Chapter 6

Cash Flow Engineering in Foreign Exchange Markets

Following our discussion of fixed-income forwards, futures, and swaps, we now turn to cash flow engineering in currency markets. We begin by introducing foreign exchange (FX) forwards and their pricing. We derive a contractual equation for foreign exchange forwards and discuss two different replicating methodologies based on money market and T-bills synthetics. We show how the covered interest rate parity (CIRP) relationship relates exchange rates to interest rates. Real-world complications such as quoting conventions and margin requirements in FX forwards and swap markets are discussed. Finally, we introduce currency swaps and their replication. We highlight differences between currency ...

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