Some AssetMarket Basics

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Some Asset-Market Basics

• Dick Sweeney
• International Finance

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Introduction

• FX markets are pretty much like any asset market
• Review of what asset markets are like
• What do rates of return look like in most asset
  markets that are "free"?
• What do asset prices look like in most asset
  markets that are "free"?

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USD/DEM Appreciation Rate
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Asset Rates of Return

• Asset rates of return look like they are random.
  See FX graph.
• Of course, this is an approximation
• Rates of return are not truly randombut patterns
  you can detect are usually not useful for making
  profits (EMH)
• What is a rate of return? In general,
• Rit (Pit - Pit-1) / Pit-1 (divit-1 / Pit-1)
  

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• divit / Pit-1 is so-called dividend yield
• Think about a deposit in a big foreign bank in
  Paris or Frankfort in Euros. Say, for one year.
• You are a U.S. resident or a USD firm, so you are
  interested in the return in USD, not in Euros.
• You know you will get the Euro-deposit rate,
  iEur, which you know in advanceno uncertainty,
  bank is "too big to fail"
• You also get price appreciation of the Euro
  

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• Euros are priced in USD, say 1.30/EUR or USD
  1.30 / EUR at time of your deposit.
• Suppose price rises over the year by 13, to USD
  1.43 / EUR. For every Euro you have on deposit,
  you now get back USD 1.43. And you paid only USD
  1.30/EUR.
• For every Euro you get back an extra USD 0.13, or
  relative to the initial price of USD 1.30, you
  get 0.13/1.30 0.10 ? 10 per year

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