Speculation IN FOREIGN EXCHANGE MARKET

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Speculation IN FOREIGN EXCHANGE MARKET:

Speculation IN FOREIGN EXCHANGE MARKET BY KUMARI POOJA 18-2009

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SPECULATION IS THE OPPOSITE OF HEDGING SPECULATORS ACCEPTS EXCHANGE RATE RISK IN THE HOPE OF MAKING PROFIT INTRODUTION THEY BELIEVE THAT THE FUTURE SPOT RATES WILL BE DIFFERENT FROM QUOTED FORWARD RATE CAN TAKE PLACE IN THE SPOT, FORWARD, FUTURES AND OPTIONS MARKETS

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Speculators who buy or sell currencies when they expect movement in the exchange rate in a particular direction . They make their profit from movement of exchange rate in the desired direction . MEANING

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SPECULATION CAN BE STABILIZING AND DESTABILIZING STABILIZING Purchase of foreign currency when the exchange rate falls in the expectation that will soon rise , thus leading to profit. Sale o f foreign currency when exchange rate rises in the expectation that it will soon fall. Stabilizing speculation moderates the fluctuations in exchange rate and performs a useful function.

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SPECULATION CAN BE STABILIZING OR DESTABILIZING DESTABILIZING Sale of foreign currency when exchange rate is low in the expectation that it will fall even further . Purchase of foreign currency when exchange rate rising in the expectation that it will rise even higher in future

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LET’S SEE SPECULATION IN DIFFERENT MARKETS

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SPECULATION IN SPOT MARKET SPOT MARKET TRANSACTIONS REQUIRE IMMEDIATE DELIVERY OF THE TRADED CURRENCY MEANING

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SPECULATION IN SPOT MARKET SPECULATION IN THE SPOT MARKET OCCURS WHEN THE SPECULATOR ANTICIPATES A CHANGE IN THE VALUE OF A CURRENCY

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Suppose the exchange rate today is Rs. 40 /US $ . The speculator anticipates this rate to become Rs. 41/US within the coming three months . Under these circumstances , he will buy US $1,000 for Rs 40000 and hold this amount for three months , although he is not committed to this particular time horizon . when the target exchange rate is reached , he will sell US $1000 at the new exchange rate , that is at Rs 41 per dollar and earn a profit of Rs. 41000- 40000 =Rs. 1000 SPECULATION IN SPOT MARKET EXAMPLE

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SPECULATION IN FORWARD MARKET VALUE DATE / SETTLEMENT DATE IS THE DAY ON WHICH THE TRADED CURRENCY IS DELIVERED MEANING

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SPECULATION IN FORWARD MARKET Their purpose is not to reduce the risk but to reap profits from the changes in the forward rate and the future spot rate, they are not very concerned with the direction of the exchange rate change. In addition to the arbitrageur or the hedger, speculators are also very in forward market operation. THEIR PURPOSE IS NOT TO REDUCE THE RISK BUT TO REAP PROFITS FROM THE CHANGES IN THE EXCHANGE RATES.THE SOURCE OF PROFIT TO THEM BEING THE DIFFERENCE BETWEEN THE FORWARD RATE AND THE FUTURE SPOT RATE, THEY ARE NOT VERY CONCERNED WITH THE DIRECTION OF THE EXCHANGE RATE CHANGE. IN ADDITION TO THE ARBITRAGEUR OR THE HEDGER, SPECULATORS ARE ALSO VERY ACTIVE IN FORWARD MARKET OPERATION .

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SPECULATION IN FORWARD MARKET Forward market speculation cannot be extended beyond the maturity date of the forward contract. However, if the speculator wants to close out the speculation operation prior to the maturity , he may buy an offsetting contract

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EXAMPLE SPECULATION IN FORWARD MARKET SUPPOSE A SPECULATOR SELLS US $ 1,000 THREE -MONTH FORWARD AT THE RATE OF Rs40.50/ US $. IF , ON MATURITY , THE US DOLLAR DEPRECIATES TO Rs. 40 , THE SPECULATOR WILL GET RS. 40,500 UNDER THE FORWARD CONTRACT . AT THE SAME TIME , HE WILL EXCHANGE RS. 40,500 AT THE THEN FUTURE SPOT RATE OF RS. 40/US $ AND WILL GET US $ 1,012.50. BOTH THESE ACTIVITIES – THE SELLING AND THE PURCHASING OF US DOLLARS WILL BE SIMULTANEOUS. THUS WITHOUT MAKING ANY INVESTMENT , THE SPECULATOR WILL MAKE A PROFIT OF US $ 12.50 THROUGH THE FORWARD MARKET DEAL .

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SPECULATION WITH CURRENCY FUTURES CURRENCY FUTURES MARKET IS AN ORGANISED MARKET, AND NOT OVER- THE – COUNTER, FOR THE SALE AND PURCHASE OF SPECIFIED AMOUNT OF CURRENCIES MEANING

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SPECULATION WITH CURRENCY FUTURES IT MAY BE NOTED HERE THAT THESE TRENSACTION INVOLVE COST THAT IS TO BE DEDUCTED FROM THE GAIN . THE TRENSACTION COST IS VERY NOMINAL FOR THE LOCALS , BUT IS SIGNIFICANT FOR THE SPECULATORS. IF THE SPOT RATE OF A PARTICULAR CURRENCY IS EXPECTED TO DEPRECIATE BELOW THE RATE MENTIONED IN THE CURRENCY FUTURES CONTRACT , THE SPECULATORS WILL SELL CURRENCY FUTURES IN THAT CURRENCY . WHEN THEY EXPECT THAT THE SPOT RATE OF A PARTICULAR CURRENCY WILL MOVE UP BEYOND THOSE MENTIONED IN THE CURRENCY FUTURES CONTRACT , THEY BUY CURRENCY FUTURES DENOMINATED IN THAT PARTICULAR CURRENCY . SPECULATORS MAKE USE OF THE CURRENCY FUTURES FOR REAPING PROFITS.

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INTRA – CURRENCY SPREAD SPECULATORS CAN BUY OR SELL FUTURES OF THE SAME CURRENCY FOR TWO DELIVERY DATES IF THE RATES FOR THOSE TWO DATES DIFFER . THIS IS KNOWN AS INTRA – CURRENCY SPREAD. SPECULATION WITH CURRENCY FUTURES

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SUPPOSE POUND IS EXPECTED TO APPRECIATE TILL JUNE AND THEN IT IS EXPECTED TO DEPRECIATE AT LEAST BY SEPTEMBER AT A FASTER RATE THAN HE FUTURES RATE .IN THIS CASE , A SPECULATOR WILL BUY A POUND FUTURES CONTRACT FOR JUNE DELIVERY AND SELL ANOTHER ONE FOR THE SEPTEMBER DELIVERY . SUPPOSE POUND FUTURES ARE AVAILABLE AT $ 0.650 /£ F OR JUNE DELIVERY AND AT $0.640/£ FOR SEPTEMBER DELIVERY . THE SPOT RATE OF POUND RISES TO $ 0.655 IN THE JUNE MATURITY BUT , CONTRARY TO THE SPECULATOR’S EXPECTATONS , FALL ONLY TO 0.642/£ BY SEPTEMBER MATURITY DATE. THE SPECULATOR WILL GAIN $ 0.005 PER POUND ON THE JUNE – DELIVERY CONTRACT BUT WILL LOSE $ 0.002 ON THE SEPTEMBER CONTRACT . THE NET GAIN WILL BE EQUAL TO $ (0.005- 0.002) *62,500 = $187.5 SPECULATION WITH CURRENCY FUTURES NOTE: IT IGNORES MARKING TO MARKET EXAMPLE

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INTER-CURRENCY SPREAD BESIDES THE INTRA- CURRENCY A SPREAD, INTER-CURRENCY SPREAD IS ALSO USED BY THE SPECULATORS . SUCH SPREAD OCCURS WHEN THE DEAL INVOLVES PURCHASE AND SALE OF FUTURE CONTRACTS WITH THE SAME DELIVERY DATE BUT WITH TWO DIFFERENT UNDERLYING CURRENCIES. SPECULATION WITH CURRENCY FUTURES

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SPECULATION WITH CURRENCY FUTURES IF POUND FUTRES CONTRACT IS AVAILABLE AT $ 1.690 AND EURO FUTURES CONTRACT IS AVAILABLE AT $ 1.250 . POUND IS EXPECTED TO APPRECIATE AND EURO IS EXPECTED TO DEPRECIATE . IN SUCH A SITUATION, A SPECULATOR WILL BUY A POUND FUTURES CONTRACT AND SELL EURO FUTURES CONTRACT FOR THE SAME MATURITY . IF , CONTRARY TO THE EXPECTATION , POUND DEPRECIATION TO $ 1.680 AND EURO DEPRECIATES TO $ 1.235 , FIND OUT THE GAIN TO THE SPECULATOR FROM THE INTER- CURRENCY SPREAD. SOLUTION : LOSS ON POUND FUTURES CONTRACT =$1.690- 1.680= $0.010 PER POND OR TOTAL LOSS =$0.010 *62500= $625 GAIN ON THE EURO FUTURES CONTRACT = 1.250-1.235=$0.015 per pound or total gain = $0.015*125000=$ 1875. Net gain =$1875-625=$1250 . NOTE: IT IGNORES MARKING TO MARKET EXAMPLE

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SPECULATING WITH OPTIONS MEANING CURRENCY OPTION CONTRACT CONFERS ON OPTIONS- BUYER PRIVILEGE OF NOT EXERCISING THE CONTRAT WHEN EXCHANGE RATE IS NOT IN HIS FAOUR

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SPECULATING WITH OPTIONS Speculators make profit out of purchase of currency options . They normally buy call option when they expect upward movement in the value of the underlying currency . On the expiry date , they buy the currency at the agreed – upon rate and sell it in the open market at a higher rate and thereby reap profits . On t he contrary , they buy put option when they expect depreciation of the underlying currency. They sell the underlying currency at an agreed – upon rate hat is higher than the spot rate . This way they get more of the other currency than they could get in the open market. Besides these simple operations, they often go in for complicated deals mixing either two calls or two puts or one call and the other put .

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SPECULATING WITH OPTIONS EXAMPLE POUND IS EXPECTED TO APPRECIATE TO $1.930. POUND OPTION ARE AVAILABLE AT A STRIKE PRICE OF $ 1.830/£ WITH A PREMIUM OF $0.03/£ . HOW DO SPECULATORES REACT TO THE APPRECIATION OF POUND ? SOLUTION: SPECULATOR WILL BUY A CALL. ON THE MATURITY , HE WILL GET £ 62500 AT $1.830/£ . IMMEDIATELY AFTER GETTING POUND , HE WILL SELL THOSE POUND IN THE OPEN MARKET TO GET DOLLAR BACK AND THIS WAY , HE WILL GAIN $ (1.930-1.830-0.03) * 62500 =$4375.

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SPECULATING WITH OPTIONS EXAMPLE POUND IS EXPECTED TO DEPRECIATE TO $1.730. POUND AT A STRIKE PRICE OF $ 1.830/£ WITH A PREMIUM OF $0.03/£ . HOW DO SPECULATORES REACT TO THE DEPRECIATION OF POUND ? SOLUTION: SPECULATOR WILL BUY A PUT. ON THE MATURITY , HE WILL GET $1,14,375 THROUGH SELLING £ 62,500 AT $1.830/£ . IMMEDIATELY AFTER GETTING DOLLAR , HE WILL SELL THOSE DOLLARS IN THE OPEN MARKET AT $ 1.730/£ TO GET POUND BACK AND THIS WAY , HE WILL GAIN $ (1.830-1.730-0.03) * 62500 =$4,375 .

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REFERENCES: BOOK – 1. INTERNATIONAL FINANCIAL MANAGEMENT BY VYUPTAKESH SHARAN 2. INTERNATIONAL FINANCE BY KEITH PILBEAM WEBSITE – WWW.GOOGLE .COM

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