exam)
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. 
Second Midterm
  Exam ---- 3/27(Closed Book Closed Notes)
·    
  Solution
Study Guide 
40 t/f questions from the
  following topics (40*2=80)
| Feature | Forward | Futures | 
| Trading
    Venue | OTC
    (Bank-to-Bank) | Exchange-traded
    (e.g., CME) | 
| Customization | Fully
    customizable | Standardized
    contracts | 
| Regulation | Not
    regulated | Regulated
    by exchanges | 
| Counterparty
    Risk | High
    (credit risk) | Low
    (guaranteed by clearinghouse) | 
| Margin
    Requirements | No
    daily margin; credit line needed | Requires
    margin + daily mark-to-market | 
| Flexibility
    & Liquidity | Flexible
    but less liquid | Less
    flexible but highly liquid | 
| Term | Meaning | 
| Initial Margin | Deposit
    to open position | 
| Maintenance Margin | Minimum
    balance to keep it open | 
| Mark-to-Market (MTM) | Daily
    profit/loss adjustment | 
| Margin Call | Add
    funds if margin falls below required | 
| Feature | Call Option | Put Option | 
| Right
    to... | Buy
    asset at strike price | Sell
    asset at strike price | 
| Market
    Expectation | Bullish
    (expect price to rise) | Bearish
    (expect price to fall) | 
| Max
    Profit | Unlimited
    (if price rises) | Limited
    (to strike price) | 
| Max
    Loss | Premium
    paid | Premium
    paid | 
V.
  5 calculation questions based on futures payoff and call/put options (long
  position only), similar to the homework questions. Total:
  5 questions, 4 points each, for a total of 20 points.
| Q# | Type | Details | Formula / Explanation | Payoff | 
| 1 | Futures – Long | Buy 800,000 NOK @ $0.098 | 800,000 × (0.102 − 0.098) | $3,200 profit | 
| Spot at maturity = $0.102 | ||||
| 2 | Futures – Long | Buy 1,000,000 NOK @ $0.100 | 1,000,000 × (0.093 − 0.100) = -7,000 | $7,000 loss | 
| Spot at maturity = $0.093 | ||||
| 3 | Call Option – Long | Strike = $0.10, Spot = $0.11, Premium = $0.007 | Spot > Strike → exercised.  Payoff = (0.11 − 0.10) × 1,000,000 = 10,000 = 10,000 Profit = (0.11 − 0.10 − 0.007) * 1,000,000 = 3,000 | $3,000 profit | 
| Contract size = 1,000,000 NOK | ||||
| 4 | Call Option – Long | Strike = $0.10, Spot = $0.095, Premium =$ 0.006 | Spot < Strike → Not exercised. Payoff = 0 | $3,000 loss | 
| Contract size = 500,000 NOK | Profit = −0.006 × 500,000 = 3,000 | |||
| 5 | Put Option – Long | Strike = $0.105, Spot = $0.120, Premium = $0.006 Contract size = 750,000 NOK | Spot > Strike → Not exercised. Payoff = 0.  Profit = -−0.006 × 750,000 = 4,500 | $4,500 loss | 
| 6 | Put Option – Long | Strike = $0.105, Spot = $0.09, Premium = $0.006 | Spot < Strike → exercised.  Payoff = (0.105 − 0.09) × 750,000 =11,250 Profit = (0.105 − 0.09 − 0.006) × 750,000 = 0.009
    × 750,000 = 6,750 | $6,750 profit | 
| Contract size = 750,000 NOK | 
Chapter
  8 Purchasing Power Parity 
 
·      Quiz       
  
 
1)      Purchasing power parity (PPP)  
Purchasing power parity (cartoon) https://www.youtube.com/watch?v=i0icL5zlQww
 
|   | 
| ·      
    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. | 
| Concept | Explanation | 
| Definition | In the absence of transaction costs, the same product should
    have the same price in all
    markets when expressed in a common currency. | 
| Condition | No transportation costs, tariffs, or other barriers to trade. | 
| Implication | Exchange rates adjust so identical goods cost the same across
    countries. | 
| Formula | 𝑃$ = 𝑃¥ × Spot Rate ($/¥) | 
| Or Rearranged | Spot Rate ($/¥) = 𝑃$ / 𝑃¥ | 
| Example | If a laptop costs $1,000 in the US and ¥120,000 in Japan →
    Spot Rate = $1,000 / ¥120,000 = $0.0083/¥; 
    or Spot Rate = ¥120,000 / $1,000 = ¥120/$ | 
·       Law of One Price – When
  It Holds vs. When It Doesn’t
| Condition | Holds | Does NOT Hold | 
| Identical Products | Products are exactly the same | Products differ in features, brand perception, etc. | 
| No Transportation Costs | Shipping is free or negligible | Shipping, logistics costs vary across countries | 
| No Tariffs or Trade Barriers | No import/export taxes | Countries impose tariffs or quotas | 
| No Transaction Costs or Taxes | No middlemen fees or sales taxes | Presence of local taxes, fees, or dealer markups | 
| Perfect Competition | Many sellers, no price manipulation | Monopolies or oligopolies influence local pricing | 
| Free Market Exchange Rates | Currencies can float freely | Government intervention distorts exchange rate equilibrium | 
·       Limitations of the
  Law of One Price      
| Limitation | Explanation | 
| Transportation Costs | Shipping and handling can drive up local prices | 
| Non-traded Goods | Services or perishable goods aren’t easily traded across
    borders | 
| Government Policies | Tariffs, subsidies, and capital controls distort prices | 
| Market Segmentation | Different markets may have unique demand and cost structures | 
| Exchange Rate Volatility | Short-term fluctuations may prevent price equalization | 
| Menu Costs | Firms may not adjust prices frequently due to cost or pricing
    strategy | 
| Branding and Consumer Preferences | Local consumer behavior or brand loyalty can affect pricing
    power | 
In Class Discussion: Can Bitcoin Obey the
  Law of One Price?                   Game            Quiz
| Factor | Can Bitcoin Hold the Same Price Globally? | Why / Why Not? | 
| Global Accessibility |  Yes, in theory | Bitcoin is decentralized and traded 24/7 across global
    platforms. Prices should converge across borders. | 
| No Trade Barriers |  Yes | There are no tariffs or borders for digital assets—Bitcoin
    doesn’t need to be shipped or cleared through customs. | 
| Exchange Rate Influence |  Partially | Bitcoin trades in local currencies. If local fiat currencies
    fluctuate, BTC's local price can vary temporarily. | 
| Arbitrage |  Helps Maintain | Traders exploit price differences across exchanges, which
    tends to bring global BTC prices back into alignment. | 
| Transaction Fees | ❌ Distortion | Blockchain and exchange fees can vary country to country and
    reduce arbitrage efficiency. | 
| Government Regulations | ❌ Major Obstacle | Countries like China, Nigeria, or India have restricted access
    to crypto, causing market fragmentation and price differentials. | 
| Liquidity Differences | ❌ Limited in Some Places | Smaller exchanges in emerging markets may have lower
    liquidity, resulting in price discrepancies. | 
| Capital Controls | ❌ Distortion | In some countries, it’s hard to convert BTC to local fiat due
    to banking regulations. | 
Conclusion:
  
·      
  Bitcoin does not always
  obey the Law of One Price perfectly, but it comes closer than most physical goods,
  especially in liquid markets
  (like the US, EU, Japan). 
·      
  Price gaps exist but are usually small and
  short-lived due to arbitrage.
·      
  ? What is your opinion?

| https://www.jufinance.com/ppp 
 | 
 
| ·       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                     Big Mac Game
·      
  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.
 
Example 1: 1£=1.6$.
  US inflation rate is 9%. UK inflation is 5%. What will happen? Calculate the
  new exchange rate using the following equation.
Math equation: ef= Ih-
  If  or ((1+ Ih)/(1+If)
  -1= ef;      ef: change in exchange rate
(1+ 9%) /(1+5%)
  -1 =  ef = 4% , and 1£=1.6$, so the new
  rate of £ =1.6*(1+4%) = 1.66 $/£.
Or use the calculator at: https://www.jufinance.com/ife/
Let's
  consider an example where a product costs £1 in the UK and $1.6 in the US. If
  there's a 5% increase in prices in the UK, the new price becomes £1 * (1 +
  5%). Simultaneously, with a 9% inflation rate in the US, the new price in the
  US should be $1.6 * (1 + 9%).
According
  to the theory of Purchasing Power Parity (PPP), these adjusted prices should
  reflect the same purchasing power across currencies. Thus, we can equate the
  new prices and solve for the new exchange rate:
·      
  New Price in UK = £1 * (1 + 5%)
·      
  New Price in US = $1.6 * (1 + 9%)
To
  find the new exchange rate:
New
  Exchange Rate = New Price in US / New Price in UK
Substituting
  the values:
New
  Exchange Rate = ($1.6 * (1 + 9%)) / (£1 * (1 + 5%))
This
  simplifies to:
·      
  New Exchange Rate = $1.6 * (1 + 9%) / (£1
  * (1 + 5%))
·      
  New Exchange Rate = $1.6 * 1.09 / (£1 *
  1.05)
·      
  New Exchange Rate = $1.744 / £1.05
·      
  New Exchange Rate ≈ $1.66 per £
So,
  based on PPP theory, the new exchange rate would be approximately $1.66 per
  £.
 
Example
  2: 1£=1.6$. US inflation rate is 5%. UK
  inflation is 9%. What will happen? Calculate the new exchange rate using the
  PPP equation.
ef = Ih – If, Ih=
  5%, If =9%, so ef =
  5%-9% = -4%, so the old rate is that 1£=1.6$. The new rate should be 4%
  lower. So new rate is that  1£=1.6*(1-4%) = 1.54$
Or,  https://www.jufinance.com/ife/
Let's
  reconsider the scenario with the US experiencing a 5% inflation rate and the
  UK facing a 9% inflation rate. In this case, the new prices in both countries
  would adjust accordingly:
·      
  Original price in the UK: £1
·      
  Original price in the US: $1.6
After
  a 9% inflation rate in the UK and a 5% inflation rate in the US:
·      
  New price in the UK = £1 * (1 + 9%)
·      
  New price in the US = $1.6 * (1 + 5%)
According
  to the theory of Purchasing Power Parity (PPP), these adjusted prices should
  be equalized by the exchange rate:
New
  Exchange Rate = New Price in US / New Price in UK
Substituting
  the values:
New
  Exchange Rate = ($1.6 * (1 + 5%)) / (£1 * (1 + 9%))
This
  simplifies to:
·      
  New Exchange Rate = $1.6 * (1 + 5%) / (£1
  * (1 + 9%))
·      
  New Exchange Rate = $1.6 * 1.05 / (£1 *
  1.09)
·      
  New Exchange Rate = $1.68 / £1.09
·      
  New Exchange Rate ≈ $1.54 per £
So,
  based on PPP theory, the new exchange rate would be approximately $1.54 per
  £.
 Homework
  – (due with final)
1.    
  A product costs £1 in the UK and 16 NOK in Norway.
  Next year, the inflation rate in the
  UK is 5%, and the inflation
  rate in Norway is 9%.
According to the Purchasing Power Parity (PPP)
  theory:
2.     Suppose the current exchange rate is 1€ = $1.10.
  The inflation rate in the Eurozone is
  expected to be 6%, while the inflation rate in the US is expected to be 3% over the next year.
Homework:
  Critical Thinking Challenge
Arbitrage involves buying a product
  in one market where it's cheaper and simultaneously selling it in another
  market where it's more expensive—profiting from the
  price difference. While this is often discussed with currencies or financial
  instruments, physical products
  (like gold, crude oil, or luxury goods) can also present arbitrage
  opportunities.
You notice that the price of gold in Dubai is $3,000 per ounce, while in
  New York, the price is $3,100 per ounce.
  Transportation and insurance costs per ounce are $20.
Sam Bankman
  Fried Explains His Arbitrage Techniques
https://finance.yahoo.com/news/sam-bankman-fried-explains-arbitrage-132901181.html
Nicholas
  Pongratz
April
  9, 2021 3 min read
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.”
Takeaway
Chapter 7   Interest Rate Parity
 
·       Interest rate parity calculator  https://www.jufinance.com/irp/
 ·         The interest rate parity implies that
  the expected return on domestic assets = the exchanged rate adjusted expected
  return on foreign currency assets.
·       Currencies
  with higher interest rates
  should depreciate in the future
  — enough to offset the interest
  rate advantage.
IRP is based on that “Investors cannot earn
  arbitrage profits” by
| Feature | Interest Rate Parity (IRP) | International Fisher Effect (IFE) | Purchasing Power Parity (PPP) | 
| Core Idea | Interest rate differences determine the forward rate
    premium/discount. | Interest rate differences reflect expected currency
    depreciation. | Inflation differences drive exchange rate changes. | 
| Key Variables | Interest rates, spot & forward rates | Interest rates, expected future spot rate | Inflation rates, spot & future exchange rates | 
| Equation (Approx.) | (Forward Rate - Spot
    Rate) / Spot Rate ≈ Interest Rate (quoted) - Interest Rate (base); Or  (F - S0) / S0 ≈ i_quoted - i_base Eg: USD/NOK = 10è 1 USD = 10 NOK è USD is the base currency; NOK is the quoted
    currency | (Expected Spot Rate
    - Spot Rate) / Spot Rate ≈ 
    Interest Rate (quoted) - Interest Rate (base); Or  (E[S1] 
    - S0) / S0 ≈ i_quoted - i_base Eg: USD/NOK = 10è 1 USD = 10 NOK è USD is the base currency; NOK is the quoted
    currency | (Expected Spot Rate
    - Spot Rate) / Spot Rate ≈ Inflation Rate (Home) - Inflation Rate
    (Foreign); Or  (E[S1] - S0) / S0 ≈ π_quoted -
    π_base Eg: USD/NOK = 10è 1 USD = 10 NOK è USD is the base currency; NOK is the quoted
    currency | 
| What it compares | Forward exchange rate vs. interest rate difference | Expected future spot rate vs. interest rate difference | Expected future spot rate vs. inflation difference | 
| Assumption | Arbitrage-free forward FX market | Equal real returns across countries | Law of one price holds across borders | 
| Used for | Forward FX pricing and hedging | Forecasting currency movements | Long-run real exchange rate alignment | 
| Prediction Type | Forward rate | Expected future spot rate | Expected future spot rate | 
·      
  Formula:
  (F - S0) / S0 = i_NOK - i_USD  (hint: 1
  USD = 10 NOK; so USD is the base currency and NOK is the quoted currency)
·      
  (Forward Rate - 10) / 10 = 0.03 - 0.05
  (Forward Rate - 10) = 10 * (-0.02) = -0.20
  Forward Rate = 10 - 0.20 = 9.8
  NOK/USD
·      
  Formula:
  (Expected Spot Rate - S0) / S0 = i_NOK - i_USD  
·      
  Step-by-step:
  (Expected Spot Rate - 10) / 10 = 0.03 - 0.05
  (Expected Spot Rate - 10) = 10 * (-0.02) =-0.20
  Expected Spot Rate = 10 - 0.20 = 9.8 NOK/USD
·      
  Formula:
  (Expected Spot Rate - S0) / S0 = Inflation_NOK - Inflation_USD
·      
  Step-by-step:
  (Expected Spot Rate - 10) / 10 = 0.01 - 0.03
  (Expected Spot Rate - 10) = 10 * (-0.02) = -0.20
  Expected Spot Rate = 10 - 0.20 = 9.8 NOK/USD
For discussion:
Should you invest in the U.S. for 5% or the U.K. for 10%?
It makes no difference
  at all!
  Thanks to Interest Rate Parity
  (IRP), returns should be equal when forward contracts are
  used — meaning no
  arbitrage opportunity exists.
Option 2: Invest in the U.K.
  with forward contract
•           Step 1: Convert USD to GBP
1500/1.5=1000
  GBP
•           Step 2: Invest at 10% in UK
1000×(1+0.10)=1100
  GBP
•           Step 3: Use forward rate to lock in
  USD return
1100×1.4318=$1575,
  so the forward rate has to be $1.4318 per GBP.
Forward Rate Derivation:
·       To prevent arbitrage, the forward rate (F)
  must satisfy IRP:
·       F=S×(1+i_quoted) / (1+i_base)
·       F =1.5×(1+0.05) / (1+0.10)=$1.4318 per GBP.
Conclusion:
Whether
  you:
Your return = 5% in USD either way
This
  demonstrates covered interest rate
  parity (CIRP) - ensuring no arbitrage in efficient global
  markets.
Equation:
Forward Rate = Spot
  Rate * [(1 + Interest Rate of quoted currency) / (1 + Interest Rate of
  base currency)]
Spot rate:  
  ¥/$, or USD/YEN (Yen is the quoted and $ is the base)
Or, 
Forward Rate = Spot
  Rate * ( Interest Rate of  quoted
  currency -  Interest Rate of  base 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
 
Exercise 1:  i$ is
  8%; iSF  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%; iyen  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 693.33 £ * 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. 
 
 
  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.

  
  
Special Topic:
  Currency Carry Trade
| Feature | Covered Interest Rate Parity (IRP / CIRP) | Uncovered Interest Rate Parity (UIP) | 
| Uses Forward Contract? |  Yes — forward rate is
    locked in |  No — relies on expected
    future spot rate | 
| Exchange Rate Risk |  Hedged — no exposure |  Exposed — risk of
    unexpected FX movements | 
| Key Assumption | No arbitrage in covered markets | Investors expect equal returns across currencies, even with FX
    risk | 
| Theory Predicts | Forward premium/discount reflects interest rate differential | High-interest-rate currency will depreciate to offset
    higher return | 
| Common Application | Hedging, FX arbitrage, pricing forward contracts | Explains expected FX movement (theoretical) | 
| Real Market Behavior |  Usually holds —
    enforced by arbitrage |  Often fails — leads to carry
    trade opportunities | 
| Investor Action | Arbitrageurs exploit forward mispricing | Traders borrow low-rate currency, invest in high-rate one | 
| Example (2024–2025) | Use forward contracts to hedge USD/JPY exposure | Carry trade: borrow JPY (~0%), invest in USD (~5.5%), earn
    spread | 
·      
  Borrow cheap money
  in a low-interest country, convert to a high-interest currency,
  invest, and profit from the interest rate spread.
·      
  No need for complicated trades — just ride the interest rate gap.
| Currency | Used For | When It Was Popular | Why It's (Not) Popular Now | 
| Japanese Yen (JPY) | Borrowing
    (funding) | Popular
    for 20+ years
    (since 1990s) | Still
    very popular – near
    0% rate, very stable | 
| Swiss Franc (CHF) | Borrowing
    (funding) | Gained
    popularity in 2000s–2010s | Still
    used, but less than JPY – slightly higher rates,
    still low risk | 
| U.S. Dollar (USD) | Investing
    (target) | Always
    in demand, but especially
    2022–2024 | Very
    popular now – high yield, strong
    economy | 
·      
  Carry trade works when the market is calm and rates are wide
  apart.
·      
  It fails when FX volatility returns or central banks surprise.
Homework chapter 7 (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 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.
6.  You are a global
  investor in early 2025. You notice that:
Part A. Would it be profitable to use a carry trade strategy in this situation?
  Explain your answer clearly in 1–2
  sentences, using the concepts of interest rate differential and exchange rate risk.
Part B. If suddenly Japan raises its interest rate from 0% to 3%, what could
  happen to carry trade positions involving JPY/USD?
  Explain in your own words how
  this affects investor profits.
  
Special Topic:
  What are
  the domestic and global economic and political implications of the 2025 U.S.
  tariff policy?
Home
  Questions (due with final)
·      
  What economic effects
  will the 10% blanket tariff have on consumers and businesses?
·      
  How might affected
  countries respond to these tariffs?
·      
  Do you think tariffs are
  effective tools for strengthening national economies? Why or why not?
·      
  Which U.S. reactions do
  you find most compelling or concerning, and why?
Chapter 11: Managing Transaction Exposure
·      
  Play
  this Importing Transaction Exposure Game
·      
  Play
  this Exporting Transaction Exposure Game
·      
  Quiz on Importing Transaction Exposure
·      
  Quiz on Exporting Transaction Exposure
Summary Table:
  Transaction Exposure & Hedging Tools
| What is Transaction Exposure? | The risk from exchange rate fluctuations after entering a
    financial obligation involving foreign currency. | 
| Who is affected? | The party that must settle in foreign currency — usually the
    buyer or borrower. | 
| Example | A U.S. firm agrees to pay €100,000 in 30 days. If EUR
    appreciates, it costs more USD at settlement. | 
| Types of FX Exposure | - Transaction: Short-term contract risk | 
| - Operating (Economic): Long-term impact on cash flows | |
| - Translation: Accounting adjustments | |
| How to Hedge | See below — different strategies depending on whether you will
    pay or receive foreign currency. | 
Hedging Strategies
  Overview
| Hedging Tool | Use Case | Action | Explanation | 
| Forward Contract | Pay or receive foreign currency | Lock in exchange rate today | Eliminates future uncertainty by setting the rate upfront | 
| Money Market Hedge | Pay or receive foreign currency | Borrow/invest based on timing | Use interest rates + spot rate to lock in future value | 
| Call Option | Importing: Must pay foreign currency | Buy call option on foreign currency | Protects against appreciation of foreign currency (you can buy
    at strike price) | 
| Put Option | Exporting: Will receive foreign currency | Buy put option on foreign currency | Protects against depreciation of foreign currency (you can
    sell at strike price) | 
In Class exercise 1:
  Hedging Currency Risk  -  Importing Salmon from Norway. 
Scenario:
  You are a U.S.-based seafood distributor. You’ve
  agreed to import 10,000 NOK worth
  of fresh salmon from a Norwegian supplier.
  The payment is due 30
  days from today, and the current spot rate is 1 NOK = 0.10 USD (so expected
  cost ≈ $1,000).
Avoid paying more than $1,000 due to
  exchange rate fluctuations.
  Question: How can you
  hedge your currency risk?
If the Norwegian krone (NOK) appreciates (e.g., 1 NOK
  = 0.11 USD in 30 days), you will need more dollars:
  10,000 NOK × 0.11 = $1,100 è
  you lose $100 unexpectedly.
Answer the following:
·      
  For reference: Play
  the Importing Game
In Class exercise 2:
  Hedging Currency Risk  -  Exporting US Made Bike to Norway. 
Scenario:
  You are a U.S. bicycle manufacturer. You’ve signed a
  contract to sell bikes worth 10,000
  NOK to a Norwegian retailer.
  You’ll receive
  payment in 30 days in NOK. The current spot rate is 1 NOK = 0.10 USD
  (so you expect to receive $1,000).
Avoid receiving less than $1,000 due to foreign currency
  depreciation.
  Question: How can you
  hedge your currency risk?
If the Norwegian krone (NOK) weakens (e.g., 1 NOK =
  0.09 USD in 30 days), you receive:
  10,000 NOK × 0.09 = $900 è  you lose $100 in value.
Answer
  the following:
·      
  For reference: Play
  the Exporting Game
 
In Class Exercise 3:  Hedging
  currency payable as a Importer
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.
 
In Class Exercise 2:  Hedging
  currency receivable as an Exportor
·         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 $0.71 = SF1.00
·         The
  one-year interest rate in Swiss is iSF = 5%
·         The
  one-year interest rate in US is i$ = 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)
Chapter 18 Long Term Debt Financing 
·     Interest rate swap
·     Currency Swap  
 
·       Video: 
 

This offsets their floating NOK loan and
  gives them effective fixed USD cost.
This mimics having a floating NOK loan — which fits their needs.
| Party | Pays (Swap) | Receives (Swap) | 
| SalmonCo | Floating NOK | Fixed USD | 
| SeaFoods | Fixed USD | Floating NOK | 
Example:  Consider a firm facing three debt strategies
v   
  Strategy #1: Borrow $1 million
  for 3 years at a fixed rate
v   
  Strategy #2: Borrow $1 million
  for 3 years at a floating rate, SOFR + 2% to be reset annually (
  SOFR (Secured Overnight Financing Rate))
v   
  Strategy #3: Borrow $1 million
  for 1 year at a fixed rate, then renew the credit annually
v   
  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
o  
  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)
v   
  It too assures funding for the
  three years but offers repricing risk
  when SOFR changes
v   
  Eliminates credit risk as its
  spread remains fixed
•         Strategy
  #3 offers more flexibility but more risk;
o  
  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
o  
  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
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
–        An agreement between two
  parties to exchange fixed-rate for floating-rate financial obligations is
  often termed a plain vanilla swap
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%
 
 
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 

 https://www.thenation.com/article/archive/goldmans-greek-gambit
·       Game
  
·       Quiz
Homework of
  chapter 18 (due with final, optional)
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.    
  Explain what
  is an interest rate swap using an example. 
3. 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% | SOFR | 
 | |
| 
 | Company  BBB | 12% | SOFR  + 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 ( SOFR  - 0.15%). 3       Firm AAA needs to pay the swap bank
    on $1,000,000 at the floating rate of ( SOFR  - 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  SOFR -0.15%, and receive 9.9% è net result: 10% - 9.9% +  SOFR -0.15% =  SOFR  -0.05%, a saving of
  0.05%, since if AAA gets the debt from the bank, AAA’s interest rate would be
   SOFR . Similarly, for BBB, pay  SOFR  +  1.5% - (
  SOFR  -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  SOFR -0.15% from AAA and pays  SOFR -0.15% to BBB, so net result = 10.3% - 9.9% +( SOFR  -0.15%) – ( SOFR =0.15%) = 0.4%, the profit of the SWAP bank.)
Final Exam and
  Term Project due
Term Project Review on 4/24/2025
·     
  Class
  Video Word Session    (in class
  4/24/2025) Part I        
·     
  Class
  Video Excel Session  (in class
  4/24/2025)
Final Exam (during final week, in class,
  non-cumulative)
You
  may also arrange to meet and take the final exam at a different time by appointment
Study Guide
Part I - 50 t/f questions (total 75 points, closed book closed notes)
Chapter 8 PPP and IFE
1.     What is Purchasing Power
  Parity (PPP)?
2.     What is the law of one
  price?
3.     What is inflation's effect
  under PPP?
  If a country has higher inflation, its currency should depreciate
  to restore PPP.
4.     What is a Big Mac Index?
  A fun way to compare PPP using the price of a McDonald's Big Mac in different
  countries.
5.     What is the limitation of
  PPP in the short run?
  PPP doesn't explain short-term exchange rates, which are affected by news,
  interest rates, and speculation.
6.     What is an example of
  arbitrage with physical goods?
  Buying gold cheaper in Dubai and selling it in New York—if price differences
  exceed transport costs.
7.     What is a major barrier to
  PPP working perfectly?
  Things like tariffs, shipping costs, taxes, and brand differences can prevent
  equal prices across countries. 
8.     What
  is IFE (International Fisher Effect)?
  A theory stating that currencies with higher
  interest rates will depreciate,
  because high rates usually reflect higher
  expected inflation.
9.     What is currency carry trade?
  A trading strategy where investors borrow in a low-interest-rate currency
  and invest in a high-interest-rate currency to earn the interest rate
  difference (the "carry"). It works if exchange rates remain stable
  or move favorably.
Chapter 7 IRP
1. What is Interest Rate Parity (IRP)?
  A theory that forward exchange rates adjust to offset interest rate
  differentials between two countries, eliminating arbitrage.
2. What is International Fisher Effect (IFE)?
  A theory that currencies with higher interest rates will depreciate,
  reflecting higher expected inflation.
3. What is Purchasing Power Parity (PPP)?
  A theory stating that exchange rates move to equalize the purchasing power of
  different currencies based on inflation differences.
4. What is the difference between IRP, IFE, and PPP?
5. What is Covered vs. Uncovered IRP?
6. What is arbitrage?
  A riskless profit opportunity that arises from price differences in different
  markets, usually corrected quickly by traders.
7. When does a currency trade at a forward premium?
  When its interest rate is lower than the base currency’s rate.
8. When does a currency depreciate under IFE or PPP?
  When the currency's country has a higher interest rate or higher inflation.
9. When do arbitrage opportunities arise under IRP?
  When the actual forward rate
  differs from the IRP-implied
  rate.
10. How does covered interest arbitrage work?
  Borrow in the low-interest-rate country, convert to the high-interest-rate currency,
  invest, and lock in the forward rate to hedge FX risk.
11. What is triangular arbitrage?
  Exploiting mispricing among three
  exchange rates to make a riskless profit by converting
  through a loop of three currencies.
12. What are the risks of carry trade?
  FX risk: If the borrowed currency appreciates, the cost of repayment rises.
  Also, unexpected rate hikes can wipe out profits.
13. Which currencies are commonly used?
14. What happens when IRP fails?
  Traders can perform covered
  interest arbitrage to earn riskless profit —
  and their actions help restore parity.
Chapter 11 – Risk Management for Receivable and Payable
1. What is transaction exposure?
  The risk of loss due to exchange rate changes between the time a transaction
  is agreed and when it is settled.
2. Who faces transaction exposure?
  Any company that must pay or receive foreign currency in the
  future (importers or exporters).
3. What happens if a company does nothing?
  The firm is exposed — it may lose money if the exchange rate moves
  unfavorably before payment/receipt.
4. What is a forward contract?
  A tool to lock in an exchange rate today
  for a future transaction. It removes exchange rate uncertainty. 
·      
  Buy
  a forward contract for payables.
·      
  Sell
  a forward contract for receivables. 
5. What is a money market hedge?
  A hedging strategy using borrowing
  and investing in domestic and foreign interest-bearing accounts to
  lock in the future value.
6. What is a call option used for?
  For importers — it gives the
  right to buy foreign currency
  at a fixed rate. It protects against the foreign currency appreciating. (Useful for payables.)
7. What is a put option used for?
  For exporters — it gives the
  right to sell foreign currency
  at a fixed rate. It protects against the foreign currency depreciating. (Useful for receivables.)
8. What is the goal of hedging?
  To eliminate or reduce exchange rate
  risk and protect the value of future cash flows.
9. What is the difference between options and forward
  contracts?
10.  What are the costs of
  options?
  You must pay a premium upfront, even if you don’t use the option later.
Chapter 18 – Interest Rate Swap
1. What is an interest rate swap?
  An agreement between two parties to exchange
  interest payments — usually one pays fixed and the other pays floating.
2. Why do firms use interest rate swaps?
  To manage interest rate risk
  and lower borrowing costs by
  using their comparative advantage
  in different markets.
3. What is a plain vanilla interest rate swap?
  A basic swap where one party pays a fixed
  rate and the other pays a floating
  rate (e.g., SOFR + spread) on the same notional amount.
4. What is comparative advantage in swaps?
  One firm borrows at better terms in the fixed market, another in the floating market — they swap to get the type they actually want
  and both save.
5. How do both sides benefit in a swap?
  Each firm gets the preferred loan
  type (fixed or floating) at a
  better rate than they could get on their own.
6. What is the role of the swap bank?
  To match the two firms, manage
  risk, and earn a small spread
  (profit) from the difference in rates exchanged.
7. What is the risk of interest rate swaps?
8. What is a currency swap (briefly)?
  A separate type of swap where parties exchange
  interest and principal in two
  different currencies — used to hedge FX and interest rate risk.
9. Why do swaps matter in long-term debt financing?
  They help companies customize their
  interest rate exposure and reduce financing costs without changing the
  original loan contract.
Part II – 2
  Calculation Questions (25 points, closed book closed notes) 
·      
  Similar
  to chapter 11 in class exercises on Hedging Receivables and payables using
  forward contract, options, and money market. 
·      
  Refer
  to
o  
   https://www.jufinance.com/game/importing_transaction_exposure.html
  (Payable, as an importer)
o  
  https://www.jufinance.com/game/exporting_transaction_exposure.html
  (receivable, as an exporter)
Happy Summer!
