Case Study Foreign Exchange (Mark: 10)
The Foreign Exchange Market is all set to welcome the FX portals that are sure to revolutionise the way Forex trading would take place in future. Their viability would depend on the way participants would embrace them and on the competition that would ensue. The two portals that have hit the market amid great fanfare are FX all and Atriax. By providing a sufficient range of currencies to the players to allow ease of execution and by giving access to a range of prices from different sources at all times, these portals are aiming to garner liquidity. Instead of being in a win-lose situation, a win-win scenario could emerge if both the systems would work in tandem and manage to capture a large enough portion of the growing Foreign Exchange Market pie. Forex trading itself is expected to zoom because of growing B2B transactions over internet as the investors are going global and holding greater foreign securities in their portfolios. Therefore, a more price sensitive and web-enabled Foreign Exchange Market would emerge, which in turn would result in transactions that are complex to liquidate and time consuming to settle. For the automated marketplace where information need looms large, lies the answer in the form of such portals.
The success of these platforms would depend on a host of factors such as their automatic execution, the method of providing prices to the users, the number of partnership agreements that the portal has the number of banks it caters to, etc. The other important feature will be their pricing engines. The quality of the pricing engine, its ability to handle huge volume of transactions and the quality of transaction services, such as ease of settlement, pre-trade information etc. will all determine their fate.
However, from the user’s point, the problem that emerges is would the cost of settling with multiple counter parties (as opposed to just using one or two lead banks for FX trading) come in the way of using a multiple price service? But the customers have been working on integration with a single bank for long, these FX platforms should be attractive, as they will only have to make one investment to access multitude of dealers.
However, for such electronic trading to gather momentum, users need to shift from telephone-based to screen-based trading which would be a tough task. Then they are to be persuaded to move to a single-dealer channel from the multi-dealer channel, which would not be very difficult once the initial step is taken.
When the traditional and clerical jobs are automated by these electronic exchanges, sales desk officers/client relationship managers would be left with more time to spend on value added activities–delivering advice and information. Hence, these platforms could go a long way in lowering cost and improving service quality.
Question:
- Do you think that a web-enabled Foreign Exchange Market would revolutionise the forex trading practices in the future? Elucidate with examples.
Q.2 Consider a stock worth $25 that can go up or downby15 percent per period. The risk-free rate is 10 percent. Use one binomial period. (05)
- Determine the two possible stock prices for the next period.
- Determine the intrinsic values at expiration of Europeancalloptionwithanexercisepriceof$25.
- Find the value of the option today.
- Construct a hedge by combining a position in stock with a position in the call. Show that the return on the hedge is the risk-free rate regardless of the outcome, assuming that the call sells for the value you obtained in part c.
- Determine the rate of return from a riskless hedge if the call is selling for $3.50 when the hedge is initiated.
