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Big Fridays Ching, Denise Yee-Ling 1977

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BIG FRIDAYS by DENISE YEE-LING ^ CHING B.Sc., U n i v e r s i t y of Toronto, 1975 A THESIS SUBMITTED IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE DEGREE OF MASTER OF BUSINESS ADMINISTRATION i n THE DEPARTMENT OE COMMERCE AND BUSINESS ADMINISTRATION We accept t h i s t h e s i s as conforming to the r e q u i r e d standard THE UNIVERSITY OF BRITISH COLUMBIA AUGUST, 1977 © Denise Yee-Ling Ching, 1977 In presenting th i s thes is in pa r t i a l fu l f i lment of the requirements for an advanced degree at the Univers i ty of B r i t i s h Columbia, I agree that the L ibrary shal l make it f ree ly ava i l ab le for reference and study. I fur ther agree that permission for extensive copying of th is thesis for scho lar ly purposes may be granted by the Head of my Department or by his representat ives. It is understood that copying or pub l i ca t ion of th is thes is for f inanc ia l gain sha l l not be allowed without my writ ten permission. Department of COMMERCE AND BUSINESS ADMINISTRATION The Univers i ty of B r i t i s h Columbia 2075 W e s b r o o k P l a c e V a n c o u v e r , C a n a d a V 6 T 1W5 ABSTRACT The U n i t e d S t a t e s operates a dua l payments system which g i v e s r i s e t o the d i s t i n c t i o n between C l e a r i n g House Funds and F e d e r a l Funds. Due to the f a c t t h a t , u n l i k e the U n i t e d S t a t e s , Canada operates a s i n g l e payments system, a p o t e n t i a l a r b i t r a g e o p p o r t u n i t y a r i s e s i n t r a n s a c t i n g between the Canadian and U.S. money markets on c e r t a i n days of the week. Thei*e are e s s e n t i a l l y two s i t u a t i o n s i n which U.S. i n v e s t o r s can have an i n t e r e s t : the Friday-Monday t r a n s a c t i o n and the Thursday-Friday t r a n s a c t i o n . Since both the f o r e i g n exchange market and the money market are almost c e r t a i n l y e f f i c i e n t , any p o t e n t i a l a r b i t r a g e o p p o r t u n i t y should be e l i m i n a t e d by adjustments i n both markets. T h i s paper looks a t the impact of the t r a n s a c t i o n s t h a t would tend to e l i m i n a t e any a r b i t r a g e o p p o r t u n i t y , upon i n t e r e s t r a t e s and exchange r a t e s . The i n s t i t u t i o n a l • d e t a i l s f o r a r r a n g i n g such t r a n s a c t i o n s are a l s o examined. Only the i m p l i c a t i o n s i n the f o r e i g n exchange market were e m p i r i c a l l y t e s t e d u s i n g d a i l y spot r a t e s and forward r a t e s from 19 73 t o 19 76. Since d a i l y i n t e r e s t r a t e s i n t h i s p e r i o d were not a v a i l a b l e , o n l y one example of d a i l y v a r i a t i o n o f i n t e r e s t r a t e w i t h i n a week was i l l u s t r a t e d . I t was found t h a t t r a n s a c t i o n s i n both the spot market and the forward market have t o be arranged one busi n e s s day i n advance. T h e r e f o r e , the spot/forward r a t e i s a l s o quoted i one b u s i n e s s day i n advance ( f o r example, spot/forward r a t e t h a t p r e v a i l s on Thursday i s quoted f o r F r i d a y ' s t r a n s a c t i o n ) . Hence the r a t e i m p l i c a t i o n from the movements of funds should be s h i f t e d one business day backward. The r e s u l t s show t h a t the day-to-day movements i n the spot and forward markets are as we would expect. W i t h i n the f o r e i g n exchange market, the forward r a t e s a d j u s t to a g r e a t e r e x t e n t than the spot r a t e i n e l i m i n a t i n g the advantage t h a t a r i s e s from the movements of funds. T h i s a l s o i n d i c a t e s t h a t most i n v e s t o r s p r e f e r to cover t h e i r investments by a r r a n g i n g forward c o n t r a c t s . The a r b i t r a g e o p p o r t u n i t y t h a t a r i s e s i n v o l v i n g movements of funds between Canada and the U n i t e d S t a t e s i s a l s o a p p l i c a b l e between the U n i t e d S t a t e s and any European country t h a t operates a s i n g l e payments system. The theory behind i t i s i d e n t i c a l t o t h a t d e s c r i b e d i n t h i s paper. F i n a l l y , i t was found t h a t even i f banks i n Canada and the U n i t e d S t a t e s use the S o c i e t y f o r Worldwide Interbank F i n a n c i a l Telecommunications (S.W.I.F.T.) f o r a number of t r a n s a c t i o n s i n the near f u t u r e , mechanisation o f the I n t e r n a t i o n a l cheque c l e a r i n g systems i s not one of the f u n c t i o n s f o r which S.W.I.F.T. w i l l be used. T h e r e f o r e , t h e "Big F r i d a y s " o p e r a t i o n s are expected to c o n t i n u e . TABLE OF CONTENTS PAGE CHAPTER I INTRODUCTION....... 1 Purpose of the study 1 Importance of the study 2 Chapter o r g a n i z a t i o n 3 I I CLEARING SYSTEMS IN CANADA AND THE UNITED STATES ... 6 C l e a r i n g system i n the U n i t e d S t a t e s 6 F e d e r a l Funds and C l e a r i n g House Funds 10 C l e a r i n g system i n Canada 13 I I I EXPLANATION OF BIG FRIDAYS 14 Friday-Monday t r a n s a c t i o n s 14 Thursday-Friday t r a n s a c t i o n s 16 IV IMPLICATIONS FOR EXCHANGE RATES AND INTEREST RATES 17 F o r e i g n Exchange Market 17 Hedging c o s t / p i c k u p 17 Spot market 19 Forward market 20 Canadian Money Markets 20 V TESTING OF IMPLICATIONS AND PROBLEMS T~ • ENCOUNTERED. . .:. . .......... ... ... . 2 2 CHAPTER PAGE Problems on T e s t i n g . . . . . . . . . . . . . 22 A v a i l a b i l i t y o f data ..... 22 Cost/pickup r a t e s * . 22 Forward r a t e s 24 I n t e r e s t r a t e s 24 I n t e r p r e t a t i o n o f data 25 Spot t r a n s a c t i o n s 25 Forward t r a n s a c t i o n s 26 The t e s t s 27 t - T e s t 27 Sign t e s t 28 Hypothesis 29 Spot r a t e s 29 Forward r a t e s 29 Cost/pickup r a t e s 29 R e s u l t s 3 0 VI DISCUSSION OF RESULTS 3 3 F o r e i g n Exchange Market 3 3 Spot r a t e s 3 3 Forward r a t e s . . . . . 3 8 Cost/pickup r a t e s 40 Money Market V I I CONCLUSIONS . 4 2 BIBLIOGRAPHY 4 5 iv. LIST OF TABLES TABLE NO. PAGE I R e s u l t s of S i g n T e s t and t - T e s t 31 I I I n t e r e s t Rates f o r C l e a r i n g House Funds and F e d e r a l Funds... 32 I I I Comparision of Expected and A c t u a l R e s u l t s of Sign T e s t 34 IV Comparison of Expected and A c t u a l R e s u l t s of t - T e s t 35 V Comparision o f Expected and A c t u a l R e s u l t s of I n t e r e s t Rate Movements....... 36 v ACKNOWLEDGEMENTS I would l i k e t o express my a p p r e c i a t i o n t o the f o l l o w i n g i n d i v i d u a l s whose a s s i s t a n c e has been i n v a l u a b l e . P r o f e s s o r Maurice L e v i of the U n i v e r s i t y of B r i t i s h Columbia i n i t i a t e d r e s e a r c h on t h i s t o p i c and has g i v e n me much guidance and encouragement throughout. He has a l s o a s s i s t e d i n d e s i g n i n g the framework of the r e s e a r c h . His a c t i v e involvement has g i v e n me a b e t t e r understanding and i n s i g h t of the study. Mr. Andrew K.C. Ee, Superintendent, I n t e r n a t i o n a l , and Mr. B r i a n P. M i l l a r d , E x e c u t i v e A s s i s t a n t both of the Bank of B r i t i s h Columbia, have p r o v i d e d a d e t a i l e d d e s c r i p t i o n of the c l e a r i n g systems i n Canada and the U n i t e d S t a t e s . Mr. Wayne Deans, Vancouver R e p r e s e n t a t i v e , S e c u r i t i e s Department of Bank of Canada p r o v i d e d much of the data used i n the s t a t i s t i c a l a n a l y s i s of 'Big F r i d a y s ' . Mr.D.B. Arber, Operations Manager of Bank of M o n t r e a l -Vancouver Regional O f f i c e , has g i v e n , i n h i s l e t t e r , an e x p l i c i t d e s c r i p t i o n of the e f f e c t s of the adoption of the S o c i e t y of Worldwide Interbank F i n a n c i a l Telecommunications (S.W.L.F.T.) on the o p e r a t i o n s of 'Big F r i d a y s ' . Mr. Robert B. McCorquodale, A s s i s t a n t Manager, I n t e r n a t i o n a l Department of the Canadian I m p e r i a l Bank of Commerce-Vancouver Regional O f f i c e , s u p p l i e d the d a i l y v i Canadian/U.S. exchange r a t e s f o r the s t a t i s t i c a l a n a l y s i s . From the two p e r s o n a l i n t e r v i e w s w i t h Mr. McCorquodale, I have l e a r n e d a l o t about a c t u a l weekend t r a d i n g i n the f o r e i g n exchange market. He a l s o p r o v i d e d me wi t h examples of d a i l y i n t e r e s t r a t e f l u c t u a t i o n s i n the money market on a one week b a s i s . Mr. K.B. F o x c r o f t , S e n i o r A d v i s o r - F o r e i g n Exchange of the Toronto-Dominion BankjHead O f f i c e , c l e a r e d up most o f the c o n f u s i n g i s s u e s I encountered i n t h i s r e s e a r c h . His l e t t e r gave a thorough and c l e a r d e s c r i p t i o n of the most c r u c i a l u n d e r l y i n g f a c t o r s of the B i g F r i d a y s o p e r a t i o n s . T h i s has allowed me to take a b i g step towards a more complete understanding of the r e s e a r c h . Mr. C h a r l e s B a r r i n g t o n J r . of Wood-Gundy L t d . , p r o v i d e d u s e f u l i n f o r m a t i o n of the a p p r o p r i a t e f a c t o r s i n v o l v e d i n t h i s r e s e a r c h such as the a v a i l a b i l i t y of the weekend c o s t / p i c k u p . His a r t i c l e , 'Basic P r i n c i p l e s o f F o r e i g n Exchange and the Money Market Salesman' s t i m u l a t e d i n i t i a l i n t e r e s t i n t h i s r e s e a r c h . v i i 1 CHAPTER I INTRODUCTION PURPOSE OF THE STUDY The purpose of t h i s study i s to examine the e f f e c t s of the d i f f e r e n c e s i n the cheque c l e a r i n g systems i n Canada and the U n i t e d S t a t e s (U.S.) and between these c o u n t r i e s , on the Canadian/U.S. d o l l a r exchange rates'and i n t e r e s t r a t e s . Canada operates on a s i n g l e payments system; t h a t i s , a l l cheques i n c l u d i n g i n t e r n a t i o n a l payments are c l e a r e d the same day. U n l i k e Canada, the U n i t e d S t a t e s operates on a d u a l payments system which g i v e s r i s e to the d i s t i n c t i o n between " C l e a r i n g House Funds" and " F e d e r a l Funds". A l l t r a n s a c t i o n s i n the f o r e i g n exchange market are conducted i n u n c l e a r e d funds t h a t are y e t to be processed through the F e d e r a l Reserve System. I t takes one busi n e s s day f o r C l e a r i n g House Funds to become F e d e r a l Funds. C l e a r i n g House Funds become F e d e r a l Funds when the t r a n s a c t i o n i s processed through the F e d e r a l Reserve System and the amount i s c r e d i t e d o r d e b i t e d to the a p p r o p r i a t e bank's account. Due to the e x i s t e n c e of the dual payments system i n the U n i t e d S t a t e s and the f a c t t h a t Canada operates a s i n g l e payments system, a p o t e n t i a l a r b i t r a g e o p p o r t u n i t y a r i s e s i n t r a n s a c t i n g i n the Canadian and the U n i t e d S t a t e s money markets on c e r t a i n days of the week. 2 Since the f o r e i g n exchange market and the money market are both c o n s i d e r e d e f f i c i e n t , any a r b i t r a g e o p p o r t u n i t y i n these markets should be smoothed out by adjustments i n both markets. T h i s paper looks a t the impact of the t r a n s -a c t i o n s t h a t would tend t o e l i m i n a t e any a r b i t r a g e o p p o r t u n i t y , upon the exchange r a t e s and i n t e r e s t r a t e s . I t a l s o examines a c t u a l procedure and t i m i n g f o r a r r a n g i n g such t r a n s a c t i o n s . I t i s expected t h a t a l l banks i n Canada and the U n i t e d S t a t e s w i l l be u s i n g the S o c i e t y f o r Worldwide Interbank F i n a n c i a l Telecommunications (S.W.I.F.T.) f o r i n t e r n a t i o n a l cheque c l e a r a n c e i n the near f u t u r e . The e f f e c t s of adopting such a system on 'Big F r i d a y s ' o p e r a t i o n s are a l s o i n v e s t i g a t e d . IMPORTANCE OF THE STUDY There are numerous a r b i t r a g e u r s working c o n s t a n t l y i n the f o r e i g n exchange market and the money market i n Canada and the U n i t e d S t a t e s who are w e l l aware of the s p e c i a l f e a t u r e s of both c l e a r i n g systems. However, there has been no pr e v i o u s formal attempt t o c l a r i f y whether t r a n s a c t i o n s such as those d e s c r i b e d i n t h i s paper can a c t u a l l y have an important impact on the f o r e i g n exchange market and the money market. To new p a r t i c i p a n t s i n the markets, t h i s study can serve as a g u i d e l i n e t o whether such movements of funds are p r o f i t a b l e to the i n v e s t o r s and g i v e s the i n s t i t u t i o n a l - d e t a i l s 3 of how and when to arrange such t r a n s a c t i o n s . Since Canada and the U n i t e d S t a t e s are major t r a d i n g p a r t n e r s , t h e r e are a s u b s t a n t i a l number of o r g a n i z a t i o n s i n both c o u n t r i e s t r a d i n g w i t h each other g i v i n g r i s e to a demand of U n i t e d States/Canadian c u r r e n c i e s i n the f o r e i g n exchange market. Whether a p a t t e r n a c t u a l l y e x i s t s f o r day t o day v a r i a t i o n s of exchange r a t e s d u r i n g the week i s important t o these o r g a n i z a t i o n s i n p l a n n i n g t h e i r t i m i n g f o r payments and c o l l e c t i o n of r e c e i v a b l e s i n f o r e i g n c u r r e n c i e s . CHAPTER ORGANIZATION The remainder of t h i s paper i s broken down i n t o s i x s e c t i o n s , namely, (i) a d e s c r i p t i o n o f the c l e a r i n g systems i n Canada and the U n i t e d S t a t e s , ( i i ) e x p l a n a t i o n of B i g F r i d a y s , ( i i i ) I m p l i c a t i o n s f o r exchange r a t e s and i n t e r e s t r a t e s , (iv) t e s t i n g of i m p l i c a t i o n s and problems encountered, (v) d i s c u s s i o n of r e s u l t s and (vi) c o n c l u s i o n s . To understand the B i g F r i d a y s o p e r a t i o n s , the under-l y i n g f a c t o r s t h a t g i v e s r i s e t o such a r b i t r a g e o p p o r t u n i t i e s are e x p l a i n e d . Chapter I I begins by g i v i n g a b r i e f h i s t o r y of the emergence of the dua l payments system i n the U n i t e d S t a t e s and the pr e s e n t cheque c l e a r i n g system. The d i f f e r e n c e between C l e a r i n g House Funds and F e d e r a l Funds are then 4 d i s t i n g u i s h e d f o l l o w e d by a d e s c r i p t i o n of the present Canadian c l e a r i n g system. Chapter I I I e x p l a i n s the B i g F r i d a y s o p e r a t i o n s . The o p p o r t u n i t i e s a v a i l a b l e f o r a r b i t r a g e i n the markets are broken down i n t o two types of t r a n s a c t i o n s ; the F r i d a y -Monday t r a n s a c t i o n and the Thursday-Friday t r a n s a c t i o n . A d e t a i l e d d e s c r i p t i o n of each i s presented i n t h i s chapter. An o b j e c t of t h i s study i s to determine the impact of B i g F r i d a y s o p e r a t i o n s on r a t e changes i n the f o r e i g n exchange market and the money market. From the des-c r i p t i o n of the movements of funds d e s c r i b e d i n Chapter I I I , Chapter IV l i s t s the i m p l i c a t i o n s of these funds movements on r a t e v a r i a t i o n s i n the spot market, the forward market and the money market. Some of the d i f f i c u l t i e s encountered i n t h i s study are the a v a i l a b i l i t y and i n t e r p r e t a t i o n of data. These problems are d i s c u s s e d i n Chapter V. The second s e c t i o n o f t h i s chapter d e s c r i b e s a number of s t a t i s t i c a l t e s t s t h a t were performed on the a v a i l a b l e data and the r e s u l t s o b t a i n e d . The r e s u l t s of the t e s t s are d i s c u s s e d i n Chapter VI. These r e s u l t s are compared t o the expected r e s u l t s as s t a t e d i n the i m p l i c a t i o n s i n Chapter IV. They are then r e l a t e d back t o the proposed theory of the impact of movements of funds on the r a t e v a r i a t i o n s i n the f o r e i g n exchange market 5 and the money market. The f i n a l chapter summarizes the more important p o i n t s r a i s e d i n the study and pr e s e n t s some c o n c l u s i o n s . The f i n a l s e c t i o n of t h i s paper w i l l attempt t o g i v e some ideas as t o what we can expect i n the near f u t u r e when the S o c i e t y f o r Worldwide Interbank F i n a n c i a l Telecommunications i s used by banks both i n Canada and the U n i t e d S t a t e s . 6 CHAPTER I I CLEARING SYSTEMS IN CANADA AND THE UNITED STATES CLEARING SYSTEM IN THE UNITED STATES The c o l l e c t i o n o f cheques on o t h e r banks i n the same community has been c a r r i e d out f o r many years i n the U n i t e d S t a t e s by means of l o c a l c l e a r i n g houses."'' "Since the es t a b l i s h m e n t o f the New York C l e a r i n g House i n 1853, the banks of n e a r l y every c i t y o f any s i z e o f importance through-out the U n i t e d S t a t e s have adopted a c l e a r i n g o r g a n i z a t i o n 2 of some s o r t . " However, exchange o f cheques between banks by messengers i s s t i l l commonly employed t o c l e a r l o c a l cheques i n communities l a c k i n g c l e a r i n g houses. P r i o r to 1914, the U n i t e d S t a t e s banking community l a c k e d an e f f i c i e n t system t o handle c o l l e c t i o n o f cheques and d r a f t s on banks out of .the l o c a l community. 3 The most l o g i c a l method a t t h a t time f o r c o l l e c t i o n of cheques as 1 "A c l e a r i n g house i s a v o l u n t a r y a s s o c i a t i o n of banks l o c a t e d i n the same c i t y j o i n e d t o g e t h e r t o f a c i l i t a t e the d a i l y exchange of cheques, d r a f t s and notes among i t s members, i n s t e a d of separate exchanges made i n d i v i d u a l l y by each bank w i t h the o t h e r s , of ' l o c a l items'." G.G. Munn, E n c y c l o p e d i a  of Banking and Finance, 6th ed. 1962. 2 F r e d e r i c k A. B r a d f o r d , Money and Banking, 4th ed. (New York: Longmans, Green & Co., 1940), p. 309. 3. I b i d . , p. 312 7 s t a t e d by B r a d f o r d was: By m a i l i n g d i r e c t l y t o the drawee banks and l e t t i n g the l a t t e r r e m it the amount of the cheques so r e c e i v e d . The f a i l u r e o f the banks to f o l l o w t h i s procedure r e s u l t e d from the p r a c t i c e o f the drawee banks o f e x a c t i n g an exchange charge from the banks sending i n such cheques f o r payment. T h i s gave r i s e t o a wide v a r i e t y o f agreements among banks i n d i f f e r e n t c i t i e s t o c o l l e c t f o r each ot h e r a t par a l l cheques drawn on banks l o c a t e d i n t h e i r r e s p e c t i v e v i c i n i t i e s or throughout a d e s i g n a t e d t e r r i t o r y . 4 Agreements were a l s o reached between country banks and t h e i r correspondent banks i n the c i t y t h a t the former can c o l l e c t t h e i r out-of-town cheques through the l a t t e r a t par.^ "The country banks o f v a r i o u s d i s t r i c t s n a t u r a l l y e s t a b l i s h e d correspondent r e l a t i o n s w i t h banks i n the f i n a n c i a l c e n t r e s f o r purpose o f cheque c o l l e c t i o n . A l m o s t every bank i n the U n i t e d S t a t e s has a correspondent bank i n New York, the commerical and f i n a n c i a l c e n t r e of the country. I t became apparent t h a t i t was d e s i r a b l e f o r i n t e r i o r banks 4 I b i d . , p.313 5 A correspondent bank i s one t h a t undertakes to p r o v i d e a v a r i e t y o f s e r v i c e f o r ot h e r banks, u s u a l l y upon the understanding t h a t the l a t t e r w i l l m a i n t ain s u b s t a n t i a l d e p o s i t balances w i t h i t . 6 Remit a t par means t h a t a bank w i l l pay the f u l l f a c e amounts of cheques drawn upon i t - t h a t i t w i l l make no r e d u c t i o n s from the face amount f o r any expenses i n c u r r e d i n making payment. 7 F r e d e r i c k A. B r a d f o r d , Money and Banking, p.313. 8 to m a i n t a i n balances i n New York s i n c e a New York d r a f t formed an acceptable means of payment of any type of banking o b l i g a t i o n o u t s i d e of the home c i t y . The bank r e c e i v i n g payment, having an account i n New York, c o u l d send the d r a f t to i t s New York correspondent f o r c o l l e c t i o n and c r e d i t t o i t s account. New York c i t y thus became a s o r t of c l e a r i n g c e n t r e f o r the banks of the e n t i r e country. With the adoption of the F e d e r a l Reserve Act i n 1 9 1 3 , "the F e d e r a l Reserve Board was granted the a u t h o r i t y as a c l e a r i n g agent f o r the twelve F e d e r a l Reserve Banks, and t o r e q u i r e the Reserve Banks i n t u r n t o a c t as c l e a r i n g p agents f o r the member banks of t h e i r d i s t r i c t s . " Kent a l s o s t a t e d t h a t : A l l member banks may employ the F e d e r a l Reserve c l e a r i n g f a c i l i t i e s f r e e of charge; and s t a t e banks, not members of the F e d e r a l Reserve System, can a l s o o b t a i n f r e e c l e a r i n g s e r v i c e s by agreeing to r e mit at par and to keep w i t h the F e d e r a l Reserve Banks of t h e i r r e s p e c t i v e d i s t r i c t , balances s u f f i c i e n t t o cover any charges t h a t may be made ag a i n s t them f o r items t h a t t u r n out to be u n c o l l e c t i b l e . A c l e a r i n g bank can send t o i t s Reserve Bank cheques drawn upon banks l o c a t e d i n any p a r t of the U n i t e d S t a t e s p r o v i d e d t h a t the drawee banks are committed to remit the F e d e r a l Reserve Banks at par.9 Since the e s t a b l i s h m e n t of the F e d e r a l Reserve System, many of the m e t r o p o l i t a n banks continue to be i n competition 8 Raymond P. Kent, Money and Banking, 5 t h Ed. (New York: R i n e h a r t and Winston, Inc."^ 1961) , p. 1 4 5 - 1 4 6 . 9 I b i d . , p.146 9 w i t h the F e d e r a l Reserve Banks i n p r o v i d i n g c l e a r i n g s e r v i c e s to o t h e r commercial banks... A study by the House Banking and Currency Committee i n the s i x t i e s i n d i c a t e s t h a t over ^.ninety percent of the v a l u e of cheques c l e a r e d by s m a l l banks are handled by c i t y correspondent banks r a t h e r than by the F e d e r a l Reserve System and some f o r t y p e r c e n t of the value of cheques of the l a r g e s t banks are a l s o processed through correspondents. "In t r y i n g t o g a i n a c o m p e t i t i v e advantage, many of the c i t y correspondent banks e s t a b l i s h c l e a r i n g r u l e s and arrangements more l i b e r a l than those of the F e d e r a l Reserve B a n k s . T h e y o f t e n g r ant immediate c r e d i t f o r a l l items sent i n without regard to time r e q u i r e d t o p r e s e n t such items t o the drawee banks. "Despite t h i s c o m p e t i t i v e a t t i t u d e , however, the correspondent banks themselves can f r e e l y use the f a c i l i t i e s of the F e d e r a l Reserve Banks, so t h a t g r e a t q u a n t i t i e s of cheques sent by country banks to correspondent banks even-t u a l l y flow through the F e d e r a l Reserve channel."-^ To W.H. Baughn, & C E . Walker, eds. The Bankers Handbook ( I l l i n o i s : Dow Jones-Irwin, Inc., 1966), pi.1013. 11 Raymond P. Kent, Money and Banking, p.150. 12 I b i d . , p.150. 10 The New York C l e a r i n g House, p i o n e e r and l a r g e s t of c l e a r i n g houses i n the U n i t e d S t a t e s , c o n t i n u e s t o be an important o r g a n i z a t i o n f o r cheque c l e a r i n g . A l l cheques and money t r a n s f e r s i n v o l v i n g the major Network C i t y Banks, which means v i r t u a l l y a l l i n t e r n a t i o n a l banking, s t i l l c l e a r through the New York C l e a r i n g House. In summary, a c i t y c o r r e s p o n d e n t bank who i s a member of i t s d i s t r i c t c l e a r i n g house and who a l s o has an agreement w i t h the F e d e r a l Reserve Bank, has two c h o i c e s o f c l e a r i n g cheques: 1. Send the cheques to the d i s t r i c t c l e a r i n g house who i n t u r n c l e a r s the cheques through the F e d e r a l Reserve Bank. 2 . Send the cheques d i r e c t l y t o the F e d e r a l Reserve Bank. T h i s d u a l payments system i n the U n i t e d S t a t e s g i v e s r i s e to the d i s t i n c t i o n between C l e a r i n g House Funds and F e d e r a l Funds. FEDERAL FUNDS AND CLEARING HOUSE FUNDS C l e a r i n g House Funds are funds used i n s e t t l e m e n t of a t r a n s a c t i o n t h a t are a v a i l a b l e f o r use (or become F e d e r a l Funds, or become good funds) a f t e r one b u s i n e s s day.. When a U n i t e d S t a t e s bank account h o l d e r d e p o s i t s a cheque i n h i s bank, the v a l u e of the cheque w i l l become -Clearing House Funds immediately (day one). A t the f o l l o w i n g b u s i n e s s day, when the cheque i s c l e a r e d through the F e d e r a l Reserve Bank, the 11 value of the cheque w i l l become f e d e r a l funds (good funds) as o f day two. The funds are now ready to be t r a n s a c t e d i n the F e d e r a l Funds Market. T h e r e f o r e , C l e a r i n g House Funds are of no value to the bank u n t i l they are c l e a r e d one business day l a t e r through the F e d e r a l Reserve System. The use of u n c l e a r e d funds i s s u c c i n c t l y d e s c r i b e d below by F o x c r o f t : T r a n s a c t i o n s i n the f o r e i g n exchange market of the world have t r a d i t i o n a l l y been conducted i n Uncleared Funds wi t h the r e s u l t i n g s ettlement payments b e i n g i n the form o f i n t e r b a n k t r a n s -f e r s . These interbank payments are processed through the normal c l e a r i n g systems of the country of the currency t h a t i s being exchanged. The U n i t e d S t a t e s i s no e x c e p t i o n to t h i s r u l e and when a f o r e i g n currency i s bought or s o l d a g a i n s t the U n i t e d S t a t e s d o l l a r , payment i n New York f o r the countervalue i s by way of an interbank payment i n Uncleared or C l e a r i n g House Funds.13 Under the F e d e r a l Reserve System, member banks must h o l d c e r t a i n l e g a l r e s e r v e s i n the F e d e r a l Reserve Banks c a l c u l a t e d on a s p e c i f i c r a t i o t o t h e i r d e p o s i t s . ^ 4 As s t a t e d by N i c h o l s : Any shortage of r e s e r v e s w i l l r e s u l t i n a s i z a b l e p e n a l t y , and any excess of r e s e r v e s w i l l r e s u l t i n an o p p o r t u n i t y c o s t which cannot be recovered. T h i s c r e a t e s an i n c e n t i v e f o r banks t o exchange r e s e r v e s among themselves 13 L e t t e r from K.B. F o x c r o f t , S e n i o r A d v i s o r - F o r e i g n Exchange, Toronto-Dominion Bank, Toronto, A p r i l 5, 1977. 14 Dorthy M. N i c h o l s * T r a d i n g i n F e d e r a l Funds (.Washington:Board of Governors of the F e d e r a l Reserve System, 1962)p.l. 12 wherever p o s s i b l e i n order t o e l i m i n a t e any d i f f e r e n c e between r e q u i r e d and a c t u a l r e s e r v e s . Thus the F e d e r a l Reserve System c r e a t e s an environment f o r an i n t e r b a n k market i n F e d e r a l Reserve Funds.15 The development of the F e d e r a l Funds Market i s summarized i n F o x c r o f t ' s l e t t e r : I n i t i a l l y , the purpose of the F e d e r a l Reserve Funds Market was t o p r o v i d e a means to f a c i l i t a t e the cover of s h o r t f a l l s experienced through the s e t t l e m e n t of cheque c l e a r i n g s , a l l o w i n g banks wit h s u r p l u s e s i n t h e i r F e d e r a l Reserve Bank accounts (as a r e s u l t of p o s i t i v e cheque c l e a r i n g s ) t o l e n d to banks w i t h d e f i c i t s i n t h e i r F e d e r a l Reserve bank accounts (as a r e s u l t of negative cheque c l e a r i n g s ) . F o l l o w i n g demands by the domestic interbank market coupled w i t h p r e s s u r e s from the Eurocurrency market, t h i s predominantly short-term market has developed i n t o a mid-term market wherein i n t e r b a n k F e d e r a l Funds d e p o s i t s are t r a n s a c t e d up to one year i n maturity.16 Commercial banks i n the e a s t e r n s t a t e s o f the U n i t e d S t a t e s such as New York are concerned about d i s t i n g u i s h i n g F e d e r a l Funds and C l e a r i n g House Funds and r e f l e c t the d i f f e r e n c e between the two i n t h e i r c a l c u l a t i n g o f i n t e r e s t f o r C l e a r i n g House Fund d e p o s i t s . An account h o l d e r d e p o s i t i n g a U n i t e d S t a t e s d o l l a r cheque would not r e c e i v e F e d e r a l Funds value u n t i l the f o l l o w i n g b u s i n e s s day. 15 James M. Boughton, Monetary P o l i c y and the F e d e r a l Reserve  Funds Market (Durham, N.C.: Duke U n i v e r s i t y P r e s s , 1972), p.4 16 I b i d . , L e t t e r from K.B. F o x f r o f t -13 Some banks i n the western s t a t e s such as Oregon and Washington do not g e n e r a l l y d i s t i n g u i s h F e d e r a l Funds and C l e a r i n g House Funds. An account h o l d e r d e p o s i t i n g a U n i t e d S t a t e s d o l l a r cheque r e c e i v e s F e d e r a l Funds va l u e a t time 17 of d e p o s i t and not the f o l l o w i n g business day. CLEARING SYSTEM IN CANADA A l l cheques i n Canada are c l e a r e d by the Canadian C l e a r i n g House managed by the Canadian Bankers A s s o c i a t i o n . Members of the Canadian Bankers A s s o c i a t i o n are the Canadian c h a r t e r e d banks who a l s o handle and c o l l e c t cheques f o r the neair-banks and non-banks. I t should be noted t h a t the r e v i s i o n of the 1977 Bank A c t proposes t h a t a l l d e p o s i t -t a k i n g i n s t i t u t i o n s must belong to the Canadian Payments A s s o c i a t i o n , as members or non-members. T h i s means t h a t i n the f u t u r e , a l l cheques w i l l be c l e a r e d d i r e c t l y through the Canadian C l e a r i n g House. Cheques sent by the Canadian c h a r t e r e d banks (at the end of day one) to the C l e a r i n g House are processed the f o l l o w i n g day (day two). When the cheques are c l e a r e d i n day two, they are back-dated t o day one when c r e d i t i n g or d e b i t i n g the bank's?reserve account. T h e r e f o r e , i n e f f e c t , the v a l u e of the cheques become good funds the moment the 18 cheque i s d e p o s i t e d i n the bank. Robert B. McCorquodale, Inte r v i e w h e l d a t the Canadian I m p e r i a l Bank of Commerce, Vancouver, B.C., May 1977. 18 Andrew K.C. Ee and B r i a n P. M i l l a r d , Interview h e l d at the Bank of B r i t i s h Columbia, Vancouver, B.C., A p r i l , 1977. 14 CHAPTER I I I EXPLANATION OF BIG FRIDAYS The d u a l payments system i n the U n i t e d S t a t e s g i v e s r i s e to the d i s t i n c t i o n between C l e a r i n g House Funds and F e d e r a l Funds. Together w i t h the f a c t t h a t Canada operates on a s i n g l e payments system, a p o t e n t i a l a r b i t r a g e o p p o r t u n i t y a r i s e s f o r U.S. i n v e s t o r s i n v e s t i n g on Thursdays and F r i d a y s . T h i s a r b i t r a g e o p p o r t u n i t y does not only p e r t a i n t o the Canadian/U.S. market. Since a number of the European c o u n t r i e s , l i k e Canada, operate on a s i n g l e payments system, the a r b i t r a t i o n or movements of funds d e s c r i b e d below can a l s o be a p p l i e d to the E u r o d o l l a r market. In f a c t , t h i s 19 phenomenon i s known as the "Thursday-Friday Game" to those who p a r t i c i p a t e i n the E u r o d o l l a r market t r a n s a c t i o n s . There are e s s e n t i a l l y two f o r e i g n o p p o r t u n i t i e s i n which U.S. i n v e s t o r s can have an.-- i n t e r e s t i n t h e i r investment of funds between Thursday and the f o l l o w i n g Monday. FRIDAY-MONDAY TRANSACTIONS I t i s advantageous f o r a U.S. i n v e s t o r ( f o r example, a U n i t e d S t a t e s commercial bank), who i s a member of the C l e a r i n g House,and who a l s o has an agreement wi t h the F e d e r a l 19 M a r t i n Mayer, The Bankers (New York: Weybright and T a l l e y , 1974) . 15 Reserve Bank t o remit a t par, to c o n s i d e r the f o l l o w i n g t r a n s a c t i o n s : purchase Canadian d o l l a r s f o r value F r i d a y f o r countervalue i n U n i t e d S t a t e s d o l l a r s and i n v e s t i n the Canadian money market f o r the weekend ( F r i d a y , Saturday and Sunday). Given t h a t a l l t r a n s a c t i o n s i n the f o r e i g n exchange market are conducted i n u n c l e a r e d funds, the payment of U n i t e d S t a t e s d o l l a r s i n C l e a r i n g House Funds would not be c l e a r e d through the F e d e r a l Reserve System and d e b i t e d a g a i n s t the bank's account t i l l the next business day which i s the f o l l o w i n g Monday. On Monday, the U n i t e d S t a t e s Bank converts i t s proceeds from the investment =•in the Canadian money market i n Canadian d o l l a r s back t o U n i t e d S t a t e s d o l l a r s i n the f o r e i g n exchange market. The proceeds, now i n U n i t e d S t a t e s d o l l a r s , would not be c r e d i t e d to the bank's account i n the F e d e r a l Reserve Bank t i l l Tuesday (the f o l l o w i n g business day). In e f f e c t , the commercial bank gets to use the funds f o r t h r e e days ( F r i d a y , Saturday and Sunday) and l o s e s the funds i n i t s r e s e r v e account f o r o n l y one day (Monday). T h e r e f o r e , t h e r e i s a net g a i n on use of funds f o r two days. T h i s process can be i l l u s t r a t e d by an example. I f the i n t e r e s t r a t e o f f e r e d i n the Canadian money market i s 3% f o r t h r e e days, the r e t u r n i s a c t u a l l y 3x3/1=9% s i n c e the bank earns three days i n t e r e s t at 3% while l o s i n g F e d e r a l 20 Funds f o r o n l y one day. 20 C h a r l e s B a r r i n g t o n J r . , " B a s i c P r i n c i p l e s of F o r e i g n Exchange and the Money Market Salesman," Wood-Gundy L t d . , August 11,19 16 Since most i n v e s t o r s are r i s k adverse, the above t r a n s a c t i o n i s u s u a l l y covered by a r r a n g i n g a forward c o n t r a c t on F r i d a y f o r d e l i v e r y o f Canadian d o l l a r s on Monday i n the amount of the expected proceeds from the investment. THURSDAY-FRIDAY TRANSACTIONS A U.S. commercial bank can g a i n i n use of funds i f i t borrows Canadian d o l l a r s on Thursday and converts the funds t o U.S. d o l l a r s . The U.S. d o l l a r s can be i n v e s t e d i n the U.S. money market o v e r n i g h t on Thursday and the Canadian l e n d e r can be repayed by c o n v e r t i n g U.S. d o l l a r s back to Canadian d o l l a r s on F r i d a y . The repayment from the U.S. i n v e s t o r ' s p o i n t o f view w i l l be i n u n c l e a r e d funds. He can keep on u s i n g the funds f o r Saturday and Sunday s i n c e they would not be c l e a r e d through the bank account w i t h the F e d e r a l Reserve System u n t i l Monday (the next business day from F r i d a y ) . As a r e s u l t , the U.S. i n v e s t o r has use of the funds f o r three days w h i l e the Canadian l e n d e r l o s e s the funds f o r o n l y one day (Thursday t o F r i d a y ) . 17 CHAPTER IV IMPLICATIONS FOR EXCHANGE RATES AND INTEREST RATES From the t r a n s a c t i o n s d e s c r i b e d above, we expect t h a t on Thursday, funds should move from Canada t o the U n i t e d S t a t e s , i . e . southbound because of the borrowing by U.S. i n v e s t o r s to i n v e s t i n the F e d e r a l Funds Market o v e r n i g h t (Thursday t o F r i d a y ) . On F r i d a y , funds should move northbound from the Un i t e d S t a t e s t o Canada f o r weekend investment i n the Canadian money market. When the o v e r n i g h t investment of Thursday-Friday matures, funds should move northbound on F r i d a y when the U.S. i n v e s t o r s repay the Canadian l e n d e r . There are thus two causes of northbound funds on F r i d a y . On Monday, when the weekend investment matures, the proceeds w i l l be sent southbound back t o the U n i t e d S t a t e s . I f we b e l i e v e t h a t the market i s e f f i c i e n t such t h a t any a r b i t r a g e o p p o r t u n i t y t h a t a r i s e s would be e l i m i n a t e d , the movements of funds d e s c r i b e d above i m p l i e s the f o l l o w i n g r a t e movements i n the f o r e i g n exchange market and the money market. FOREIGN EXCHANGE MARKET  HEDGING COST/PICKUP To a v o i d exchange r i s k t h a t r e s u l t from r a t e s f l u c t u a t i o n s i n t h e . f o r e i g n exchange market, most i n v e s t o r s 18 who p a r t i c i p a t e i n the movements of funds on Thursday-Friday and Friday-Monday cover t h e i r t r a n s a c t i o n s by hedging i n the forward market. Consider a U.S. i n v e s t o r i n v e s t i n g i n the Canadian money "market f o r the weekend. To make sure t h a t h i s proceeds i n Canadian d o l l a r s can be converted back t o U n i t e d S t a t e s d o l l a r s a t a known r a t e , he can arrange a s a l e of h i s Monday proceeds a t a known r a t e i n the f o r e i g n exchange market. I f the r a t e a t which he can s e l l h i s Canadian d o l l a r proceeds a g a i n s t U n i t e d S t a t e s d o l l a r s i s high e r than the spot r a t e p r e v a i l i n g on F r i d a y (that i s , Canadian d o l l a r i s t r a d i n g a t a premium), the U n i t e d S t a t e s i n v e s t o r has earned a 'pickup', 21 a g a i n i n f o r e i g n exchange i n the Friday-Monday swap. On the other hand, i f the r a t e a t which he can s e l l h i s Canadian d o l l a r proceeds f o r Un i t e d S t a t e s d o l l a r s on Monday i s lower than the spot r a t e on F r i d a y (that i s , Canadian d o l l a r i s t r a d i n g a t a d i s c o u n t ) , a 'cos t ' has i n c u r r e d which means t h a t the U n i t e d S t a t e s i n v e s t o r has t o pay c e r t a i n c o s t i n the f o r e i g n exchange market t o secure h i s s a l e of the Canadian d o l l a r s on Monday. The i m p l i c a t i o n s on whether a 'cost' or 'pickup' p r e v a i l s a t c e r t a i n day of the week due to the movements of funds are as f o l l o w s : 1. 'Pickups' are expected on Thursdays to U.S. i n v e s t o r s due o 1 Swap i s the simultaneous purchase of spot currency and the s a l e o f the same f o r a forward date, or v i c e v e r s a . Donald R. Mandich, ed., F o r e i g n Exchange T r a d i n g , Techniques and  C o n t r o l s (Washington: American Bankers Association,1976) P.196. 19 to the e x p e c t a t i o n of the northbound movements of funds on F r i d a y s pushing up the p r i c e of the Canadian d o l l a r . 2 . 'Costs' are expected on F r i d a y s by U.S. i n v e s t o r s due to the e x p e c t a t i o n of the r e t u r n of funds (or southbound movements of funds) from weekend investments pushing down the p r i c e of the Canadian d o l l a r on Mondays. SPOT MARKET 22 1. The spot r a t e on Thursdays are g r e a t e r than t h a t on Wednesdays due to an i n c r e a s e i n demand f o r U.S. d o l l a r s when U.S. i n v e s t o r s borrow Canadian d o l l a r s and convert them t o U.S. currency f o r investment o v e r n i g h t (Thursday-Friday) i n the F e d e r a l Funds Market. 2 . The spot r a t e on F r i d a y s are l e s s than t h a t on Thursdays due to an i n c r e a s e i n demand f o r Canadian currency by two e f f e c t s : the repayment o f funds by U.S. i n v e s t o r s from the Thursday-Friday investment and the northbound movements of funds f o r weekend investment i n the Canadian money market. 3. The spot r a t e on Mondays are g r e a t e r than t h a t on F r i d a y s due to the r e t u r n o f the proceeds from the weekend investment back t o the U n i t e d S t a t e s i n c r e a s i n g the demand f o r U.S. d o l l a r s . o p Spot r a t e s are expressed as Canadian c u r r e n c y / U n i t e d Sta t e s currency i n t h i s paper. 20 FORWARD MARKET Assuming t h a t t r a n s a c t i o n s are covered: 23 1. Forward r a t e s on Thursdays are l e s s than t h a t on Wednesdays because there i s an i n c r e a s e i n demand to purchase forward Canadian currency on Thursdays by i n v e s t o r s engaging i n the Thursday-Friday t r a n s a c t i o n s . 2. Forward r a t e s on F r i d a y s are g r e a t e r than t h a t on Thursdays because t h e r e i s an i n c r e a s e i n demand to s e l l forward Canadian currency on F r i d a y s by i n v e s t o r s engaging i n the Friday-Monday t r a n s a c t i o n s . CANADIAN MONEY MARKET 1. Overnight (or sh o r t term) i n t e r e s t r a t e s for C l e a r i n g House Funds are h i g h e r on Thursdays than on Wednesdays. Since the U.S. borrower gains use of F e d e r a l Funds f o r th r e e days, the r e t u r n s o f f e r e d by the market i s expected t o i n c r e a s e . 2. Overnight (or s h o r t term) i n t e r e s t r a t e s are lower on F r i d a y s than on Thursdays. Since the Canadian borrower gets o n l y one day value i n F e d e r a l Funds,the r e t u r n s o f f e r e d by the market i s expected to decrease. 23 Forward r a t e s are a l s o expressed as Canadian c u r r e n c y / U n i t e d S t a t e s currency i n t h i s paper. 21 3 . Overnight (or s h o r t terra) i n t e r e s t r a t e s on Mondays, Tuesdays and Wednesdays f o r C l e a r i n g House Funds should be r e l a t i v e l y the same s i n c e there i s no i n c e n t i v e f o r i n v e s t i n g i n e i t h e r the Canadian money market or the U.S. money market on these €hree days. T h e r e f o r e the demand f o r investment i n e i t h e r market w i l l not be i n f l u e n c e d by any movements of funds. 22 CHAPTER V TESTING OF IMPLICATIONS AND PROBLEMS ENCOUNTERED To see whether the movements o f funds d e s c r i b e d p r e v i o u s l y a c t u a l l y can a f f e c t r a t e f l u c t u a t i o n s i n the f o r e i g n exchange market and the money market, the i m p l i -c a t i o n s l i s t e d i n Chapter IV are t e s t e d s t a t i s t i c a l l y u s i n g the S i g n T e s t f o r Matched P a i r s and the t - T e s t . Before proceeding to the t e s t s , two major problems t h a t were encountered are d i s c u s s e d . PROBLEMS ON TESTING .1. A v a i l a b i l i t y of Data Not a l l data necessary f o r t e s t i n g every i m p l i c a t i o n l i s t e d were a v a i l a b l e , a. Cost/Pickup Rates Although o v e r n i g h t and weekend c o s t / p i c k u p r a t e s e x i s t and are quoted s p e c i f i c a l l y f o r Thursday-Friday and Friday-Monday t r a n s a c t i o n s , these r a t e s were not a v a i l a b l e f o r t h i s r e s e a r c h . T h e r e f o r e , t h i r t y - d a y c o s t / p i c k u p r a t e s were used i n s t e a d . Using t h i r t y - d a y c o s t / p i c k u p r a t e s reduces the s e n s i t i v i t y of the t e s t s . T h i s can be i l l u s t r a t e d i n the f o l l o w i n g example. 23 I f the r e t u r n t o an account i n v e s t i n g C l e a r i n g House Funds on a F r i d a y f o r t h i r t y - o n e days i s 4 . 6 1 % , the r e t u r n when viewed as a F e d e r a l Funds investment i s a c t u a l l y 4 . 9 3 % . T h i s occurs because the account i s e a r n i n g a t 4 . 6 1 % f o r t h i r t y - o n e days but i s employing F e d e r a l Funds f o r o n l y 24 twenty-nine days. 4 . 6 1 x 'IL- = 4 . 9 3 % 29 The account makes payment on F r i d a y (e.g. January 1) i n C l e a r i n g House Funds. Since i t takes one business day f o r C l e a r i n g House Funds to become F e d e r a l Funds, the account has put F e d e r a l Funds t o work on Monday (January 4 ) . The C l e a r i n g House Funds which the account r e c e i v e s on February 1 (Tuesday) do not become F e d e r a l Funds u n t i l February 2 (Wednesday). The r e f o r e the account has employed F e d e r a l Funds from January 4 t o February 2 which i s twenty-nine days. I n t e r e s t , however, i s being earned f o r t h i r t y - o n e days, g i v i n g us the m u l t i p l i e r of 3 1 / 2 9 . Shortening the term i n c r e a s e s the m u l t i p l i e r . A C l e a r i n g House investment from January 1 to January 4 which i s t h r e e days i s a F e d e r a l Funds investment f o r one day. The m u l t i p l i e r becomes 3/1 and the r e t u r n i n c r e a s e s from 4 . 6 1 % to 1 3 . 8 3 % . 4 . 6 1 x 3/1 = 1 3 . 8 3 % 24 T h i s example i s taken from " B a s i c P r i n c i p l e s o f F o r e i g n Exchange and the Money Market Salesman" by C h a r l e s B a r r i n g t o n J r . 24 Since i t appears t h a t there i s g r e a t e r advantage i n v e s t i n g s h o r t term (or overnight, or weekend), i t i s expected t h a t s h o r t term (or o v e r n i g h t , or weekend) c o s t / p i c k u p r a t e v a r i a t i o n s t o smooth out t h i s advantage should be g r e a t e r than those quoted f o r t h i r t y - d a y p e r i o d . T h e r e f o r e , u s i n g the t h i r t y - d a y c o s t / p i c k u p r a t e s reduces the e f f e c t s shown on f l u c t u a t i o n s of these r a t e s by the movements of funds. b. Forward Rates Since d a i l y o v e r n i g h t forward r a t e s were again not a v a i l a b l e , t h i r t y - d a y forward r a t e s were ob t a i n e d u s i n g the a v a i l a b l e spot r a t e s and the t h i r t y - d a y c o s t / p i c k u p r a t e s i n the f o l l o w i n g formula: 1 2 x ( spot r a t e - forward r a t e ) = 30-day c o s t / p i c k u p r a t e forward r a t e £ , 12 x spot r a t e . . forward r a t e = c  30-day c o s t / p i c k u p r a t e + 12 Again, f o r the same reason as d e s c r i b e d i n the c o s t / pickup r a t e s s e c t i o n , r e s u l t s of h i g h e r s e n s i t i v i t y would be expected i f o v e r n i g h t and weekend forward r a t e s were a v a i l a b l e . c. I n t e r e s t Rates Short term (overnight and t h i r t y - d a y ) i n t e r e s t r a t e s on a d a i l y b a s i s were not a v a i l a b l e s i n c e the banks do not keep a running r e c o r d of such r a t e s . T h e r e f o r e , s t a t i s t i c a l t e s t i n g was not p o s s i b l e on r a t e movements i n the money market. However, 25 an example of a ' t y p i c a l ' p a t t e r n of d a i l y i n t e r e s t r a t e of i n v e s t i n g C l e a r i n g House Funds o v e r n i g h t (or f o r the weekend) was a v a i l a b l e . Hence, an attempt to d i s c u s s t h i s p a t t e r n of i n t e r e s t r a t e v a r i a t i o n s was p o s s i b l e . 2. I n t e r p r e t a t i o n of Data There was some c o n f u s i o n i n i t i a l l y i n the i n t e r -p r e t a t i o n o f the d a t a . I t was found l a t e r on t h a t the t i m i n g f o r a r r a n g i n g the spot and forward t r a n s a c t i o n s i s c r u c i a l to the i n t e r p r e t a t i o n and t e s t i n g p r o c e s s . a. Spot T r a n s a c t i o n s In the U n i t e d S t a t e s , a spot t r a n s a c t i o n i s "a t r a n s a c t i o n f o r spot currency purchased or s o l d f o r d e l i v e r y i n two business days from the t r a n s a c t i o n date, or one 25 b u s i n e s s day f o r Canadian currency." S i m i l a r l y , i n Canada, i t takes one b u s i n e s s day t o arrange a spot t r a n s a c t i o n f o r purchase or s a l e of U.S. c u r r e n c y . T h e r e f o r e , t o s e l l Canadian currency f o r U.S. currency on a Thursday, the t r a n s a c t i o n has to be arranged on Wednesday. L i k e w i s e , t o purchase Canadian currency on F r i d a y , the arrangement has to be made on Thursday and to s e l l Canadian currency f o r U.S. currency on Monday, arrangement has to be made on the p r e v i o u s E r i d a y . 25 Donald R. Mandich ed. .Foreign Exchange T r a d i n g , Techniques  and C o n t r o l s , p.196. 26 Because the p r i c e f o r a spot t r a n s a c t i o n i s quoted a t one business day i n advance, the p r i c e f o r F r i d a y ' s t r a n s a c t i o n s i s Thursday's spot r a t e . S i m i l a r l y , the s p o t -p r i c e f o r Thursday's t r a n s a c t i o n s i s the spot r a t e quoted on Wednesday,etc. Because of the way spot r a t e s are quoted, the expected p a t t e r n of spot r a t e v a r i a t i o n s due to the movements of funds d e s c r i b e d p r e v i o u s l y i n Chapter IV should now a c t u a l l y be changed to the f o l l o w i n g : P r e v i o u s l y Now Thursday>Wednesday Wednesday>Tuesday Friday<Thursday Thursday<Wednesday f o l l o w i n g Monday>Friday Friday>Thursday E x p e c t a t i o n of spot r a t e v a r i a t i o n s b. Forward T r a n s a c t i o n s S i m i l a r to a r r a n g i n g spot t r a n s a c t i o n s , "a forward c o n t r a c t i n the U n i t e d S t a t e s i s s e t t l e d i n two business days f o r major European c u r r e n c i e s or one business day f o r Canadian 2 6 d o l l a r s . " L i k e w i s e , i n Canada, a forward c o n t r a c t i s s e t t l e d i n one business day f o r U.S. d o l l a r s . Consequently, the e x p e c t a t i o n of r a t e v a r i a t i o n s i n the forward market d e s c r i b e d i n Chapter IV should be changed to the f o l l o w i n g : E x p e c t a t i o n of forward r a t e v a r i a t i o n s P r e v i o u s l y Friday>Thursday Thursday<Wednesday Now Thursday>Wednesday Wednesday<Tuesday 26 I b i d . , p.193 27 c. Cost/Pickup Rates Since both the spot and the forward t r a n s a c t i o n s have t o be arranged one day i n advance, the e x p e c t a t i o n on the c o s t / p i c k u p r a t e s a l s o have to be a l t e r e d . E x p e c t a t i o n of c o s t / p i c k u p r a t e by U.S. i n v e s t o r s ( c o s t - ve pickup + ve) P r e v i o u s l y Costs are expected on F r i d a y s Friday<Thursday Pickups are expected on Thursdays Thurs day >Wedne sday Now Costs are expected on Thursdays Thursday<Wednesday Pickups expected on Wednesdays We dne s day > Tue s day THE TESTS The S i g n T e s t f o r Matched P a i r s and the t - T e s t were used f o r t e s t i n g the h y p o t h e s i s . t - T e s t The t-T.est was used s i n c e the v a r i a n c e of the p o p u l a t i o n i s not known, so t h a t the standard e r r o r of the sample mean cannot be determined. However, s i n c e the sample s i z e (n) used is. s u b s t a n t i a l (n>200) , the r e s u l t s o b t a i n e d u s i n g the t - d i s t r i b u t i o n t a b l e s are very c l o s e to those o b t a i n e d by u s i n g the normal t a b l e s . For a h i g h e r degree of accuracy 27 i n t h i s case, the t - t a b l e s were used. 27 Robert L. Winkler, W i l l i a m L. Hays, S t a t i s t i c s , P r o b a b i l i t y , Inference and D e c i s i o n , 2nd ed. (New York: H o l t , Ranehart and Winston, 1975), p.366. 28 The t value i s o b t a i n e d u s i n g the f o l l o w i n g e q u a t i o n s : E s t i m a t i o n of the Sample standard d e v i a t i o n standard d e v i a t i o n = ' of the mean /number o f samples - 1 Sample mean t = ; standard d e v i a t i o n of the mean Sign T e s t The Sign T e s t takes i n t o c o n s i d e r a t i o n o n l y the s i g n of the d i f f e r e n c e between samples and does not c o n s i d e r the magnitude of the d i f f e r e n c e between them. T h e r e f o r e , i t i s not a very powerful t e s t . I t was used simply because the data i n t h i s r e s e a r c h can be arranged i n t o matched p a i r s . The r e s u l t s of t h i s t e s t i s o n l y subordinate t o what i s obtained from the t - T e s t . The p-value, i n d i c a t i n g whether the d i f f e r e n c e s i n the number of p l u s s i g n s and minus s i g n s observed have o c c u r r e d by chance i s c a l c u l a t e d as shown i n the f o l l o w i n g : Number o f s i g n s i n m a j o r i t y - number of samples x 0.5 - 0/i5 Z = —  ^number of samples x 0.5 x 0.5 From the t a b l e s of the normal d i s t r i b u t i o n , the p-value i s o b t a i n e d . 29 HYPOTHESIS  Spot Rates (S) 1. Hypothesis A l t e r n a t i v e 2. Hypothesis A l t e r n a t i v e 3. Hypothesis A l t e r n a t i v e Wednesday(W) S - Tuesday (T) S = 0 WS - TS > 0 Thursday(TH) S - WS- = 0 THS - WS < 0 F r i d a y ( F ) S -THS = 0 FS -THS > 0 The h y p o t h e s i s i s r e j e c t e d a t l e v e l o f s i g n i f i c a n c e = 0.05 Forward Rates (f) 1. Hypothesis : A l t e r n a t i v e : 2. Hypothesis : A l t e r n a t i v e : TH'f - W'f = 0 THf - Wf > 0 Wf - T f = 0 Wf - T f < 0 The hypothesis i s r e j e c t e d a t l e v e l of s i g n i f i c a n c e = 0.05 Cost/Pickup Rates (c/p) 1. Hypothesis : A l t e r n a t i v e : THc/p - Wc/p = 0 THc/p - Wc/p < 0 30 2. Hypothesis : Wc/p - Tc/p = 0 A l t e r n a t i v e : Wc/p - Tc/p > 0 The hypothesis i s r e j e c t e d a t l e v e l o f s i g n i f i c a n c e =0.05 RESULTS The r e s u l t s o f the Si g n T e s t and the t - T e s t are summarized i n Table 1. The p-value c a l c u l a t e d f o r the Sign T e s t i n d i c a t e s the p r o b a b i l i t y o f r e j e c t i n g the proposed dominant s i g n f o r each corresponding r a t e d i f f e r e n c e . The t- v a l u e obtained from the data i s compared t o the t - v a l u e at 0.05 co n f i d e n c e l e v e l t o determine whether the hypothesis i s accepted. I t should be emphasized here t h a t o n l y the r e s u l t s o f the t - t e s t are used as the c r i t e r i o n t o determine i f the hypothesis i s accepted. Although d a i l y i n t e r e s t r a t e s were not a v a i l a b l e f o r s t a t i s t i c a l t e s t i n g , o v e r n i g h t (or one busi n e s s day) d e p o s i t r a t e s f o r F e d e r a l Funds and E u r o - d o l l a r C l e a r i n g House Funds 2 8 f o r a week were a v a i l a b l e . These r a t e s are l i s t e d i n Table 28 The data was g i v e n i n Mr. F o x c r o f t ' s l e t t e r . TABLE 1 RESULTS OF SIGN TEST AND t - T E S T SIGN TEST t - TEST RATE DIFFERENCE DOMINANT SIGN P-VALUE SAMPLE MEAN t -VALUE t O . 05 HYPOTHESIS ALTERNATIVE WS - TS - 0.048 0.00464 3.522 1.645 r e j e c t e d . a c c e p t e d SPOT THS - WS - 0.104 -0.00021 2.000 1.645 r e j e c t e d a c c e p t e d RATES FS - THS + 0.007 0.00027 2.491 1.645 r e j e c t e d a c c e p t e d FORWARD Wf - T f - • 0.001 -0 .00170 9.062 1.645 r e j e c t e d a c c e p t e d RATES THf - Wf + 0.001 0.00154 8.556 1.645 r e j e c t e d a c c e p t e d COST/PICK-UP Wc/p - T c / p - 0.060 1 . 7 8 2 6 2 9 9.806 1.645 r e j e c t e d a c c e p t e d RATES THc/p - Wc/p - 0.303 -2 .0859 12.107 1.645 r e j e c t e d a c c e p t e d 29 The f i g u r e f o r c o s t / p i c k u p r a t e i s e x p r e s s e d as % p e r annum. 32 TABLE I I INTEREST RATES FOR CLEARING HOUSE FUNDS AND FEDERAL FUNDS MONDAY TUESDAY WEDNESDAY THURSDAY FRIDAY (3DAYS) FEDERAL FUNDS 4 3/4% 4 3/4% 4 3/4% 4 3/4% 4 3/4% per day per annum CLEARING HOUSE FUNDS 5% 5% 5% 14% 2% per day per annum 33 CHAPTER VI DISCUSSION OF RESULTS A comparison of the expected r e s u l t s proposed i n t h i s paper and the a c t u a l r e s u l t s o b tained are summarized i n T a b l e I I I (Sign T e s t ) , Table IV (t-Test) and Table V ( I n t e r e s t R a t e s ) . FOREIGN EXCHANGE MARKET The r e s u l t s of the t - T e s t agree: completely w i t h what was expected (or proposed). a. Spot Rates In the spot market, the Wednesday r a t e was found g r e a t e r than the Tuesday r a t e . Bearing i n mind t h a t a spot t r a n s a c t i o n takes one b u s i n e s s day t o arrange, the r e s u l t agrees w i t h the proposed theory: on Thursday, due to the advantage of borrowing Canadian currency to i n v e s t i n the U n i t e d S t a t e s o v e r n i g h t , t h e r e i s a tendency f o r funds to move southbound from Canada to the U n i t e d S t a t e s r e s u l t i n g i n a d e p r e c i a t i o n of the Canadian d o l l a r . T h e r e f o r e , spot r a t e s were expected to go up on Wednesday,the day on which Thursday's t r a n s a c t i o n s are arranged. S i m i l a r l y , the Thursday spot r a t e was found to be lower than the spot r a t e on Wednesday due to the two reasons proposed p r e v i o u s l y . On F r i d a y , funds t h a t were i n v e s t e d i n the U.S. market on Thursday mature and are r e t u r n e d to Canada. The advantage of i n v e s t i n g i n 34 TABLE I I I COMPARISION OF EXPECTED AND ACTUAL RESULTS OF SIGN TEST EXPECTED ACTUAL PROBABILITY OF EXPECTED AND SIGN DOMINANT REJECTING ACTUAL RESULT SIGN DOMINANT SIGN AGREES SPOT RATES WS - TS + - 0.048 No THS - WS - - 0.104 Yes FS - THS + + 0.007 Yes FORWARD '" RATES Wf - T f - - <0.001 Yes THf - Wf + + <0.001 Yes COST/PICKUP RATES Wc/p - Tc/p + - 0.060 No THc/p - Wc/f — — <0.001 Yes 35 TABLE IV COMPARISON ,OF EXPECTED AND ACTUAL RESULTS OF t-TEST EXPECTED tO. 05 ACTUAL EXPECTED RESULT AGREES WITH ACTUAL RESULT SIGN SIGN t-VALUE SPOT RATES WS - TS + 1.645 3.522 YES THS - WS - . 1.645 _ 2.000 YES FS - THS + . 1.645 + 2.491 YES FORWARD RATES Wf - T f - 1.645 9.062 YES THf - Wf + 1.645 + 8.556 YES COST/PICKUP RATES Wc/p -Tc/p + 1.645 + 9.806 YES THc/p-Wc/p — •1.645 • — 12.107 YES 36 TABLE V COMPARISION OF EXPECTED AND ACTUAL INTEREST RATE MOVEMENTS EXPECTED MOVEMENT ACTUAL MOVEMENT EXPECTED RESULT AGREES WITH ACTUAL RESULT CLEARING HOUSE FUNDS MONDAY - WEDNESDAY STABLE STABLE (5%) YES THURSDAY INCREASE INCREASE (14%) YES FRIDAY DECREASE DECREASE(2%) YES FEDERAL FUNDS MONDAY - FRIDAY STABLE STABLE1(;4 3/4%) YES 37 the Canadian money market f o r the weekend a t t r a c t s f u r t h e r funds moving northbound from the U n i t e d S t a t e s i n t o Canada. Hence the p r i c e of the Canadian d o l l a r i s pushed up on Thursday, the day on which F r i d a y ' s t r a n s a c t i o n s are arranged. The F r i d a y spot r a t e was found h i g h e r than the Thursday spot r a t e because on Monday, the weekend investment i n the Canadian money market matures and funds are sent back to the U n i t e d S t a t e s hence pushing down the p r i c e of the Canadian d o l l a r (or an i n c r e a s e i n the spot rate) on F r i d a y , the day on which Monday t r a n s a c t i o n s are arranged. The r e s u l t s of the S i g n T e s t do not agree with the expected r e s u l t s completely. The r e s u l t s show a dominance i n n e g a t i v e s i g n when Tuesdays spot r a t e i s s u b t r a c t e d from Wednesday spot r a t e which i s c o n t r a r y to what was expected. Although the r e s u l t s of the Thursday spot r a t e minus the Wednesday spot r a t e and the F r i d a y spot r a t e minus the Thursday spot r a t e agree w i t h what was proposed, the prob-a b i l i t y o f r e j e c t i n g the s i g n o b tained i n the t e s t s was q u i t e h i g h ; 10.4% -for the Thursday r a t e minus the Wednesday r a t e and 7% f o r the F r i d a y spot r a t e minus the Thursday spot r a t e . As mentioned p r e v i o u s l y , the Sign T e s t i s not powerful i n the a n a l y s i s and t h e r e f o r e the r e s u l t s o b t a i n e d i n t h i s t e s t are of much l e s s importance than those o b t a i n e d i n the t - T e s t . 38 b. Forward Rates The t - T e s t on forward r a t e s a l s o shows r e s u l t s t h a t agree w i t h what was expected. The t - v a l u e s o b t a i n e d i n the two t e s t s on forward r a t e s are much h i g h e r than those o b t a i n e d i n the t e s t s on spot r a t e s i n d i c a t i n g t h a t adjustments i n exchange r a t e s r e s u l t i n g from the movements of funds are h i g h e r i n the forward market than i n the spot market. T h i s a l s o confirms the p r o p o s a l t h a t most i n v e s t o r s who p a r t i c i p a t e i n the movements of funds p r e f e r t o cover the t r a n s a c t i o n s by a r r a n g i n g forward c o n t r a c t s to a v o i d exchange r i s k . Due to the i n c r e a s e i n the demand f o r forward c o n t r a c t s , the adjustments i n forward r a t e s are s u b s t a n t i a l . T h i s can be seen from the h i g h t - v a l u e s o b t a i n e d i n the t e s t s . Remembering t h a t forward c o n t r a c t s are arranged one b u s i n e s s day i n advance, Wednesdays' forward r a t e s are found to be much lower... than Tuesdays* forward r a t e s because on Thursdays, i n v e s t o r s cover t h e i r investments i n the U.S. money market by a r r a n g i n g forward c o n t r a c t s . T h i s c r e a t e s a high supply o f U.S. c u r r e n c y and a h i g h demand f o r Canadian currency i n the f u t u r e hence pushing down the forward r a t e s on Wednesdays, the days on which Thursdays' forward t r a n s a c t i o n s are arranged. S i m i l a r l y , Thursdays' forward r a t e s are h i g h e r than Wednesdays' forward r a t e s because on F r i d a y s , ^demand i n c r e a s e s f o r forward„contracts 39 f o r s a l e of Canadian currency and purchase of U.S. currency i n the f u t u r e . Due to t h i s i n c r e a s e i n demand f o r forward c o n t r a c t s , the forward r a t e s are pushed up on Thursdays, the days on which F r i d a y s ' forward c o n t r a c t s are arranged. R e s u l t s from the Sign T e s t a l s o support the r e s u l t s d i s c u s s e d above. The dominant s i g n o b t a i n e d agrees w i t h the expected s i g n and the p r o b a b i l i t y o f r e j e c t i n g the dominant s i g n i s l e s s than 0.0001% f o r both t e s t s . T h i s a l s o strengthens the i n d i c a t i o n t h a t adjustments i n exchange r a t e s r e s u l t i n g from the movements of funds are h i g h e r i n the forward market than i n the spot market. c. Cost/Pickup Rates Again, the r e s u l t s o f the t - T e s t agree wi t h the expected r e s u l t s . R e s u l t s show t h a t a p o s i t i v e s i g n i s observedcwhen Tuesday's c o s t / p i c k u p r a t e i s s u b t r a c t e d from Wednesday's c o s t / p i c k u p r a t e . On Wednesday, the day on which Thursday's t r a n s a c t i o n s are arranged, pickup i s earned by U.S. i n v e s t o r s due to the e x p e c t a t i o n o f the northbound movements of funds on F r i d a y s pushing up the p r i c e of the Canadian d o l l a r . When Wednesday's c o s t / p i c k u p r a t e i s sub-t r a c t e d from Thursday's c o s t / p i c k u p r a t e , a n e g a t i v e s i g n i s observed. On Thursdays the day on which F r i d a y ' s t r a n s a c t i o n s are arranged, a c o s t i s i n c u r r e d t o U.S. i n v e s t o r s due to the e x p e c t a t i o n o f the r e t u r n o f funds t o the U n i t e d S t a t e s 40 from weekend investments i n the Canadian money market pushing down the p r i c e of the Canadian d o l l a r on Monday. The Sign T e s t on the Wednesday minus Tuesday r a t e shows r e s u l t c o n t r a r y to those o b t a i n e d i n the t - T e s t . However, the Sign T e s t on the Thursday minus Wednesday r a t e agrees w i t h the r e s u l t s from t - T e s t . I t should be emphasized again t h a t the t - T e s t i s always use i n p r i o r i t y to the Sign T e s t i n the a n a l y s i s . MONEY MARKET From the d i f f e r e n c e i n the weekly p a t t e r n of d a i l y i n t e r e s t r a t e s between C l e a r i n g House Funds and F e d e r a l Funds, i t can be seen t h a t the market i s w e l l aware of the d i f f e r e n c e between the two types of funds and r e f l e c t the d i f f e r e n c e i n the c a l c u l a t i n g of i n t e r e s t r a t e s . In other words, the movements of funds d e s c r i b e d i n t h i s paper i n f l u e n c e i n t e r e s t r a t e s v a r i a t i o n s i n the money market. On Thursday, due t o the advantage t o borrow Canadian currency t o i n v e s t i n the U.S. money market (Thursday-Friday t r a n s a c t i o n ) , the i n t e r e s t r a t e f o r E u r o - d o l l a r i n C l e a r i n g House Funds i n c r e a s e s t o 14%'; Since the U.S. i n v e s t o r who engages i n the Thursday-Friday t r a n s a c t i o n gets t o use the funds f o r a t o t a l of t h r e e days when he can i n v e s t i n the F e d e r a l Funds Market, t h i s i s e q u i v a l e n t t o e a r n i n g a t o t a l i n t e r e s t of 14^% ( 3 x 4 3/4%) . The i n c r e a s e i n the i n t e r e s t r a t e -for 41 E u r o - d o l l a r from 5% to n e a r l y t h r e e times as much (14%) e l i m i n a t e s most -of the advantage of the Thursday-Friday t r a n s a c t i o n . On F r i d a y , due to the advantage to i n v e s t i n the Canadian money market f o r the weekend, the i n t e r e s t r a t e f o r C l e a r i n g House Funds drops from a normal r a t e " ^ of 5% to 2%. Since i n v e s t o r s who p a r t i c i p a t e i n the Friday-Monday t r a n s a c t i o n s earn t h r e e days i n t e r e s t w h i l e l o s i n g the funds f o r one day on l y , they are e a r n i n g a t o t a l i n t e r e s t of 6% ( 3 x 2 % = 6%). But t h i s i s much l e s s than what they c o u l d earn i f the normal r a t e p r e v a i l s on F r i d a y (the t o t a l i n t e r e s t they c o u l d have earned i f the normal r a t e p r e v a i l s i s 3 x 5% = 15%). Hence we can see what a l a r g e p a r t of the advantage i s e l i m i n a t e d by t h i s drop i n i n t e r e s t r a t e on F r i d a y . Contrary t o the i n t e r e s t r a t e s f o r C l e a r i n g House Funds, the i n t e r e s t r a t e s f o r F e d e r a l Funds remain s t a b l e d u r i n g the week s i n c e i t i s not a f f e c t e d by the movements of funds d e s c r i b e d i n t h i s paper. 3T5 Normal r a t e here means the i n t e r e s t r a t e t h a t p r e v a i l s from Monday to Wednesday, when there i s no unusual movement of funds t a k i n g p l a c e . 42 CHAPTER VII CONCLUSIONS From the f i n d i n g s of t h i s study, the f o l l o w i n g c o n c l u s i o n s can be drawn: The du a l payments system i n the U n i t e d S t a t e s t h a t g i v e s r i s e t o the d i s t i n c t i o n between C l e a r i n g House Funds and F e d e r a l Funds encourages movements of funds between Canada and the U n i t e d S t a t e s on c e r t a i n days o f the week. However, both the f o r e i g n exchange market and the money market are e f f i c i e n t i n smoothing out the advantage t h a t a r i s e s from the movements of funds by a d j u s t i n g the exchange r a t e s and the i n t e r e s t r a t e s . The advantage o f borrowing Canadian funds and i n v e s t i n g the funds i n the U.S. money market on Thursdays i s p a r t l y e l i m i n a t e d by an i n c r e a s e i n the i n t e r e s t r a t e t o almost th r e e times the normal i n t e r e s t r a t e i n the Canadian E u r o - d o l l a r market f o r C l e a r i n g House Funds on Thursdays. The f o r e i g n exchange market a l s o r e a c t s t o smooth out t h i s advantage by an i n c r e a s e i n the spot r a t e and a decrease i n the forward r a t e on Wednesday/., the day on which Thursday's t r a n s a c t i o n s are arranged. 'Pickups' are u s u a l l y earned by U.S. i n v e s t o r s f o r Thursday's t r a n s a c t i o n s . S i m i l a r l y , the advantage of moving U.S. funds northbound and i n v e s t i n the Canadian money market f o r the weekend i s p a r t l y e l i m i n a t e d by a decrease i n the i n t e r e s t 43 r a t e to almost o n e - t h i r d i t s normal i n t e r e s t r a t e i n the Canadian E u r o - d o l l a r market f o r C l e a r i n g House Funds. In the f o r e i g n exchange market, the spot r a t e decreases, forward r a t e i n c r e a s e s , and i n s t e a d of e a r n i n g a ' p i c k u p 1 , a c o s t i s i n c u r t o U.S. I n v e s t o r s on Thursday, the day on which F r i d a y ' s t r a n s a c t i o n s are arranged. The r e s u l t s of the t e s t s show t h a t the forward r a t e s a d j u s t to a g r e a t e r extent than spot r a t e s i n e l i m i n a t i n g the advantage t h a t a r i s e s from the movements of funds. T h i s a l s o i n d i c a t e s t h a t most i n v e s t o r s p r e f e r to cover t h e i r investments by a r r a n g i n g forward c o n t r a c t s . U n f o r t u n a t e l y , the data on d a i l y i n t e r e s t r a t e f o r the past f o u r years was not a v a i l a b l e . T h e r e f o r e , i t i s not p o s s i b l e t o t e s t whether i n t e r e s t p a r i t y h o l d s on Thursdays, F r i d a y s and Mondays when the movements of funds take p l a c e . The movements of funds between Canada and the U n i t e d S t a t e s i s a l s o a p p l i c a b l e between Un i t e d S t a t e s and other European c o u n t r i e s . T h i s i s because most European c o u n t r i e s operate a s i n g l e payments system as opposed to the d u a l payments system operated i n the U n i t e d S t a t e s . Although no formal a n a l y s i s has been done here on the movements o f funds between U n i t e d S t a t e s and the European c o u n t r i e s , i t seems proba b l e t h a t any advantage t h a t a r i s e s i s a l s o e l i m i n a t e d by adjustments i n the f o r e i g n exchange market and the 44 E u r o - d o l l a r market. The e f f e c t o f S.W.I.F.T. on the advantage t h a t a r i s e s from the movements of funds i s d e s c r i b e d i n Arber's l e t t e r : Although i t i s expected t h a t e v e n t u a l l y , S.W.I.F.T. w i l l be expanded t o i n c l u d e a number of t r a n s a c t i o n s i n c l u d i n g the t r a n s m i t t a l of statements and e l e c t r o n i c c l e a r i n g o f l a r g e cheques, f o r the immediate f u t u r e , S.W.I.F.T. w i l l o n l y be used f o r making payments between banks. Mechanisation of the I n t e r n a t i o n a l cheque c l e a r i n g systems i s not one of the f u n c t i o n s f o r which S.W.I.F.T. w i l l be used. T h e r e f o r e , the B i g F r i d a y s o p e r a t i o n s i s expected to continue t o p r e v a i l , a t l e a s t i n the near f u t u r e . 31 L e t t e r from D..B. ~Arber, Operations'Manager, Bank of Montreal-Vancouver Regional O f f i c e , Vancouver, March 23, 1977. 45 B I B L I 0 G R A P H Y A. BOOKS Baughn, W.H. and Walker, C.E., eds. The Bankers Handbook I l l i n o i s : Dow Jones-Irwin, Inc., 1966. Boughton, James M. Monetary P o l i c y and the F e d e r a l Reserve Funds Market. Durham, N.C. : Duke U n i v e r s i t y P r e s s , 1972. Bradf o r d , F r e d e r i c k A. Money and Banking. 4th Ed. New York: Lougmans, Green & Co., 1940 Kent, Raymond P. Money and Banking. 5th Ed. New York: R i n e h a r t and Winston, Inc., 1961. Mandich, Donald R., gd. F o r e i g n Exchange T r a d i n g , Techniques  and C o n t r o l s . Washington: American Bankers A s s o c i a t i o n , 1976. Mayer, M a r t i n . The Bankers. New York: Weybright and T a l l e y , 1974. N i c h o l s , Dorthy M. T r a d i n g i n F e d e r a l Funds. Washington: Board o f the F e d e r a l Reserve System, 1962. Winkler, R.L. and Hays, W.L. S t a t i s t i c s , P r o b a b i l i t y , I n f erence and D e c i s i o n . 2nd ed. H o l t , R i n e h a r t and Winston, 1975. B. INTERVIEWS Ee, Andrew K.C. and M i l l a r d , B r i a n P. Bank of B r i t i s h Columbia, Vancouver, B r i t i s h Columbia. Interview, A p r i l 1977. McCorquodale, Robert B. Canadian I m p e r i a l Bank o f Commerce, Vancouver, B r i t i s h Columbia, Interview, May 1977. 46 C. LETTERS Arber, D.B. Operations Manager, Bank of Montreal -Vancouver Regional O f f i c e , Vancouver. L e t t e r dated March 23, 1977. ".. F o x c r o f t , D.B. S e n i o r A d v i s o r - F o r e i g n Exchange, Toronto-Dominion Bank, Toronto. L e t t e r dated A p r i l 5, 1977. D. UNPUBLISHED MATERIALS B a r r i n g t o n , C h a r l e s J r . "B a s i c P r i n c i p l e s of F o r e i g n Exchange and the Money Market Salesman." Wood-Gundy L t d . , August 11, 1972. 

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