Description
Case Study Foreign Exchange (Mark: 10) The Foreign Exchange Market is all set to welcome the FX portals that are sure to revolutionize the way. Forex trading will take place in the 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 good 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 systems work in tandem and manage to capture a large enough portion of the growing Foreign Exchange Market pie. Forex trading is expected to zoom because of growing B2B transactions over the internet as investors are going global and holding more outstanding foreign securities in their portfolios. Therefore, a more price-sensitive and web-enabled Foreign Exchange Market would emerge, resulting in complex transactions 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 the massive volume of transactions, and the quality of transaction services, such as ease of settlement, pre-trade information, etc., will determine their fate. However, from the user’s point of view, the problem that emerges is would the cost of settling with multiple counterparties (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 a long; these FX platforms should be attractive, as they will only have to make one investment to access a 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 challenging task. Then they are to be persuaded to move to a single-dealer channel from the multi-dealer channel, which would be relatively easy once the initial step is taken. When these electronic exchanges automate the traditional and clerical jobs, 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 costs and improving service quality. Question: Do you think that a web-enabled Foreign Exchange Market would revolutionize the forex trading practices in the future? Elucidate with examples. Q.2 Consider a stock worth $25 that can go up or down by 15 percent per period. The risk-free rate is 10 percent. Use one binomial period. (05) a. Determine the two possible stock prices for the next period. b. Determine the intrinsic values at the expiration of Europeancalloptionwithanexercisepriceof$25. c. Find the value of the option today. d. Construct a hedge by combining a position in the 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.
