Hey guys,
I have a question. I know this is all over the internet and it is easy to find info. But I am trying to do this question in one of my text books and the answer provided by the tutor is confusing the hell out of me.
So, I will ask my question in parts:
[B][U]Part 1:[/U][/B] If there is a quote, AUD/DM = 1.4410/1.4108
That means the buy is 1.4410 and sell is 1.4108. Right? This quote is in the bank’s perspective right? That is the bank will buy 1 AUD and give you 1.4410 DM and if you want 1 AUD you will have to pay 1.4108 DM, is that correct?
[B][U]Part 2:[/U][/B] Basically the question is this importer could have paid in DM but has already signed a contract to pay in AUD. The bank tells the importer you could have probably saved if you paid in AUD. So I basically have to find out if the importer saves or not. The spot rate is AUD/DM = 1.4410-1.4108.
3 Month forward discount rate is 0.0320(buy) and 0.0345(sell). So if the importer wanted DM so that he could pay the exporter in DM, you would use 1.4410 + 0.0320 = 1.4730. So you would pay the bank 1 AUD and get 1.4730 DM. Right?
Well that is what I think it is. But our tutor has used 1.4108+0.0345 as the rate to get DM. Which is right?
Thank you!
Part 1 is incorrect. Trading would be too easy if it was the case you described.
If the spot quote is AUD/DM = 1.4410/1.4108, it’s not right.
Bid is always left, and ask is always right. 1.4408/1.4410 would be what you see.
As for the purchase, you would sell to the right, and buy from the left. So, to enter a trade, you always pay you always pay the higher price buying, and the lower price selling. The difference between the two is the spread the broker gets.
Part 2, the tutor is right.
The bank would use the lower number to buy your aussie.
My tutors question is in such a way. I am so confused. It feels like someone scratching nails on a blackboard, that I cant get this.
Thank you for your reply. But I hope you can help me a bit more.
So this is the question, word to word, tell me if my tutor has phased it wrong:
Your customer, Machine Sales Ltd, purchases horticulture machinery from a Company in Germany. Delivery of the machinery tends to be erratic but payments which are made shortly after the receipt of the goods amount to approximately DEM 1.5m in a three month period. The Company’s finance director calls to see you to discuss ways in which the Company can be protected from its foreign exchange risk.
You are asked to quote rates which would provide forward cover for these imports and to advise whether there is an alternative method to obtain protection for the whole of the DEM exposure period for the next 12 months. The finance director would like to be able to arrange cover at the current exchange rate of AUD 1 = 1.4108
The rates on the day of the discussion are:
Buy Sell
SPOT 1.4410 1.4108
Premium Forward Margins
3 month .0320 .0345
6 month .0606 .0636
9 month .0800 .0825
12 month .0955 .0986
Now it is the OP SPEAKING: So what you see above is the question. The Buy is the first column and the sell is the second column. So is my professor wrong in making the question like this?