International Finance: Putting Theory Into Practice

130 CHAPTER 4. UNDERSTANDING FORWARD EXCHANGE RATES FOR CURRENCY

Figure 4.2:Spot/Forward/Money Market Diagram: the general picture

HCT FCT

HCt FCt

× 1.^121 ×1.21

HCmoney market

× 1.^110 ×1.10

FCmoney market

× 110

× 1 / 110

forward market

× 100

× 1 / 100

spot market





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• Anyt-subscripted symbolHCt(FCt) refers to anamountof spot money; and
  anyT-subscripted symbolHCT(FCT) refers to aT-dated known amount of
  money, e.g. promised under apn,A/P,A/Ror deposit, or forward contract.


• Any possible transaction (spot or forward sale or purchase; home or foreign
  money-market deal) is shown as an arrow. A transaction is characterized by
  two numbers: (a) your position before the transaction, an input amount you
  surrender to the bank, and (b) your position after the transaction, the output
  amount you receive from the bank. The arrow starts from the (a) part and
  ends in the (b) part. For example,
  
  
  • a moveHCt→FCtrefers tobuyingfc—spot (see “t”)
  
  
  • a moveFCT→HCTrefers tosellingfc—forward (see “T”)
  
  
  • a moveHCt→HCTrefers toinvestingorlendinghc
  
  
  • a moveFCT →FCtrefers toborrowingagainst afcincome—e.g. dis-
    counting afc pn.
  
  
  
  


• Next to each arrow we write the factor by which its “input” amount has to
  be multiplied to compute the “output” amount. Again: “input” is what you
  give to the bank (at eithertorT), “output” is what you receive from it.