 Welcome back everyone. So for today we're going to discuss foreign exchange markets and to do we're going to look at the monetary standards, how these monetary standards evolved, what are the different monetary policies that are applied by different countries. We'll look at currencies, what currencies are, the different currency exchange rates. We will also examine the difference between direct and indirect quotations and finally we'll look at cross rates, forward rates and currency swaps. So first things first, if we want to discuss how the monetary standards evolved throughout time, perhaps the best way to start is by the gold standard which was pre-World War I. The gold standard in short means that the value of a particular currency was set and fixed to an ounce of gold. The very first country that adopted the gold standard was the United Kingdom, it was back in the 1800s and the way that it was determined is through basically the UK had a reserve of gold and so each ounce of gold was equivalent to a particular currency exchange rate that is equivalent to the value of the gold held by the United Kingdom and so this is how the gold standard basically worked. So the UK was the one of the very first to adopt the gold standard and then other countries, including the US, started adopting the gold standard as well. However, later on in the 1900s the gold standard of the UK decided to unpeg its currency. So what we had in terms of the gold standard was some sort of a peg the currency and we will look together what does a peg what pegging means and so in the 1900s the UK decided to unpeg its currency from the gold and so the currency or the pound sterling became a free floating currency and the reason for the unpegging was because again the United Kingdom was trying to finance its operations was trying to finance for the war that was going on in Europe and so because of that they needed to print money. Having the gold standard meant that you are unable to print money if you are unable to print money if it exceeds the value of the gold that you held in your reserves. However, by printing and excess money from the reserve basically the UK unpegged its currency from the gold and so this was pre-World War I and now post-World War II we had a different system, we had different standard the Bretton Woods standard which was basically the basis for the creation of the IMF on the international monetary fund and as for the Bretton Woods the Bretton Woods came to request the standardization and the stability of the currency exchanges, the currency exchange rates basically in a way to try to prevent competitive evaluation of the currencies and so in the 1970s basically the agreement did not work so countries started to withdraw from the agreement and the currencies that were part of the Bretton Woods Agreement became free-flowing currencies and by free-flowing we will see together what a free-flowing currency refers to and what it means once we look at the different currencies and the currency exchanges. But what we're concerned about here in terms of the Bretton Woods Agreement is that once the agreement fell and certain countries started to make or turn their currencies into free-floating currencies for example many countries decided to peg their currency to the US dollars while others decided to peg it to the Deutsche Mark. Now with that in mind we also have different monetary policies that different countries opt for or adopt depending on the situation that they're going through or depending on the kind of simulation for the economy that they want to create. For example we have what is referred to as an expansionary monetary policy and using the expansionary monetary policy governments aim to stimulate the growth in the national economy and how do they do this exactly? They do it by expanding the supply of money basically in a way that is more than that they would do usually. At the same time they might also opt for lowering the short-term interest rates and in that way they aim to simulate the national economy to simulate the growth in the national economy. On the other hand we have a contractionary monetary policies and as part of the use of this kind of monetary policy states here or countries aim to decrease the money supply so that they could counter raising inflation rates and here what countries would do or what governments would do is basically reduce their spending or what they would do also is lower the rate of their monetary expansion. Now there is another type of a monetary policy that some countries opt for and this is known as the Tobin tax and the Tobin tax is simply a tax that a country or a government imposes on international flow of money so international flow of capital in a way that would allow them to reduce the movement of exchange rates and that basically helps them limit the inflow and outflow of international capital and the reason that they do this is basically to reduce the spending or to lower the rate of monetary expansion. Other states used it as a way to try to control the rising debt like in Italy in 2013 for example. Now these are just the different monetary policies that governments would opt for and this is a brief look into the monetary standards or that we had throughout the years. Now with that in mind we've discussed while looking at the Britain's agreements and while looking at the gold standard we've discussed few terms like a pegged currency and the free floating currency and this is exactly what we're going to look into here but before we do that the very first thing that we need to remember is the foreign exchange rates and by foreign exchange rates what we mean is the value of a particular currency when measured against another one so basically the value of a US dollar for example against the Mexican peso. Now if we're talking about currencies that are free floating or maybe even currencies that are pegged normally we have what is referred to as either managed exchange rates or demand based exchange rates so the demand based exchange rates are basically or flea floating currencies are basically currencies that their value is basically allowed to be determined by the supply and demand of this particular currency so it is basically up to the market to determine its value. Now this is what is known as a free floating currency and an example of that is the US dollar on the other hand if we're talking about managed exchange rates or managed currencies here we're talking about perhaps a dirty float or what is referred to as a dirty float and in this instance you have currencies basically that their exchange rate is determined or set by a particular government. I think about the Malaysian ring it for example now a fixed exchange rate is when you have a particular currency that have an exchange rate fixed to a particular foreign currency so think about the Saudi real where the price of a Saudi real is already fixed to a US dollar per every unit of US dollar a soft peg is basically a form of tying a currency to another currency to the national currency to a foreign currency so in a way it is a fixed type of a fixed a fixed currency now when it comes to the soft peg on the other hand is a different form of a fixed currency exchange rate so here what we're talking about is a currency that's value is determined by the market however the government intervenes if the exchange rate starts to move rapidly in one direction this is for example the case of the Costa Rican column the crawling peg on the other hand is basically a form of an exchange rate where the currency the national currency is allowed to fluctuate within a particular ratio think of the Honduran limpira for example on the other hand when we're talking about fixed exchange rates we have another form of a fixed exchange rate that is known as a hard peg and the hard peg or the dollarization is basically a form of fixed exchange rate whereby the central government determines the value of the of the national currency think about the Argentinean peso in 1999 or the Lebanese lira Lebanese pound pre 2019 a currency merger on the other hand is basically when a country decides to join a another country in the use of one common one country or more in the use of one common currency for example the euro now with these in mind now that we know all the different currency exchange at all the different types of currencies it is perhaps a good time for us to start learning about what direct codes and what are indirect codes and how they are calculated and how they help us basically understand the the currency exchange rate of the different foreign currencies direct currency code is basically when we try to calculate or measure the number of national currency units that we need to buy a particular foreign currency on the other hand or on the flip side you have the indirect currency code and here what we do we have foreign currency and so we try to measure how much we can buy with that foreign currency in a national currency now normally when we talk about direct codes and indirect codes the base currency that we always calculate on is the US dollar however there are some exceptions to that rule which is basically when we talk about commonwealth-based currencies or even the UK or even the British pound now to calculate the direct code all we need to do is basically the direct code equals one over the indirect code so it's very straightforward there's nothing much to it to there's no much room for confusion or no much room for difficulty over here now when we're talking also about currency exchange rates there are a few things that we can look into so we can look at the forward rates and normally forward rates are the settlement prices or the settlement price of a particular forward contract now these forward rates basically they act as an indication of the market's expectations of a particular price movement in the future but one thing that we need to highlight here and perhaps it is the first time you might hear of it a settlement price a settlement price is basically the spot rate and the spot rate is the transacted exchange rate that the buyers and the sellers read on at a particular period of time now on the other hand we have forward contracts which was basically the basis of the forward rates and forward contracts are the exchange of a pre-agreed on amount of money or currency basically on a predetermined date between the buyer and the seller at a specific exchange rate that they've agreed on before now these forward contracts are normally traded in forward markets and forward markets are there for currency markets for transactions at a forward rate now there are also other things that are associated but with the forward contracts and with currency exchanges and one of those is basically the currency the cross rates now a cross rate is the exchange rate of two currencies that are not particularly used or official for the country where the exchange code is being given now a currency a currency swap is basically when you have the buying and selling of a particular currency for two different dates happening all at the same time so the buying and selling takes place at the same time for for this currency at two different dates now we looked at the what we will look at now is basically the spot contracts and spot contracts is when you buy and sell commodities securities or even currencies for a settlement on a particular spot date and as we said the spot date is normally at two business dates after the trade took place derivatives as you may know is basically a financial product that's value is derived from an underlying asset and this underlying asset comes in a form of a financial instrument that could be either all that could also be a commodity or it could be a another currency now the final thing that we'll be discussing today is the bootstrapping method and the bootstrapping method is basically a way to try and find out the zero coupon fixed income yield curve for from a price of a set of coupon bearing products now these coupon bearing products are normally bonds or swaps but how does this happen so basically let's assume we are trying to find how much interest we can get from lending money to different through different periods of time in this case what we want to do is we want to look at the price of some of the products that could pay interest and here we are looking basically at either bonds or we're looking at or at swaps and now after this what we normally would do is we would look at these products and figure out their different maturity dates because each product has its own maturity dates and has its own interest rates and so we would try to figure out the maturity dates and the interest rates of these products and then from there what we will do is use these prices that we've gathered to calculate the present value or basically in simple terms how much money we will get back if we invested in these instruments now the next thing that we will do we will try to find the zero coupon rate for these different periods of times for the instruments that we've identified and this is exactly how we will be using the bootstrap method so it is a way for us to help us guess or find the zero coupon rate for these different instruments that we've that we've looked into or we are thinking about investing in now this is basically what we've had for today but before I leave you I'd like for you to think about something do a little research and figure out what do you think about currency exchange rate policies how do you feel that countries opt for a particular currency exchange rate policy what are the rules or maybe what are the principles that they follow and how do they come to the decision that perhaps a free-floating currency is more suitable for them or maybe some sort of a pegged currency is better is a better option do your research and we'll meet next week thank you