Lecture 2 Exchange rate quotations and arbitrage By Juan Yao

BUSINESS
SCHOOL

The Exchange Rate and its Quotation
› Every bilateral exchange rate treats one currency as the item or commodity/base which is being priced with the other priced, currency as the units in which its price is measured (“terms” or “quote”).
› For the exchange rate quote AUD=USD 0.7205, the
Australian dollar is the “commodity” currency and US dollar is y y the “terms” currency.
› In theory, the choice of commodity currency is entirely arbitrary. We could have the US dollar as commodity currency and the Australian dollar as the terms currency so that USD1 = AUD 1 3879  (AUD1 = USD 0 7205)
1.3879
0.7205)
› The market convention is to quote most exchange rates against USD with USD as th b i t ith the base currency, with exception ith ti of GBP, AUD, NZD and EUR.
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The Exchange Rate and its Quotation

› Let S(i/j)
= spot price of currency j expressed in units of currency i.
= no. of units currency i per unit of currency j.
 j is the commodity currency, i is the terms currency.
› e g AUD = 0 7205  S(USD/AUD) = 0.7205.
e.g
0.7205
0 7205
Currency i is the US dollar (terms currency); currency j is the Australian dollar ( y (commodity currency) y y)

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The Exchange Rate and its Quotation g ›  S( / )  appreciation of currency j (relative to i )
S(i/j)
f
(
(appreciation of “commodity” currency)
›  S(i/j)  depreciation of currency j (relative to i )
( p
(depreciation of the commodity currency) y y)
› e.g if St (USD/AUD) = 0.7205 and St-3(USD/AUD) = 0.7109 g (
)
(
)
then Australian dollar is said to have appreciated 1.35%
[100*(0.7205-0.7109)/(0.7109) = 1.35%] against the US dollar over the 3day period period. › How much did US$ depreciated against the A$?

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Describing c a ges in e c a ge rates esc b g changes