5.7. CFO’S SUMMARY 211
amount PV risk spread upfront totalA eur1m^1 m× 1.^003.^010 = 9,708.7 1000 + 5,000.0 = 6,000 15,708.7
B eur1m^1 m× 1.^003.^005 = 4,854.4 2000 + 7,500.0 = 9,500 14,354.4
C usd1.333m^1.^333 m 1. 04 ×^0.^009 / 1 .333 = 8.653.8^1 ,000+1 1.^333. 333 m×^0.^005 = 5,750.2 14,404.0So the second loan is best. The issue of whether or not to speculate then boils down
to whether you are keen on selling a large amount ofusd360 days—for instance to
speculate on a fallingusd, or to hedge otherusdincome.
5.7 CFO’s Summary
This concluding section has two distinct parts. First I want to simply review the
main ideas you should remember from this chapter. The second item is a very much
bird’s view of the currency markets and their players.
5.7.1 Key Ideas for Arbitrageurs, Hedgers, and Speculators
We opened this chapter with a discussion of bid-ask spreads. Any transaction or
sequence of transactions (“trip”) that is not a round-trip (not a pure arbitrage
transaction) can still be made through two different routes. In imperfect markets—
and, notably, with positive spreads—it is a near certainty that one route will be
cheaper than the other, and therefore, it generally pays to compare the two ways
of implementing a “trip.” The route chosen matters because, with spreads, it is
mathematically impossible that for every single trip the two routes end up with
exactly the same result. Equality of outcomes may hold, by a fluke, for at most one
trip. And even if the difference between the outcomes of the two routes is small in
the wholesale market, that difference can be more important in the retail market,
where costs are invariably higher.
But there is more to be taken into consideration than spreads. Differential tax-
ation of capital gains/losses and interest income/cost provides another reason why
two routes are likely to produce different outcomes. For most corporate transactions,
however, taxes may not matter, since interest and short-term capital gains (like for-
ward premia received or paid) typically receive the same tax treatment. Lastly, in-
formation asymmetries can induce incompatibilities between the risk spreads asked
by different banks; and if the loans also differ by currency, one can go for the best
spread and then switch to the most attractive currency via a swap. Recall that the
attractiveness of a loan is mainly determined by its (PV’ed) risk spread, not the total
interest rate.
A second implication of bid-ask spreads relates to the cost of hedging. In Chapter
4, we argued that, in perfect markets, hedging has no impact on the value of the