Assessment 2-Stage 2-FX Group Report 32 PDF

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Warning: TT: undefined function: 32Higher education cover sheetfor submission of work assessmentSchool School of Economics, Finance and Marketing Program name Program code Course/unit name Financial Makets Course/unit code BAFI Name of lecturer/teacher Obaid Awan Name of tutor/marker Pete Fernandes ...

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Higher education cover sheet for submission of work assessment School School of Economics, Finance and Marketing

Office use only

Program name

Program code

Course/unit name

Financial Makets

Name of lecturer/teacher Name of tutor/marker Assignment no.

Course/unit code

BAFI1002

Obaid Awan Date stamp

Pete Fernandes

02 Due date (DD/MM/YYYY) 29 May 2020

Class day/time Wednesday 16:3—17:30

Campus City

Student/s Family name

Phung

Given name

Ha Chi

Student no.

s3757245

Family name

Yang

Given name

Yi

Student no.

s3798354

Family name

Chen

Given name

Wenzhao

Student no.

s3714451

Family name

Given name

Student no.

Family name

Given name

Student no.

Family name

Given name

Student no.

Declaration and statement of authorship 1. I/we hold a copy of this work that can be produced if the original is lost/damaged. 2. This work is my/our original work and no part of it has been copied from any other student’s work or from any other source except where due acknowledgement is made. 3. No part of this work has been written for me/us by any other person except where such collaboration has been authorised by the lecturer/teacher concerned. 4. I/we have correctly acknowledged the re-use of any of my/our own previously submitted work within this submission. 5. I/we give permission for this work to be reproduced, communicated, compared and archived for the purpose of detecting plagiarism. 6. I/we give permission for a copy of my/our marked work to be retained by the school for review and comparison, including review by external examiners. I/we understand that: 7. plagiarism is the presentation of the work, idea or creation of another person as though it is my/our own. It is a form of cheating and is a very serious academic offence that may lead to exclusion from the University. Plagiarised material can be drawn from, and presented in, written, graphic and visual form, including electronic data and oral presentations. Plagiarism occurs when the origin of the material used is not appropriately cited. 8. plagiarism includes the act of assisting or allowing another person to plagiarise or to copy my/our work.

Student signature/s I/we declare that I/we have read and understood the declaration and statement of authorship.

1

Chi Phung

4

2

Yi Yang

5

3

WENZHAO CHEN

6

Further information relating to the penalties for plagiarism, that range from a notation on your student file to expulsion from the University, is contained in the Student Conduct Regulation, Division 2. Academic Misconduct and the Assessment Policy that are available on the Policies and Procedures website at rmit.edu.au/about/governance-management/policies. Copies of this form can be downloaded from the student forms webpage at rmit.edu.au/students/student-essentials/forms/assessment-forms.

Integrity | Higher education cover sheet for submission of work for assessment

0806 0220 | 1 of 1

ASSESSMENT TASK 2 BAFI1002

Session attended: 03 Instructor: Name of FX Session Instructo r: Rui Huo

ASSIGNMENT GROUP STAGE 2: FX REPORT 32

CONTRIBUTION PAGE

Student’s Name

Student’s ID

Contribution Percentage

Yang Yi

s3798354

33.33%

Phung Ha Chi

s3757245

33.33%

Chen Wenzhao

s3714451

33.33%

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I.

INTRODUCTION

Our group is working for a renowned FX trading company, Xhi-Trade. The company specializes in trading major currencies such as Australian dollar (AUD), United States dollar (USD), Japanese Yen (JPY), Euro (EUR) and Great British Pound (GBP). Our main responsibility is trading foreign currencies in order to improve the firm's trading strategy and profits. We will be devising trading strategies that help companies take advantage of our predicted changes in the exchange rates. While implementing those strategies, there would be existing several risks that the company might face in the future and therefore offer some recommendations which will be discussed below.

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II.

QUESTION 1

Trading strategy According to forecasts based on the market view on stage one, the exchange rate of the US dollar to the Japanese yen will show an upward trend in the next six months which means the US dollar will appreciate against the Japanese yen. Therefore, the general strategy is to short the Japanese yen and go long on the US dollar for the maximum of the profits at the end. For the pair of USD/JPY and as a price taker, first of all we sell the US dollar and buy the Japanese yen at the bid rate which means make the US dollar at a short position and the Japanese yen at a long position. As an Australian company, we transact both the US dollar and the Japanese yen to the Australian dollar at the mid rate to get the profit. After that we sell the Japanese yen and buy the US dollar at the ask rate which equalative to shorting the Japanese yen and making the US dollar at the long position as we expected.

Comm / Terms

Bid

Ask

Mid

AUD/USD AUD/EUR EUR/AUD AUD/GBP GBP/AUD

0.5741 0.5378 1.8588 0.4956 2.0169

0.5743 0.5381 1.8591 0.4960 2.0174

0.5742 0.5380 1.8590 0.4958 2.0172

AUD/JPY 63.48 63.52 63.5 EUR/USD 1.0673 1.0675 1.0674 GBP/USD 1.1580 1.1584 1.1582 USD/JPY 110.62 110.64 110.63 EUR/GBP 0.9214 0.9218 0.9216 EUR/JPY 118.05 118.10 118.08 GBP/JPY 128.09 128.14 128.12 Table 1: Exchange rates for April 24, 2020. Mid rate = (bid rate + ask rate)/2

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•

The first step

The senior management has allocated 400,000,000 as the initial balance for speculation strategy for speculating on AUD, USD, EUR or GBP and 25,000,000,000 for speculating on JPY. For instance, we are speculating on USD/JPY and decided to short the USD then we have been allocated 400,000,000 US dollars for this purpose. As a price taker, the long position of the Japanese yen should be calculated using bid rates provided in Table 1 which is 110.62. Based on this position, we estimate the opening AUD value of the current portfolio using the mid rates in Table 1 which are 0.5742 and 63.5 and then we can calculate the profit for the first stage. The data shows below in Table 2.

Currenc y

Opening Position (current)

Position in AUD (Current)

-400,000,000

696,621,386.276 6

44,248,000,00 0

696,818,897.637 8

Net Trade s

Net Position (Expected )

Net Position in AUD (Expected )

Change in Positio n (AUD)

AUD USD GBP EUR JPY Net Position (AUD)

197,511.3612 Table 2: FX portfolio position summary

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III.

QUESTION 2 Calculate bid rate, ask rate and mid rate

Comm / Terms

Bid

Ask

Mid

AUD/USD AUD/EUR

0.6135 0.5545

0.614 0.5549

0.6138 0.5547

EUR/AUD

1.8022

1.8035

1.8029

AUD/GBP

0.4927

0.4928

0.49275

GBP/AUD AUD/JPY

2.0291 66.1967

2.0298 66.269

2.0295 66.2329

EUR/USD GBP/USD

1.1063 1.2437

1.1064 1.2441

1.1064 1.2439

USD/JPY

107.9

107.93

107.9150

EUR/GBP

0.8879

0.8888

0.8884

EUR/JPY 119.3698 119.4138 119.3918 GBP/JPY 134.1952 134.2757 134.2355 Table 3: Calculated expected exchange rates for June, 2020. Mid rate = (bid rate + ask rate)/2 •

The second step

At the beginning for this stage, the first goal is to go long on the US Dollar, increase its price by maintaining a long-term position of the currency at the end of the session. Next is the risk management recommendation for senior managers by eliminating the positions of currencies not speculation while simultaneously maximizing profits during the session. We sold the total amount of 400,000,000 USD then collected 44,248,000,000 JPY as the bank quote for USD/JPY is 110.62/64. Our current position in AUD of USD and JPY is 696,818,897.6378 and 696,818,897.6378 respectively. We use the ask rate of table 3 to calculate the net trade which is 409,969,424.6271. When we have an opening position and net trade, therefore we can calculate the net position which equals 9,969,424.6271. From that, a net position in AUD was smoothly calculated since the mid rate for AUD/USD is 0.6138. When the session ended, we had gained 16,044,627.1645 AUD as net profits for the company.

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Since the session was over, our group has seen risks and obstacles when implementing big trading strategies. Trading company is mainly affected in a vulnerable way when it comes to changes in currency and exchange rates since it might be hard for them to expect their returns. One of the risks must be mentioned is transaction risks. This happens due to differences when the time of the contract is commited and actual cash flows (Marc, G ,Tim, K & Werner, R 2015). Therefore, a financial instrument - a forward exchange contract can be applied here to avoid the exchange rate fluctuations when transact money. A forward exchange contract is an agreement whereby a business agrees to buy or sell a certain amount of foreign currency on a specific date in the future (RBA, 2006). By using this instrument, the business can protect itself from exchange rate’s movements and minimize their loss (Marc, G, Tim, K & Werner, R 2015). Although this risk is not a long-term problem and can be defined clearly, the company should pay attention to it otherwise the company will lose a plenty of profit when they can not control the purchase and sale transactions. •

Calculate the value of your FX portfolio at the end of June using the calculated bid/ask rates

Curre ncy

Opening Position (current)

Position in AUD (Current)

400,000,0 00

696,621,386 .2766

Net Trades

Net Position (Expected )

Net Position in AUD (Expected)

9,969,424. 6271

16,242,138. 5257

Change in Position (AUD)

AUD USD

409,969,424 .6271

GBP EUR JPY Net Positio n (AUD)

44,248,00 0,000

696,818,897 .6378 197,511.361 2

44,248,000, 000

0

16,242,138. 5257

16,044,627. 1645

Table 2 updated: FX portfolio position summar 6

IV. QUESTION 3 IDENTIFY POTENTIAL ARBITRAGE OPPORTUNITIES IN AUD, USD AND GBP CURRENCIES

From the expected exchange rates in Question 2 table 3, we can see that there is a price difference between buying and selling from AUD, USD and GBP currency, therefore the company can generate profits through the triangular arbitrage. The way of triangle arbitrage is to let the traders convert one currency (A) to another currency (B) in one bank, after that they will convert the second currency (B) to another currency (C) in the second bank, and finally convert the third currency (C) to the original currency (A) in the third bank. The same bank will have information efficiency to ensure that all its currency exchange rates keep the same consistently, so different financial institutions will gain profits better in real life.

It would be better if a company can choose the

institution with the lowest buying and the highest selling exchange rate according to different financial institutions in the future, the company will be able to generate more profits from interest rate differences in different financial markets. But for this problem, if the exchange rates of all the financial institutions' currencies in the market are the same, then the earned interest rate difference should be considered according to the exchange rates between the currencies themselves. According to Table 1, we can analyse if there is a chance for Australian Dollars, the US Dollars and the Great Britain Pounds. According to the strategy mentioned above, if we first use USD as the principal, so we will purchase AUD by 1 million USD, then convert AUD to GBP, and then convert GBP to USD, we will gain 1189 USD as profit. Second, we use AUD as the principal, so we will purchase GBP by 1 million AUD, then convert GBP to USD and then convert USD back to AUD, we will gain 927 AUD as profit. Third, we use GBP as the principal, so we will purchase AUD by 1 million GBP, then convert AUD to USD and then 7

convert USD back to GBP, as a result, we will lose profit. So, the result proves that the triangle arbitrage between these three currencies cannot be all profitable. When using the US dollars and Australian dollars as the principal, the company can get a profit. Therefore, we can advise Australian companies to use the Australian dollars as the principal for the triangular arbitrage between these three currencies.

Table 4: Expected exchange rates of AUD, GBP and USD According to the exchange rates of the three currencies of AUD, USD and GBP provided in the figure above (Table 4), the traders can generate profits by buying currency with high Bid rate and selling convert another currency with low Bid rate. So the traders can exchange the amount currency at one exchange rate (country B / country A), which is GBP/AUD, then convert it as another rate (B / C), which is GBP/USD, and finally convert it the third currency back to the original currency (A / C), which is AUD/USD, the traders will generate profits by this triangular arbitrages as well as we assume the transaction cost is low. According to the profit principle of arbitrage, only buying a currency with a high exchange rate and selling it with a currency with low exchange rate can gain profits. Therefore, according to the exchange rate shown in the table, the highest exchange rate of the three currencies is GBP / AUD, so you can buy pounds with Australian dollars, then buy US dollars with the pounds you hold, and finally buy Australian dollars back with the US dollars. In this way, the initial Australian dollars will be profitable through triangle arbitrage.

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Now the company has 200,000,000 AUD, which can be brought in for calculation through the triangular arbitrage method mentioned above. We will use the bid rate to calculate the profits. The bid rate between the three currencies listed below: 1.

AUD/USD=0.6135

2.

GBP/AUD=2.0291

3.

GBP/USD=1.2437

According to the triangle arbitrage mentioned above, first, the company will convert 200,000,000 AUD to GBP at the exchange rate of 2.0291, which is 200,000,000 AUD multiple 2.20291 equals 405,820,000 GBP, so the company now has 405,820,000 Pounds. Next, the company convert holding 405,820,000 Pounds to US dollars at the exchange rate of 1.2437, which is 405,820,000 GBP divide 1.2437 equals to 326,300,555 USD, so the company now have 326,300,555 US dollars. Then, the company using the holding US dollars converts it back to the Australian dollars at the exchange rate of 0.6135, 326,300,555 USD multiple 0.6135 equals to 200,185,390 AUD. So, after triangle arbitrage of AUD, USD and GBP, the company finally has 200,185,390 AUD assets. Subtracting the 200,000,000 AUD initial principal, the final total profit from a risk-free arbitrage is 185,390 AUD. In general, through the triangular arbitrage method of AUD, GBP and USD currency exchange rate, the company can finally make a profit. That is, first use the Australian dollar to buy the Pounds through the GBP / AUD bid rate, then convert the Pounds into the US dollars through the GBP / USD bid rate, and finally convert the US dollars into the Australian dollar through the AUD / USD bid rate. In the end, the company gained a profit of 185,390 Australian Dollars.

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The best condition for using the arbitrage trading method is that the main trend direction of the currency pair is consistent with the arbitrage direction, but it should be noted that there is a considerable risk in the arbitrage trading strategy. If there is no proper risk management, the trader may be evacuated due to the unexpected sudden reversal of the market trend.

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V.

CONCLUSION

This report includes two parts. The first part is a trading strategy that includes two steps in total and the second part explains what the triangular arbitrage is and to show how much profit can we get using the predicted exchange rate based on the triangular arbitrage. This report is based on forecasting currency exchange rates in the coming six months at the first stage of the FX trading session. As we expected, the exchange rate of the US dollar to the Japanese yen will show an upward trend in the next six months which means the US dollar will appreciate against the Japanese yen. During the trading strategy, our team was first asked to calculate and predict the profits according to the exchange rate of USD to JPY as a price taker. We short the US dollar at the bid price, the profit in this step comes from the exchange rate difference between this pair of currencies. The data was shown above in Table 2. Next, we short the Japanese yen at the ask price to buy back the US dollar at a lower rate to get the profit. After that we estimate the opening AUD value of the current portfolio using the mid rates to calculate the final profit because we are in an Australia company. The final profit should be the current net position minus the net position of the first stage and the result is also shown in the updated Table 2. As predicted, this trading strategy has brought us profits, so we have been asked to determine the potential arbitrage opportunities for AUD, USD and GBP currencies based on the expected exchange rate and explain the triangular arbitrage from the perspective of price taker. The triangular arbitrage is the result of a discrepancy between three foreign currencies that occurs when the currency's exchange rates do not exactly match up. According to the calculation above, we expect to get 185,390 Australian dollars as the profit if we got 200,000,000 Australian dollars at the beginning.

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VI. REFERENCE LIST 1. Jon, S 2018, ‘How global currency fluctuations affect small businesses’, Small Business, 12 July, viewed 28 May 2020, . 2. Marc, G ,Tim, K & Werner, R 2015, ‘Getting a better handle on currency risk’, McKinsey&Company, 1 July, viewed 25 May 2020, .

3. Organisation for Economic 2018, OECD shows the short-term-interest-rates summary tables, Organisation for Economic, viewed 21 April 2020, .

4. Organisation for Economic 2018, OECD shows the inflation-cpi - summary tables, Organisation for Economic, viewed 21 April 2020, .

5. Reserve Bank of Australia 2006, Limiting Foreign Exchange Exposure through Hedging: The Australian Experience, Reserve Bank of Australia, viewed 26 May 2020, .

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