Foreign Exchange E-Book

Tim Weithers

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: Wiley Finance Editions
• Sprache: Englisch

Seitenzahl: 476

Veröffentlichungsjahr: 2011

Beschreibung

Praise for Foreign Exchange "Tim Weithers starts by telling the reader that foreign exchange is not difficult, just confusing, but Foreign Exchange: A Practical Guide to the FX Markets proves that money is much more exciting than anything it buys. This useful book is a whirlwind tour of the world's largest market, and the tour guide is an expert storyteller, inserting numerous fascinating insights and quirky facts throughout the book." -John R. Taylor, Chairman, CEO and CIO, FX Concepts "The book reflects the author's doctorate from the University of Chicago, several years' experience as an economics professor, and, most recently, a very successful decade as an executive at a huge international bank. These fundamental ingredients are seasoned with bits of wisdom and experience. What results is a very tasty intellectual stew." -Professor Jack Clark Francis, PhD, Professor of Economics and Finance, Bernard Baruch College "In this book, Tim Weithers clearly explains a very complicated subject. Foreign Exchange is full of jargon and conventions that make it very hard for non-professionals to gain a good understanding. Weither's book is a must for any student or professional who wants to learn the secrets of FX." -Niels O. Nygaard, Director of Financial Mathematics, The University of Chicago "An excellent text for students and practitioners who want to become acquainted with the arcane world of the foreign exchange market." -David DeRosa, PhD, founder, DeRosa Research and Trading, Inc., and Adjunct Professor of Finance, Yale School of Management "Tim Weithers provides a superb introduction to the arcana of foreign exchange markets. While primarily intended for practitioners, the book would be a valuable introduction for students with some knowledge of economics. The text is exceptionally clear with numeric examples and exercises that reinforce concepts. Frequent references are made to the economic theory behind the trading practices." -John F. O'Connell, Professor of Economics, College of the Holy Cross

Leseprobe

Table of Contents

Title Page

Copyright Page

Dedication

Preface

Acknowledgments

CHAPTER 1 - Trading Money

INTRODUCTION

TRADING MONEY

THE ROLES MONEY PLAYS

THE MAJOR CURRENCIES

SOME INTERESTING QUESTIONS

APPENDIX: Countries, Currencies, and ISO Codes

CHAPTER 2 - Markets, Prices, and Marketmaking

WHAT IS A “MARKET”?

WHAT IS A “PRICE”?

BUYERS AND SELLERS

MARKETMAKING

SUMMARY

CHAPTER 3 - Interest Rates

WHAT ARE “INTEREST RATES”?

INFLATION

DAY COUNT OR DAY BASIS

COMPOUNDING

DISCOUNTING

TYPES OF INTEREST RATES

INTEREST RATES IN THE REAL WORLD

CHAPTER 4 - Brief History of Foreign Exchange

HISTORICAL BACKGROUND

THE FX MARKETS TODAY

THE REGULATORY ENVIRONMENT AND CENTRAL BANK INTERVENTION

SUMMARY

CHAPTER 5 - The Foreign Exchange Spot Market

THE SPOT MARKET

SPOT FX QUOTING CONVENTIONS

ECONOMIC INTERPRETATION

PURCHASING POWER PARITY

CROSS RATES AND TRIANGULAR ARBITRAGE IN THE SPOT MARKET

THE BID-ASK SPREAD IN FOREIGN EXCHANGE

TIMING

SETTLEMENT

MARKET JARGON

“THE BEST ARBITRAGE AROUND!”

CHAPTER 6 - Foreign Exchange Forwards

INTRODUCTION TO FORWARDS AND FORWARD PRICING

FOREIGN EXCHANGE FORWARDS AND FORWARD PRICING

INTEREST RATE PARITY (COVERED INTEREST ARBITRAGE)

FX SPOT-FORWARD ARBITRAGE

FX FORWARD PRICE QUOTES AND FORWARD POINTS

TIMING

OFF-MARKET FORWARDS

FOREIGN EXCHANGE FORWARDS IN THE REAL WORLD

CHAPTER 7 - Foreign Exchange Futures

BACKGROUND

FUTURES VERSUS FORWARDS

FOREIGN EXCHANGE FUTURES CONTRACT SPECIFICATIONS

MARGIN

WHY USE FUTURES?

OPTIONS ON FX FUTURES

SUMMARY

CHAPTER 8 - Foreign Exchange Swaps or Cross-Currency Swaps or Cross-Currency ...

INTRODUCTION

FX SPOT-FORWARD SWAPS

CROSS-CURRENCY SWAPS OR FX CROSS-CURRENCY INTEREST RATE SWAPS OR FX BOND SWAPS

SUMMARY

CHAPTER 9 - Foreign Exchange Options

OPTION BASICS

EQUITY OPTIONS

PUT-CALL PARITY WITH EQUITY OPTIONS

IN-THE-MONEY, AT-THE-MONEY, AND OUT-OF-THE-MONEY

THEORETICAL OPTION VALUE AND OPTION RISK MEASURES (“THE GREEKS”)

FOREIGN EXCHANGE OPTIONS

PUT-CALL PARITY IN FOREIGN EXCHANGE

PERSPECTIVE MATTERS

FX OPTION PREMIUM

VOLATILITY

USES AND STRATEGIES

APPENDIX: Theoretical Option Valuation

THE BINOMIAL MODEL

THE BLACK-SCHOLES/GARMAN-KOHLHAGEN MODEL

THE GARMAN-KOHLHAGEN OPTION RISK MEASURES OR “GREEKS”

CHAPTER 10 - Exotic Options and Structured Products

WHAT IS AN EXOTIC OPTION?

NONSTANDARD OPTIONS

DIGITAL OR BINARY OPTIONS

BARRIER OPTIONS

OTHER EXOTIC OPTIONS

FX-LINKED NOTES

CHAPTER 11 - The Economics of Exchange Rates and International Trade

MONEY VERSUS CURRENCY

TYPES OF FX EXPOSURES

FIXED VERSUS FLOATING EXCHANGE RATES

IMPLICATIONS OF MONETARY POLICY

TRADE DEFICITS: A CURSE OR A BLESSING

POLITICS AND ECONOMICS

CHAPTER 12 - Currency Crises

THE END OF BRETTON WOODS

BANKHAUS HERSTATT

THE ERM CRISIS OF 1992

THE ASIAN CRISIS OF 1997

THE RUSSIAN CRISIS OF 1998

THE TURKISH LIRA CRISIS OF 2001

THE ARGENTINEAN PESO CRISIS OF 2002

SUMMARY

CHAPTER 13 - Technical Analysis

INTRODUCTION

WHAT IS TECHNICAL ANALYSIS?

METHODS OF TECHNICAL ANALYSIS

TECHNICAL ANALYSIS IN FOREIGN EXCHANGE

TECHNICAL ANALYSISTODAY

SUMMARY

CHAPTER 14 - Where Do We Go from Here?

CHAPTER 15 - Conclusion

APPENDIX - Precious Metals

Answers to the Chapter Exercises

Notes

References

About the Author

Index

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Copyright © 2006 by Tim Weithers. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

Published simultaneously in Canada.

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Library of Congress Cataloging-in-Publication Data:

Weithers, Timothy M. (Timothy Martin), 1956 –

Foreign exchange : a practical guide to the FX markets / Tim Weithers.

p. cm.—(Wiley finance series)

Includes bibliographical references and index.

ISBN-13: 978-0-471-73203-7 (cloth) ISBN-10: 0-471-73203-6 (cloth)

1. Foreign exchange market. 2. International finance. I. Title. II. Series.

HG3851.W44 2006

332.4’5—dc22

2005038005

Dedication:

To my boys: Michael, Stephen, and Peter

Preface

I have been teaching about foreign exchange for more than a dozen years now and thinking about money and trade for even longer. At the University of Chicago, on my way to a Ph.D. in economics, I enrolled in the 1980s in an international trade course (“with money”—as opposed to “real” trade) with Jacob Frenkel [who, from 1991 through 2000, was governor of the Bank of Israel (i.e., Israel’s counterpart to Alan Greenspan/Ben Bernanke) and who subsequently served as president of the international division of an investment bank and then chairman and CEO of the Group of Thirty (G-30)]. The University of Chicago is proud of its role in instituting the “quarter system” (the summer being one of the “quarters”—that is, in establishing what most people would call the trimester system in which three 10-week sessions constitute the academic year). Mr. Frenkel distributed what seemed to me like a particularly thick syllabus for a 10-week term. Chicago graduate students in the Department of Economics were required to take courses in a relatively large number of different fields. International trade was not one of my areas of specialization, so I stopped by Mr. Frenkel’s office to ask if he could tell me which were the more important papers. His succinct response: “Zey are oll important!” While I was reading the material, some of the journal articles seemed to refer to the exchange rate as, say, Dollars per Pound, while others appeared to take the exchange rate to indicate Pounds per Dollar; it was truly confusing! This was my first exposure to the ambiguity and frustration associated with foreign exchange.

Engaging in that fascinating phenomenon that I believe psychologists refer to as the “continuing cycle of child abuse,” I went on to teach economics at Fordham University for several years. After my wife and I had our third son, I joined an amazing little partnership called O’Connor and Associates, a proprietary option trading firm based in Chicago that had its own in-house Education Department (of which I was the third fulltime instructor). Many businesses refer to internal development programs as “training”; one of my colleagues was always quick to point out, “You train animals; you educate people.” While the name of this business has changed repeatedly over the years (O’Connor and Associates, LLP; SBC/OC; Swiss Bank Corporation (SBC), SBC Warburg; SBC Warburg Dillon Read; Warburg Dillon Read; UBS Warburg; and UBS) and while my title has changed (though slightly less often), I am still teaching (and still enjoy teaching) for “the Bank.” Up until a few years ago, with rare exception, the only people whom our group, now called Financial Markets Education, taught were internal employees; more recently, we have opened many of our more popular classes to UBS’s top clients. We have both invited them into our regularly scheduled courses and, on occasion, taught dedicated seminars for them. Foreign Exchange has been, and continues to be, one of our best attended and most demanded courses.

In addition, starting back in the Fall of 1997, the University of Chicago began offering a financial engineering graduate degree, organized by the Department of Mathematics, through its Masters of Science in Financial Mathematics. At that time, Niels Nygaard, the director of the program, sought teaching assistance from what he referred to as the “practitioner” community. I have taught Foreign Exchange, among other things, every year since the start of that program (with friends and former colleagues, Al Kanzler and Jeff Krause).

This book is a synthesis of what I teach at UBS, what I teach at the University of Chicago, and also what I find interesting about foreign exchange (FX) that may not have made its way into either of the two aforementioned forums. I have assumed no prior exposure to foreign exchange (which, obviously, depending on the reader, may be grossly inaccurate); because I start from the basics, though, it’s my belief that this book is selfcontained. More importantly, I would like to think that this book is practical, insightful, and useful for anyone who is, or who will be, working in the area of foreign exchange.

The organization of the book is as follows:

Chapter 1 describes what I believe foreign exchange is all about in very general terms, identifies the most important currencies, and provides (in an Appendix) a relatively exhaustive listing of the names for, and standardized abbreviations of, money from around the globe.

Chapter 2, for those who have not worked in the financial community, is a brief exposition on prices and markets that might differ slightly from what you may have heard in a college economics or finance course, but an understanding of these concepts is essential, and will set the stage for what follows.

Chapter 3 serves as an introduction to interest rates. The phenomenon of interest, through which money tends to multiply, distinguishes foreign exchange from many of the traditional asset classes. Compounding conventions, day count, discounting, and examples of actual market rates are all discussed here.

Chapter 4 gives some historical perspective and color on the evolution and development of the foreign exchange markets. Moreover, it contains some information about the current state of the FX markets (as of late 2005).

In Chapter 5 we introduce the FX spot market. Everything in foreign exchange revolves around spot. If you understand the following statement: “I buy 10 bucks, Dollar-Swiss, at the offer of one-twenty-five—the figure,” you may skip to Chapter 6.

Chapter 6 presents FX forwards—in as intuitive a fashion as I have been able to devise over the years. FX forward valuation and forward points, while they could be viewed as being somewhat mechanical, are the source of a great deal of confusion, and this chapter is an attempt to eliminate any obfuscation and to empower the reader with some solid intuition regarding the pricing of these useful and frequently traded instruments.

FX futures, although not terribly significant as a fraction of FX trading volume, can be a source of market information (in a world dominated by nontransparent, over-the-counter transactions) and are covered in Chapter 7.

The subject of Chapter 8, Cross-Currency Interest Rate Swaps, is really a “funding” or interest rate topic; these instruments are most easily explained after our discussion of FX forwards (really being nothing more than “bundlings” of FX forwards into single contracts). They are very important for the world of international debt issuance.

Options follow in Chapter 9 [in which we start by comparing and contrasting the way most people understand and talk about options (that is, from the equity point of view) versus their foreign exchange counterparts]. There is always the question of where to start and where to end with options; terminology, graphical representations, option spreads, theoretical valuation, option risk measures (or “the Greeks”), and strategies all deserve treatment. We save the more formal, quantitative modeling issues for an Appendix.

In FX, exotic (or non-standard) options are really not all that “exotic”—trading more, and more liquidly, in this product area than in any other. In this sense, they constitute an important component of the FX markets. Even if one does not trade FX exotic options, everyone dealing with foreign exchange should still have an understanding of, and appreciation for, what these instruments are all about because, as Chapter 10 attempts to point out, they can have a significant impact on the movement and behavior of the FX spot market.

Once we have laid out the spectrum of products found within the world of foreign exchange, we circle back and talk about exchange rates within their larger economic context in Chapter 11. This includes a discussion of the pros and cons of fixed versus flexible exchange rate systems or regimes, beggar-thy-neighbor policies, and the implications of monetary policy for the foreign exchange markets.

While a firm believer in the efficiency and benefits of free markets, anyone writing about FX is compelled to address the numerous currency crises that have occurred throughout history; selected documentation of these incidents are the focus of Chapter 12.

Most academic economists and the majority of finance professors, who are quick to articulate their belief in market efficiency, would, therefore, rule out the potential usefulness or effectiveness of technical analysis as a tool for understanding and predicting foreign exchange movements; while in no way an instruction manual or course on the finer points of charting, Chapter 13 attempts to survey some of the methods used by those who practice this “art.”

The book winds down with a view to the future of the FX markets and circles back to gold and other precious metals, not themselves foreign exchange, in an Appendix to the final chapter.

Because I consider them an integral part of the learning process, I have included a number of examples and exercises within the text and at the end of several of the chapters; there is no doubt that one learns by doing problems and, by working through these practice exercises, one will advance one’s understanding of, facility with, and confidence in engaging in foreign exchange transactions. Answers to these homeworks can be found at the end of the book.

Finally, while intended for those who work in the real world, I would like to think that this book will also be relevant and helpful for those in the academic world: students of finance, economics, international trade, and/or international business.

Acknowledgments

I would like to thank Joe Troccolo, my manager at UBS, my teacher, and my mentor for over 12 years; it was in his classroom that I was first introduced to real finance (and by that, I generally mean the opposite of academic finance). Thanks also to my associates in Financial Markets Education: Walter Braegger, Joe Bonin, Onn Chan, Lindsey Matthews, Radha Radhakrishna, Kai Hing Lum, and Spencer Morris; you are a collegial, stimulating, and wonderfully critical and supportive group. Finally, much of what I know about FX, I have learned from my friends and colleagues in foreign exchange at UBS and its legacy institutions; thanks to Ed Hulina (who taught me to navigate the Merc Floor), Ellen Schubert, Mark Schlater, Fabian Shey, Carol Gary-Tatti (who created the FX screen shots found in this book and helped in many other ways), Ed Pla, Urs Bernegger, Daniel Katzive, Raj Kadakia, Ramon Puyane, John Meyer, Dan Denardis, Heinz Henggeler, Paul Richards, Maryellen Frank, Brian Guidera, Brian Jennings, Andy Robertson, Denise Giordano, Christine Gilfillan, Matt Slater, Jason Perl, Dave Toth, and many, many others. Thanks also to my former and exceptional summer interns: Eric Dai, David Alpert, and Kaitlin Briscoe.

I would also like to acknowledge the invaluable support and cheerful assistance of Martha Ciaschini and Rob Greco who run the Information Center in our UBS office in Stamford, Connecticut. It would be difficult for me to do my job without your help.

Knowing about a particular topic, especially a specialized or technical topic, and even teaching about such a topic, is one thing; bringing a book to life on that material is quite another. From the original conception of this book (in which he can claim no small part), Bill Falloon has been incredibly supportive. He is a man who loves the financial markets (their history, their excitement, their lore and legend); in this we are kindred souls. Moreover, the encouragement and assistance of Laura Walsh, Bill’s colleague at John Wiley & Sons, Inc., has also been vital in the completion of this work. Thanks are also due to Emilie Horman and Todd Tedesco of John Wiley & Sons and the staff at Cape Cod Compositors.

Finally, I’d like to offer a blanket recognition and expression of gratitude to all of my students at both UBS and the University of Chicago, for helping me develop many of the ideas in this book. Of course, any remaining errors are entirely mine.

CHAPTER 1

Trading Money

INTRODUCTION

When many of us think of foreign exchange, what comes to mind are those little booths in the airport at which we can exchange, say, our United States Dollars for British Pounds Sterling when on our way to or from a vacation or business trip. Indeed, in some ways, there is nothing more complicated about the market for foreign exchange than that; it is all about buying and selling money.

But there are two things to note up front about foreign exchange that make it appear a bit daunting.

First, the realm of foreign exchange is rife with incomprehensible slang, confusing jargon, a proliferation of different names for the same thing, and the existence of convoluted conventions that make working in this field (unless you have already gained a facility with the rules) a real challenge. Banks and other financial institutions can’t even agree as to what this business area or “desk” should be called: FX, Currencies, Treasury Products, ForEx or Forex, Bank Notes, Exchange Rates, . . .

Second, and more fundamentally, what constitutes “foreign” depends upon where you consider “home” (e.g., whether you are from the U.S. or the U.K.). Having taught about this product for years, working for a large global bank, I know that what is “foreign” for me may very well be “domestic” for you. For that reason, I will make every attempt to avoid the use of the expressions “foreign” and “domestic” in our explanations—not so much out of my hope that this book may achieve some degree of international success, but out of my inclination to want to avoid any ambiguity (and also based on the fact that I, as an “ugly American,” would almost always revert to thinking in terms of U.S. Dollars). This will keep me honest. We see later, though, in the context of options that perspective really can and does matter!