《外汇交易实战图表与交易心理》 作 者：(新加坡)许强 (美国)Gary Weiss

In previous chapters I discussed the idea of dollar parity as a pricing component of any foreign exchange contract. Only in passing however，did I go through the idea of cross currency interest rate comparisons as being equally significant. As a general concept the idea of interest rates being a core determinant of a currency price is not particularly arcane. However, it is the relativity of the interest rates that underlie each component of the particular currency pair that actually is one of the key pricing issues. These cross currency interest rate differentials are known figures, however, they are anything but static. Usually, they reflect the market expectation as to whether and by how much the interest rates may move during a specific period of time. By way of example, it*s worth putting this into a specific time component and drawing some conclusions. For this purpose I will refer to the interest rate structure of various currency pairs that existed as of January 2005. In this instance the Euro overnight interest rate was 2.25%, the US Dollar overnight interest rate was 2.50% and the Japanese Yen overnight interest rate was 0.0%. By using these static components, one can see that the differential on interest rates from high to low is clearly in favor of both the Dollar and the Euro, as opposed to the Yen. However by looking at this situation more critically, one can also see that the widest differential is between the Euro against the Yen and also, the Dollar against the Yen, as opposed to the Euro against the Dollar. This is an important observation because it actually goes to the core of what a currency pair represents in the first place, which is both a loan and a deposit taken out simultaneously; a deposit in the context of the long side of the pair and a loan, representative of the short side. For example, a long Dollar Yen position is in reality nothing more than a Dollar deposit and a Yen loan. In fact, most bank funding operations are intricately tied to foreign exchange because the idea of making the most spread on loans or deposits can most often be expressed through the use of multiple layers of currency.

Take for example, a simple funding operation at a money center bank. At any given moment the bank may be bidding for funds, lets assume in a base currency of US Dollars at a rate of 2.48%, and simultaneously offering funds at 2.52%. In this example, lets assume that the bank gets taken on its offer at 2.52% meaning it has booked a dollar deposit at 2.52% (or in effect, the trading counterpart has taken out a loan from the bank at 2.52%) . The bank in this case will deposit funds at the location of the other trading counterpart and earn overnight 2.52% for those dollars. To make this transaction profitable for the bank, ideally, the trading operation will now have to source out a loan or an internal source of funds that will cost less than 2.52% for the same period. It is clear in this context, that by using base US dollar rates, the amounts to be earned in this example are maybe a few basis points at best. But, what if the funding desk can borrow in yen, for example, and actually pay 0.0%, against the dollar income of 2.52% ? Obviously, the transaction would now become infinitely more interesting. How ever, by borrowing in Yen, the trading desk would also be effectively putting on a Dollar Yen position, in this case being long dollars and short yen. All things considered, this position

would earn approximately 2.52% per day except that the position would also need to be rolled over, so as to match the physical funding requirements for each day it might be outstanding. The rollover, or the physical delivery of currency in this situation would require that the yen loan proceeds be sold each night so as to get dollars in to pay for the dollar deposit. Here, of course is where the cost side of the equation would come in. As mentioned in the chapter on dollar parity, the cost of this one day rollover should come close to reflecting the rate that would otherwise be earned by being long dollars and short yen or effectively close to 2.52%. Once again however, as might be the case in numerous circumstances, the cost for this operation may not always be exactly as expected. This of course is the baseline idea for funding operations at banks in general. By examining in detail the cross funding differentials of interest rates in multiple currencies, money market operations at banks can be maximized. All of which is consequential to the foreign exchange trader only because it proves the intrinsic valuation theory of currency pairs in general; specifically, that currency relationships are to a very large extent, controlled by interest rate differentials of the currency components in a particular pair.

This concept is also important because it deals directly with the selection of currency pairs that one might view as applicable for any particular strategy when trading foreign ex change in the short to intermediate term. For example, if one is looking for the Yen to increase in value, over time against the Euro, or the Dollar for that matter, it needs to be borne in mind that this increase must be accomplished against a backdrop of constantly deteriorating value. Meaning that each day the position is held, it will lose money even if the price stays the same (which of course reflects the cost of rollovers as mentioned in the example above) .This is also true with virtually any counter currency against the Yen, because its* interest rates are effectively 0.0%.