MODULE 2

MARKET FOR FOREIGN EXCHANGE

 Chapter Objectives:

•This chapter serves to introduce the student to the

institutional framework within which exchange rates are
determined.

•This chapter lays the foundation for much of the discussion

throughout the remainder of the syllabus, thus it deserves
your careful attention.
MARKETS FOR FOREIGN EXCHANGE WHY
DO THEY EXIST?
 To buy and sell currencies, of course, buy why trade
currencies
 To permit transactions of goods and services across
borders
 To link savers and investors across borders
 Money represents purchasing power.
 Resident of other country or one wants to purchase form other
country – requires purchase of other country currency.
 Selling ones own currency with the other
 Market for foreign exchange is the largest financial market in the
world by virtually any standard.
 Working hours 24/7
 London remains the world’s largest foreign exchange centre
 Daily turnover of foreign exchange market $1.65 trillion a day
 FX market encompasses the conversion of purchasing power from
one currency into another, bank deposits of foreign currency, the
extension of credit denominated in a foreign currency, foreign trade
financing, trading in foreign currency options and future contracts,
and currency swaps.
 spot and forward markets for foreign exchange.
The Currency Market:
where money denominated in on currency is bought and sold with
money denominated in another currency.
International Trade and Capital Transactions:
Facilitated with the ability to transfer purchasing power
between countries
Location: OTC-type: no specific location
Most trades by phone, telex, or SWIFT
 FUNCTION AND STRUCTURE OF FOREX MARKET:

 The structure of fx market is an outgrowth of one of the primary

functions of a commercial banker: to assist client in conducting the
international commerce.
1. Transfer Of Purchasing Power I Clearing Function - to facilitate the
conversion of one currency into another i.e. payment between exporters and
importers.
2. Credit Function - provides credit to both national and international, to promote
foreign trade.
3. Hedging Function - Under this function the foreign exchange market tries
to protect the interest of the persons dealing in the market from any unforseen
changes in exchange rate.
 Spot and forward foreign exchange market are the OTC
markets:
 Not take place in central market
 World wide linkages of bank currency traders, non bank dealers
and FX brokers who assist in trade via Telephones, computer
terminals and automated dealing system.

 Reuters and Electronic Banking System (EBS) are the

largest vendors of the quote screen monitors used in
trading currency.
 Three major market segments are ; Australian, European and North
America
 Australian market includes: Sydney, Tokyo, Hong kong, Singapore
and Bahrain
 Europe includes: Zurich, Frankfurt, Paris, Brussels, Amsterdam, and
London
 North America Includes: New York, Montreal, Toronto, Chicago, San
Francisco and Los Angels
 Operation timings :
 Circadian Rhythms of the FX Market

Electronic Conversations per Hour

average peak
45000
40000
35000
30000
25000
20000
15000
10000
5000
0
1:00 3:00 5:00 7:00 9:00 11:00 1:00 15:00 5:00 19:00 9:00 11:00
10 am in Lunch Europe Asia Lunch Americas London New 6 pm in
Tokyo hour in coming in going out hour in coming in going out Zealand NY
Tokyo London coming in
 HOW WOULD AN EFFICIENT FX MARKET DO
THAT?

 Facilitate the real objectives without excessive “transactions costs”

such as brokerage fees, taxes, red tape. (Operating efficiency)

 Channel capital to its most efficient use (Allocative efficiency)

 Allow prices to signal real value (Informational efficiency)

 FX MARKET PARTICIPANTS

 Participants of Forex Market can be categorised into

 International Banks

 Customer Bank

 Non-Bank Dealers

 FX Brokers and Central Bank

 International Banks provides the core of the FX markets:
 Approximately 100-200 banks world wide make a market
 Serves retail clients and bank customer, in conducting foreign commerce
or making international investment in foreign assets
 Bank Customer broadly include : MNC, Money Managers and Private
Speculators.
 Non Bank Dealers: large non bank FI such as Investment banker,
mutual fund, pension fund and hedge fund whose size and frequency of
trade makes – Cost effective. Trade directly in the interbank market for
their foreign exchange needs.
 International banks involves adjusting the inventory
positions they hold on various foreign currencies.
 Most inter bank trades are speculative or arbitrage
transaction. Predicts and makes the profit.
 FX BROKERS

 Match the dealer order to buy and sell currencies for a fee
 Do not take own position.
 Knowledge of quotes of many dealers
 Today only few specialized broking firm exists.
 Majority of inter bank trade flows over Reuters and EBS
 In the past 10 years non bank dealers using electronic trading
platforms can compete with bank trades and non bank dealers
 Central Bank intervention – influence price of its currency
against its major trading partner.
 Buy own currency and in order to decrease its supply and
thus increase its value in the foreign exchange market or Vis
–a – versa
 When intervene in the market often lose the bank reserve in
attaining to accomplish their goal.
 Massive intervention can materially affect exchange rates.
 SWIFT, CHIPS AND ECHO

 International commercial banks communicate with one another with:

 SWIFT:
 CHIPS:
 ECHO, the first global clearinghouse for settling interbank FOREX
transactions.
 TYPES OF FOREIGN EXCHANGE MARKET

 Market for foreign exchange can be viewed as a two tier.

1. Whole sale or Interbank market
The wholesale market is also called interbank market. The size of
transactions in this market is very large. Dealers are highly professionals
and are primary price makers.

The main participants are Commercial banks, Business corporations and

Central banks. Multinational banks are mainly responsible for determining
exchange rate.
2. Retail or Client market
 The retail market is a secondary price maker. Here
travelers, tourists and people who are in need of foreign
exchange for permitted small transactions, exchange
one currency for another.
 3. OTHER PARTICIPANTS:

(a) Brokers:
 Brokers have more information and better knowledge of market.
They provide information to banks about the prices at which there
are buyers and sellers of a pair of currencies. They act as middlemen
between the price makers.
(b) Price Takers:
 Price takers are those who buy foreign exchange which they require
and sell what they earn at the price determined by primary price
makers.
(c)Indian Foreign Exchange Market:
 It is made up of three tiers
 Here dealings take place between RBI and Authorized
dealers (ADs) (mainly commercial banks).
 Here dealings take place between Ads
 Here ADs deal with their corporate customers.
 TYPES OF TRANSACTIONS IN FOREX MARKET

 TOD - supply of currency on the day of transaction conclusion

 TOM - supply of currency on the next working day
 SPOT - supply of currency in 2 working days
 FORWARD - OTC currency exchange transaction involving the future supply of currency on
the fixed date with the transaction rate agreed on the day of transaction
 FUTURES - standardized exchange contract, involving the future supply of currency on the
fixed date with the transaction rate agreed on the day of transaction
 SWAP - a combination of two opposite currency exchange transactions for the same amount
with different valuation dates
 OPTION - a contract that provides the buyer with the right to buy or sell a certain amount of
currency at a certain date and price fixed by the contract
THREE MAJOR TYPES OF TRANSACTIONS

Spot transaction
 An agreement on price today, with settlement usually
two business days later.
 Settlement = actual delivery of currency for currency
 In the case of the US dollar for the Canadian dollar (or
the Mexican peso), settlement is on the next day of the
transaction
Forward transaction
An agreement on price today for settlement at some
date (called the “value date”) in the future (one or two
weeks, or 1 ~ 12 months).
Example: Exxon has a scheduled payment of £25
million in 8 months and buys that amount of British
pounds forward today. No money will change hands
now.
 SWAP

 A sale (purchase) of a foreign currency with a simultaneous agreement

to repurchase (resell) it at some date in the future. Usually in the inter-
bank market
 Example: Citibank buys DM 2.5 million from Deutsch Bank for $1
million, with a simultaneous agreement to sell the DM back in 6
months for $1.05 million. $50,000 = swap rate.

 FX transaction: 65% of transactions: spot, 33% of transactions : swap

2%, outright forward
 THE SPOT MARKET

 Spot Rate Quotations

 The Bid-Ask Spread

 Spot FX Trading

 Cross Exchange Rate Quotations

 Triangular Arbitrage

 Spot Foreign Exchange Market Microstructure

 Spot market involves almost the immediate purchase or
sale of foreign exchange.
 Settlement is made in two business day between US $ and
non American currency
 US $ and Mexican peso or Canadian $ settlement takes
place in a day.
 According to BIS statistics, spot transaction accounts to
35% of FX trades
 SPOT RATE QUOTATIONS

 Direct quotation
 the U.S. dollar equivalent
 e.g. “a Japanese Yen is worth about a penny”
 Indirect Quotation
 the price of a U.S. dollar in the foreign currency
 e.g. “you get 100 yen to the dollar”.

4-30
 Spot Rate Quotations
Curre ncy
Wednesday, January 8, 1997 U.S. $ e quiv. pe r U.S. $
Country Wed. Tues. Wed. Tues.
EXCHANGE RATES
The New York foreign exchange selling rates below apply to
trading among banks in amounts of $1 million and more, as quoted
Japan (Yen)
30-Day Forw ard
90-Day Forw ard
.008639
.008676
.008750
.008681
.008718
.008791
115.75
115.26
114.28
115.20
114.71
113.76
The direct quote
at 4 p.m. Eastern time by Dow Jones Telerate Inc. and other sources. 180-Day Forw ard .008865 .008907 112.80 112.28
Retail transactions provide few er units of f oreign currency per
dollar.
Curre ncy
Jordan (Dinar)
Kuw ait (Dinar)
Lebanon (Pound)
1.4075
3.3367
.0006445
1.4075
3.3389
.0006445
.7105
.2997
1551.50
.7105
.2995
1551.50
for British pound
Malaysia (Ringgit) .4018 .4002 2.4885 2.4990
is:
U.S. $ e quiv. pe r U.S. $
Country Wed. Tues. Wed. Tues. Malta (Lira) 2.7624 2.7701 .3620 .3610
Argentina (Peso) 1.0012 1.0012 .9988 .9988 Mexico (Peso) .... .... .... ....
Australia (Dollar) .7805 .7902 1.2812 1.2655 Floating rate .1278 .1277 7.8220 7.8330
Austria (Schilling) .09043 .09101 11.058 10.988 Netherland (Guilder) .5655 .5699 1.7685 1.7547
Bahrain (Dinar) 2.6525 2.6525 .3770 .3770 New Zealand (Dollar) .7072 .7106 1.4140 1.4073
Norw ay (Krone) .1540 .1548 6.4926 6.4599
Belgium (Franc)
Brazil (Real)
Britain (Pound)
30-Day Forw ard
.03080
.9607
1.6880
1.6869
.03105
.9615
1.6946
1.6935
32.470
1.0409
.5924
.5928
32.205
1.0401
.5901
.5905
Pakistan (Rupee)
Peru (new Sol)
Philippines (Peso)
.02529
.3814
.03800
.02529
.3840
.03802
39.540
2.6218
26.318
39.540
2.6039
26.300
£1 = $1.688
90-Day Forw ard 1.6843 1.6910 .5937 .5914 Poland (Zloty) .3460 .3475 2.8900 2.8780
180-Day Forw ard 1.6802 1.6867 .5952 .5929 Portugal (Escudo) .006307 .006369 158.55 157.02
Canada (Dollar) .7399 .7370 1.3516 1.3568 Russia (Ruble) (a) .0001787 .0001788 5595.00 5594.00
30-Day Forw ard .7414 .7386 1.3488 1.3539 Saudi Arabia (Riyal) .2666 .2667 3.7503 3.7502
90-Day Forw ard .7442 .7413 1.3437 1.3489 Singapore (Dollar) .7116 .7124 1.4053 1.4037
180-Day Forw ard .7479 .7450 1.3370 1.3422 Slovak Rep. (Koruna) .03259 .03259 30.688 30.688
Chile (Peso) .002352 .002356 425.25 424.40 South Africa (Rand) .2141 .2142 4.6705 4.6690
China (Renminbi) .1201 .1201 8.3272 8.3276 South Korea (Won) .001184 .001184 844.75 844.65
Colom bia (Peso) .0009985 .0009985 1001.50 1001.50 Spain (Peseta) .007546 .007603 132.52 131.53
Czech. Rep (Krouna) .... .... .... .... Sw eden (Krona) .1431 .1435 6.9865 6.9697
Commercial rate .03662 .03677 27.307 27.194 Sw itzerland (Franc) .7334 .7387 1.3635 1.3537
Denm ark (Krone) .1663 .1677 6.0118 5.9633 30-Day Forw ard .7357 .7411 1.3593 1.3494
Ecuador (Sucre) .... .... .... .... 90-Day Forw ard .7401 .7454 1.3511 1.3416
Floating rate .0002766 .0002787 3615.00 3587.50 180-Day Forw ard .7470 .7523 1.3386 1.3293
Finland (Markka) .2121 .2135 4.7150 4.6841 Taiw an (Dollar) .03638 .03637 27.489 27.493
France (Franc) .1879 .1893 5.3220 5.2838 Thailand (Baht) .03902 .03906 25.625 25.605
30-Day Forw ard .1882 .1896 5.3126 5.2741 Turkey (Lira) .00000911 .00000915 109755.00 109235.00
90-Day Forw ard .1889 .1903 5.2935 5.2558 United Arab (Dirham) .2723 .2723 3.6720 3.6720
180-Day Forw ard .1901 .1914 5.2617 5.2243 Uruguay (New Peso) .... .... .... ....
Germ any (Mark) .6352 .6394 1.5744 1.5639 Financial .1145 .1145 8.7300 8.7300
30-Day Forw ard .6364 .6407 1.5714 1.5607 Venezuela (Bolivar) .002098 .002096 476.70 477.12
90-Day Forw ard .6389 .6432 1.5652 1.5547 ---
180-Day Forw ard .6430 .6472 1.5552 1.5450 SDR 1.4315 1.4326 .6986 .6980
Greece (Drachma) .004049 .004068 246.98 245.80 ECU 1.2308 1.2404 .......... ...........
Hong Kong (Dollar) .1292 .1292 7.7390 7.7390
Hungary (Forint) .006139 .006164 162.89 162.23 Special Draw ing Rights (SDR) are based on exchange rates for
India (Rupee) .02787 .02786 35.875 35.890 the U.S., German, British, French, and Japanese currencies. Source:
Indonesia (Rupiah) .0004233 .0004233 2362.15 2362.63 International Monetary Fund.
Ireland (Punt) 1.6664 1.6714 .6001 .5983 European Currency Unit (ECU) is based on a basket of community
Israel (Shekel) .3079 .3085 3.2474 3.2412 currencies.
Italy (Lira) .0006483 .0006510 1542.50 1536.00 a-fixing, Moscow Interbank Currency Exchange.

McGraw-Hill/Irwin Copyright
4-31
© 2001 by The McGraw-Hill
 Spot Rate Quotations
Curre ncy
Wednesday, January 8, 1997 U.S. $ e quiv. pe r U.S. $
EXCHANGE RATES
The New York foreign exchange selling rates below apply to
Country
Japan (Yen)
30-Day Forw ard
Wed.
.008639
.008676
Tues.
.008681
.008718
Wed.
115.75
115.26
Tues.
115.20
114.71
The indirect
trading among banks in amounts of $1 million and more, as quoted 90-Day Forw ard .008750 .008791 114.28 113.76
at 4 p.m. Eastern time by Dow Jones Telerate Inc. and other sources.
Retail transactions provide few er units of f oreign currency per
dollar.
180-Day Forw ard
Jordan (Dinar)
Kuw ait (Dinar)
.008865
1.4075
3.3367
.008907
1.4075
3.3389
112.80
.7105
.2997
112.28
.7105
.2995
quote for British
Lebanon (Pound) .0006445 .0006445 1551.50 1551.50

Country
Argentina (Peso)
U.S. $ e quiv.
Wed.
1.0012
Tues.
1.0012
Curre ncy
pe r U.S. $
Wed.
.9988
Tues.
.9988
Malaysia (Ringgit)
Malta (Lira)
Mexico (Peso)
.4018
2.7624
....
.4002
2.7701
....
2.4885
.3620
....
2.4990
.3610
....
pound is:
Australia (Dollar) .7805 .7902 1.2812 1.2655 Floating rate .1278 .1277 7.8220 7.8330
Austria (Schilling) .09043 .09101 11.058 10.988 Netherland (Guilder) .5655 .5699 1.7685 1.7547
New Zealand (Dollar) .7072 .7106 1.4140 1.4073
Bahrain (Dinar)
Belgium (Franc)
Brazil (Real)
Britain (Pound)
2.6525
.03080
.9607
1.6880
2.6525
.03105
.9615
1.6946
.3770
32.470
1.0409
.5924
.3770
32.205
1.0401
.5901
Norw ay (Krone)
Pakistan (Rupee)
Peru (new Sol)
.1540
.02529
.3814
.1548
.02529
.3840
6.4926
39.540
2.6218
6.4599
39.540
2.6039
£.5924 = $1
30-Day Forw ard 1.6869 1.6935 .5928 .5905 Philippines (Peso) .03800 .03802 26.318 26.300
90-Day Forw ard 1.6843 1.6910 .5937 .5914 Poland (Zloty) .3460 .3475 2.8900 2.8780
180-Day Forw ard 1.6802 1.6867 .5952 .5929 Portugal (Escudo) .006307 .006369 158.55 157.02
Canada (Dollar) .7399 .7370 1.3516 1.3568 Russia (Ruble) (a) .0001787 .0001788 5595.00 5594.00
30-Day Forw ard .7414 .7386 1.3488 1.3539 Saudi Arabia (Riyal) .2666 .2667 3.7503 3.7502
90-Day Forw ard .7442 .7413 1.3437 1.3489 Singapore (Dollar) .7116 .7124 1.4053 1.4037
180-Day Forw ard .7479 .7450 1.3370 1.3422 Slovak Rep. (Koruna) .03259 .03259 30.688 30.688
Chile (Peso) .002352 .002356 425.25 424.40 South Africa (Rand) .2141 .2142 4.6705 4.6690
China (Renminbi) .1201 .1201 8.3272 8.3276 South Korea (Won) .001184 .001184 844.75 844.65
Colom bia (Peso) .0009985 .0009985 1001.50 1001.50 Spain (Peseta) .007546 .007603 132.52 131.53
Czech. Rep (Krouna) .... .... .... .... Sw eden (Krona) .1431 .1435 6.9865 6.9697
Commercial rate .03662 .03677 27.307 27.194 Sw itzerland (Franc) .7334 .7387 1.3635 1.3537
Denm ark (Krone) .1663 .1677 6.0118 5.9633 30-Day Forw ard .7357 .7411 1.3593 1.3494
Ecuador (Sucre) .... .... .... .... 90-Day Forw ard .7401 .7454 1.3511 1.3416
Floating rate .0002766 .0002787 3615.00 3587.50 180-Day Forw ard .7470 .7523 1.3386 1.3293
Finland (Markka) .2121 .2135 4.7150 4.6841 Taiw an (Dollar) .03638 .03637 27.489 27.493
France (Franc) .1879 .1893 5.3220 5.2838 Thailand (Baht) .03902 .03906 25.625 25.605
30-Day Forw ard .1882 .1896 5.3126 5.2741 Turkey (Lira) .00000911 .00000915 109755.00 109235.00
90-Day Forw ard .1889 .1903 5.2935 5.2558 United Arab (Dirham) .2723 .2723 3.6720 3.6720
180-Day Forw ard .1901 .1914 5.2617 5.2243 Uruguay (New Peso) .... .... .... ....
Germ any (Mark) .6352 .6394 1.5744 1.5639 Financial .1145 .1145 8.7300 8.7300
30-Day Forw ard .6364 .6407 1.5714 1.5607 Venezuela (Bolivar) .002098 .002096 476.70 477.12
90-Day Forw ard .6389 .6432 1.5652 1.5547 ---
180-Day Forw ard .6430 .6472 1.5552 1.5450 SDR 1.4315 1.4326 .6986 .6980
Greece (Drachma) .004049 .004068 246.98 245.80 ECU 1.2308 1.2404 .......... ...........
Hong Kong (Dollar) .1292 .1292 7.7390 7.7390
Hungary (Forint) .006139 .006164 162.89 162.23 Special Draw ing Rights (SDR) are based on exchange rates for
India (Rupee) .02787 .02786 35.875 35.890 the U.S., German, British, French, and Japanese currencies. Source:
Indonesia (Rupiah) .0004233 .0004233 2362.15 2362.63 International Monetary Fund.
Ireland (Punt) 1.6664 1.6714 .6001 .5983 European Currency Unit (ECU) is based on a basket of community
Israel (Shekel) .3079 .3085 3.2474 3.2412 currencies.
Italy (Lira) .0006483 .0006510 1542.50 1536.00 a-fixing, Moscow Interbank Currency Exchange.

McGraw-Hill/Irwin Copyright
4-32
© 2001 by The McGraw-Hill
 Spot Rate Quotations
Curre ncy
Wednesday, January 8, 1997 U.S. $ e quiv. pe r U.S. $
Country Wed. Tues. Wed. Tues.
EXCHANGE RATES
The New York foreign exchange selling rates below apply to
trading among banks in amounts of $1 million and more, as quoted
Japan (Yen)
30-Day Forw ard
90-Day Forw ard
.008639
.008676
.008750
.008681
.008718
.008791
115.75
115.26
114.28
115.20
114.71
113.76
Note that the
at 4 p.m. Eastern time by Dow Jones Telerate Inc. and other sources. 180-Day Forw ard .008865 .008907 112.80 112.28
Retail transactions provide few er units of f oreign currency per
dollar.
Curre ncy
Jordan (Dinar)
Kuw ait (Dinar)
Lebanon (Pound)
1.4075
3.3367
.0006445
1.4075
3.3389
.0006445
.7105
.2997
1551.50
.7105
.2995
1551.50
direct quote is
Malaysia (Ringgit) .4018 .4002 2.4885 2.4990

the reciprocal of
U.S. $ e quiv. pe r U.S. $
Country Wed. Tues. Wed. Tues. Malta (Lira) 2.7624 2.7701 .3620 .3610
Argentina (Peso) 1.0012 1.0012 .9988 .9988 Mexico (Peso) .... .... .... ....
Australia (Dollar) .7805 .7902 1.2812 1.2655 Floating rate .1278 .1277 7.8220 7.8330
Netherland (Guilder) .5655 .5699 1.7685 1.7547
Austria (Schilling)
Bahrain (Dinar)
Belgium (Franc)
Brazil (Real)
.09043
2.6525
.03080
.9607
.09101
2.6525
.03105
.9615
11.058
.3770
32.470
1.0409
10.988
.3770
32.205
1.0401
New Zealand (Dollar)
Norw ay (Krone)
Pakistan (Rupee)
.7072
.1540
.02529
.7106
.1548
.02529
1.4140
6.4926
39.540
1.4073
6.4599
39.540
the indirect
Peru (new Sol) .3814 .3840 2.6218 2.6039
Britain (Pound)
30-Day Forw ard
90-Day Forw ard
180-Day Forw ard
1.6880
1.6869
1.6843
1.6802
1.6946
1.6935
1.6910
1.6867
.5924
.5928
.5937
.5952
.5901
.5905
.5914
.5929
Philippines (Peso)
Poland (Zloty)
Portugal (Escudo)
.03800
.3460
.006307
.03802
.3475
.006369
26.318
2.8900
158.55
26.300
2.8780
157.02
quote:
Canada (Dollar) .7399 .7370 1.3516 1.3568 Russia (Ruble) (a) .0001787 .0001788 5595.00 5594.00
30-Day Forw ard .7414 .7386 1.3488 1.3539 Saudi Arabia (Riyal) .2666 .2667 3.7503 3.7502
90-Day Forw ard .7442 .7413 1.3437 1.3489 Singapore (Dollar) .7116 .7124 1.4053 1.4037
180-Day Forw ard .7479 .7450 1.3370 1.3422 Slovak Rep. (Koruna) .03259 .03259 30.688 30.688
Chile (Peso) .002352 .002356 425.25 424.40 South Africa (Rand) .2141 .2142 4.6705 4.6690
China (Renminbi) .1201 .1201 8.3272 8.3276 South Korea (Won) .001184 .001184 844.75 844.65
Colom bia (Peso) .0009985 .0009985 1001.50 1001.50 Spain (Peseta) .007546 .007603 132.52 131.53
Czech. Rep (Krouna) .... .... .... .... Sw eden (Krona) .1431 .1435 6.9865 6.9697
Commercial rate .03662 .03677 27.307 27.194 Sw itzerland (Franc) .7334 .7387 1.3635 1.3537
Denm ark (Krone) .1663 .1677 6.0118 5.9633 30-Day Forw ard .7357 .7411 1.3593 1.3494
Ecuador (Sucre) .... .... .... .... 90-Day Forw ard .7401 .7454 1.3511 1.3416
Floating rate
Finland (Markka)
.0002766 .0002787 3615.00 3587.50
.2121 .2135 4.7150 4.6841
180-Day Forw ard
Taiw an (Dollar)
.7470
.03638
.7523
.03637
1.3386
27.489
1.3293
27.493
1
1.688 =
France (Franc) .1879 .1893 5.3220 5.2838 Thailand (Baht) .03902 .03906 25.625 25.605
30-Day Forw ard .1882 .1896 5.3126 5.2741 Turkey (Lira) .00000911 .00000915 109755.00 109235.00
90-Day Forw ard .1889 .1903 5.2935 5.2558 United Arab (Dirham) .2723 .2723 3.6720 3.6720
180-Day Forw ard .1901 .1914 5.2617 5.2243 Uruguay (New Peso) .... .... .... ....
Germ any (Mark) .6352 .6394 1.5744 1.5639 Financial .1145 .1145 8.7300 8.7300
30-Day Forw ard .6364 .6407 1.5714 1.5607 Venezuela (Bolivar) .002098 .002096 476.70 477.12
---

.5924
90-Day Forw ard .6389 .6432 1.5652 1.5547
180-Day Forw ard .6430 .6472 1.5552 1.5450 SDR 1.4315 1.4326 .6986 .6980
Greece (Drachma) .004049 .004068 246.98 245.80 ECU 1.2308 1.2404 .......... ...........
Hong Kong (Dollar) .1292 .1292 7.7390 7.7390
Hungary (Forint) .006139 .006164 162.89 162.23 Special Draw ing Rights (SDR) are based on exchange rates for
India (Rupee) .02787 .02786 35.875 35.890 the U.S., German, British, French, and Japanese currencies. Source:
Indonesia (Rupiah) .0004233 .0004233 2362.15 2362.63 International Monetary Fund.
Ireland (Punt) 1.6664 1.6714 .6001 .5983 European Currency Unit (ECU) is based on a basket of community
Israel (Shekel) .3079 .3085 3.2474 3.2412 currencies.
Italy (Lira) .0006483 .0006510 1542.50 1536.00 a-fixing, Moscow Interbank Currency Exchange.
 For spot rate quotation in general will be denoted as S(j/k) refers
to the price of one unit of currency k in terms of currency j

 For example British pound on given day is S($/£)=1.9077 the

correspondent European quotes is S(£/$)= 0.5242.

 where as the S denotes the spot rates.

 In a currency pair, the first currency in the pair is called the base
currency and the second is called the quote currency.

 Currency pairs can be separated into two types, direct and indirect. In
a direct quote the foreign currency is the base currency, while the
domestic currency is the quote currency.

 An indirect quote is just the opposite: the foreign currency is the

quote currency and the domestic currency is the base currency. For an
American trader, the USD/EUR quote is an indirect one. So, for
example, a quote of 0.80 USD/EUR would mean that it takes 0.80
euros to purchase US$1.

For example, if Canada is the domestic currency,
a direct quote would be 1.18 USD/CAD and
means that USD$1 will purchase C$1.18 .

The indirect quote for this would be the inverse

(1/1.18), 0.85 CAD/USD, which means with C$1,
you can purchase US$0.85.
 Although nearly 89% of the currency trades made around the world
involve the U.S. dollar, the EUR/USD currency pair is always quoted
indirectly.
 The reason for this is mostly convention. A EUR/USD quote could easily
be shown as USD/EUR by making a simple calculation, but there are no
strict rules that determine whether a currency pair is shown directly or
indirectly.
 The way currency pairs are quoted can also vary depending on the
country in which the trader lives - most countries use direct quotes,
while the U.K., Australia, New Zealand and Canada prefer indirect
quotes.
 THE BID-ASK SPREAD

 The bid price is the price a dealer is willing to pay you for
something.

 The ask price is the amount the dealer wants you to pay for the
thing.

 The bid-ask spread is the difference between the bid and ask
prices.
 A Forex Trading Bid price is the price at which the market is prepared
to buy a specific currency pair in the Forex trading market. This is the
price that the trader of Forex buys his base currency.
 In the quote, the Forex bid price appears to the left of the currency
quote. For example, If the EUR/USD pair is 1.2342/47, then the bid
price is 1.2342. Meaning you can sell the EUR for 1.2342 USD.

 A Forex asking price is the price at which the market is ready to sell a
certain Forex Trading currency pair in the online Forex market. This is
the price that the trader buys in. It appears to the right of the Forex
quote. For example, in the same EUR/USD pair of 1.2342/47, the ask
price us 1.2347. This means you can buy one EUR for 1.2347 USD.
 Bid-Ask Quotation: Spread is used to calculate the fee charged by the
bank. It is the difference between bid and Ask. Bid = the price at which
the bank is willing to buy Ask = the price it will sell the currency

Factors That Affect the Spread

1. Order costs.
2. Inventory costs
3. Competition.
4. Volume.
5. Currency risk
 SPOT FX TRADING

 Quotes are carried out to four decimal points.

 Some European currency quote to two three decimal where as in American terms quotation
may be carried out as many as seven decimals.

 In the interbank market, the standard size trade is about U.S. $10 million.

 Spot quotations are good only for few seconds – make his mind in few seconds or quotes will
be withdrawn.

 FX traders uses shorthand observations Ex: $1.9072-$1.9077. Here 1.90 is known as big figure

 Other two digits is known as small figures. Traders responds within 72-77.
 The establishment of bid ask spread will facilitate acquiring and or disposing of
inventory.
 Ex: $/£ bid ask quote is 1.9072-1.9077
 If trader believes that pound will soon appreciate desire to acquire large amount of
inventory. 73-78 encourages some to sell and some to buy.
 If traders thinks pound is ready to depreciate, he sells his inventory. ie 71-76.
 The retail bid –ask spread is wider than a interbank spread.
 Lower bid and higher ask prices apply to the smaller sums traded at the retail level.
 To cover the fixed cost of trade
 1500 quotes and 400 traders trades in a day.
CROSS EXCHANGE RATE QUOTATION

 It is an exchange rate between a currency pair where

neither currency is in US Dollar
 Cross exchange rate can be calculated from the US dollar
exchange rate for the two currencies using either European
or American term quotation.
 CROSS RATES

 Suppose that S($/DM) = .50 What must the $/¥ cross rate be?
 i.e. $1 = 2 DM
 and that S(¥/DM) = 50
 i.e. DM1 = ¥50
$ $ DM
since =  ,
¥ DM ¥
$1 DM 1 $1
 =  S ($ / ¥) = .01 or $1 = ¥100
DM 2 ¥50 ¥100
4-44
 TRIANGULAR ARBITRAGE

 Certain banks specializes in making a direct market between non-

dollar currencies, particularly at a narrower bid-ask spread than the
cross rate spread.
 Imposes certain discipline on non dollar market maker.
 If direct quotes are not consistent with cross exchange rates, a
triangular arbitrage is possible.
 A Triangular arbitrage is the process of trading out of the US dollar
into second currency, then trading it for third currency, which is in
turn traded for US dollar for the purpose of earning profit
TRIANGULAR ARBITRAGE

Suppose we observe
these banks posting $
these exchange rates.
Barclays
Credit Lyonnais
S(¥/$)=120
S(£/$)=1.50

First calculate the ¥ £

implied cross Credit Agricole
rates to see if an S(¥/£)=85
arbitrage exists.
TRIANGULAR ARBITRAGE

The implied S(¥/£) cross $

rate is S(¥/£) = 80 Barclays
Credit Lyonnais
S(¥/$)=120
Credit Agricole has posted a £1.50 $1 £1 S(£/$)=1.50
 =
quote of S(¥/£)=85 so $1 ¥120 ¥80
there is an arbitrage ¥ £
opportunity.
Credit Agricole
S(¥/£)=85
So, how can we make money?
TRIANGULAR ARBITRAGE
As easy as 1 – 2 – 3:
$
1. Sell our $ for £, Barclays
Credit Lyonnais
2. Sell our £ for ¥, S(¥/$)=120
£1.50 $1 £1 S(£/$)=1.50
 =
3. Sell those ¥ for $. $1 ¥120 ¥80
¥ £
Credit Agricole
S(¥/£)=85
TRIANGULAR ARBITRAGE
Sell $100,000 for £ at S(£/$) = 1.50
receive £150,000
Sell our £ 150,000 for ¥ at S(¥/£) = 85
receive ¥12,750,000
Sell ¥ 12,750,000 for $ at S(¥/$) = 120
receive $106,250
profit per round trip = $ 106,250- $100,000 = $6,250
SPOT FOREIGN EXCHANGE
MICROSTRUCTURE
 Market Microstructure refers to the mechanics of how a
market place operates.
 Bid-Ask spreads in the spot FX market:
 increase with FX exchange rate volatility and
 decrease with dealer competition.
 Private information is an important determinant of spot
exchange rates.
THE FORWARD MARKET

 Forward Rate Quotations

 Long and Short Forward Positions
 Forward Cross Exchange Rates
 Swap Transactions
 Forward Premium
 THE FORWARD MARKET

 In conjunction with spot trading, there is also a forward foreign

exchange market.
 A forward market is a market for exchange of foreign
currencies at future date, according to agreed upon delivery
date, exchange rate and amount.
 The price of foreign currency for future delivery is known as a
forward rate.
 Valid for settlement irrespective of the actual spot rate on the
maturity date of the forward contract.
 FORWARD RATE QUOTATIONS

 The forward market for FOREX involves agreements to buy and sell
foreign currencies in the future at prices agreed upon today.
 A forward contract usually represents a contract between a large
money centers bank and a well known customer having a well
defined need to hedge exposure to fluctuations in exchange rates.
 Bank quotes for 1, 3, 6, 9, and 12 month maturities are readily
available for forward contracts.
 Longer-term swaps are available.
FORWARD RATE QUOTATIONS

 Consider the example from above:

for Japanese yen, the spot rate is
¥115.75 = $1.00
While the 180-day forward rate is
¥ 112.80 = $1.00
 What’s up with that?
 Currency
Wednesday, January 8, 1997 U.S. $ equiv. per U.S. $
Country Wed. Tues. Wed. Tues.
EXCHANGE RATES Japan (Yen) .008639 .008681 115.75 115.20
The New York foreign exchange selling rates below apply to 30-Day Forw ard .008676 .008718 115.26 114.71
trading among banks in amounts of $1 million and more, as quoted 90-Day Forw ard .008750 .008791 114.28 113.76
at 4 p.m. Eastern time by Dow Jones Telerate Inc. and other sources. 180-Day Forw ard .008865 .008907 112.80 112.28
Retail transactions provide few er units of foreign currency per Jordan (Dinar) 1.4075 1.4075 .7105 .7105
dollar. Kuw ait (Dinar) 3.3367 3.3389 .2997 .2995
Currency Lebanon (Pound) .0006445 .0006445 1551.50 1551.50
U.S. $ equiv. per U.S. $ Malaysia (Ringgit) .4018 .4002 2.4885 2.4990
Country Wed. Tues. Wed. Tues. Malta (Lira) 2.7624 2.7701 .3620 .3610
Argentina (Peso) 1.0012 1.0012 .9988 .9988 Mexico (Peso) .... .... .... ....
Australia (Dollar) .7805 .7902 1.2812 1.2655 Floating rate .1278 .1277 7.8220 7.8330
Netherland (Guilder) .5655 .5699 1.7685 1.7547
Austria (Schilling)
Bahrain (Dinar)
Belgium (Franc)
.09043
2.6525
.03080
.09101
2.6525
.03105
11.058
.3770
32.470
10.988
.3770
32.205
New Zealand (Dollar)
Norw ay (Krone)
.7072
.1540
.7106
.1548
1.4140
6.4926
1.4073
6.4599
Clearly the
Pakistan (Rupee) .02529 .02529 39.540 39.540
Brazil (Real)
Britain (Pound)
30-Day Forw ard
.9607
1.6880
1.6869
.9615
1.6946
1.6935
1.0409
.5924
.5928
1.0401
.5901
.5905
Peru (new Sol)
Philippines (Peso)
.3814
.03800
.3840
.03802
2.6218
26.318
2.6039
26.300 market
90-Day Forw ard 1.6843 1.6910 .5937 .5914 Poland (Zloty) .3460 .3475 2.8900 2.8780
180-Day Forw ard
Canada (Dollar)
1.6802
.7399
1.6867
.7370
.5952
1.3516
.5929
1.3568
Portugal (Escudo)
Russia (Ruble) (a)
Saudi Arabia (Riyal)
.006307
.0001787
.2666
.006369
.0001788
.2667
158.55
5595.00
3.7503
157.02
5594.00
3.7502
participants
30-Day Forw ard .7414 .7386 1.3488 1.3539
90-Day Forw ard
180-Day Forw ard
.7442
.7479
.7413
.7450
1.3437
1.3370
1.3489
1.3422
Singapore (Dollar)
Slovak Rep. (Koruna)
South Africa (Rand)
.7116
.03259
.2141
.7124
.03259
.2142
1.4053
30.688
4.6705
1.4037
30.688
4.6690
expect that the
Chile (Peso) .002352 .002356 425.25 424.40
China (Renminbi)
Colombia (Peso)
Czech. Rep (Krouna)
.1201 .1201 8.3272
.0009985 .0009985 1001.50 1001.50
.... .... ....
8.3276

....
South Korea (Won)
Spain (Peseta)
Sw eden (Krona)
.001184
.007546
.1431
.001184
.007603
.1435
844.75
132.52
6.9865
844.65
131.53
6.9697
yen will be
Sw itzerland (Franc) .7334 .7387 1.3635 1.3537
Commercial rate
Denmark (Krone)
Ecuador (Sucre)
.03662
.1663
....
.03677
.1677
....
27.307
6.0118
....
27.194
5.9633
....
30-Day Forw ard
90-Day Forw ard
.7357
.7401
.7411
.7454
1.3593
1.3511
1.3494
1.3416
worth MORE in
180-Day Forw ard .7470 .7523 1.3386 1.3293
Floating rate
Finland (Markka)
France (Franc)
.0002766 .0002787 3615.00 3587.50
.2121
.1879
.2135
.1893
4.7150
5.3220
4.6841
5.2838
Taiw an (Dollar)
Thailand (Baht)
.03638
.03902
.03637
.03906
27.489
25.625
27.493
25.605 dollars in six
30-Day Forw ard .1882 .1896 5.3126 5.2741 Turkey (Lira) .00000911 .00000915 109755.00 109235.00
90-Day Forw ard
180-Day Forw ard
.1889
.1901
.1903
.1914
5.2935
5.2617
5.2558
5.2243
United Arab (Dirham)
Uruguay (New Peso)
Financial
.2723
....
.1145
.2723
....
.1145
3.6720

8.7300
....
3.6720

8.7300
.... months.
Germany (Mark) .6352 .6394 1.5744 1.5639
30-Day Forw ard .6364 .6407 1.5714 1.5607 Venezuela (Bolivar) .002098 .002096 476.70 477.12
90-Day Forw ard .6389 .6432 1.5652 1.5547 ---
180-Day Forw ard .6430 .6472 1.5552 1.5450 SDR 1.4315 1.4326 .6986 .6980
Greece (Drachma) .004049 .004068 246.98 245.80 ECU 1.2308 1.2404 .......... ...........
Hong Kong (Dollar) .1292 .1292 7.7390 7.7390
Hungary (Forint) .006139 .006164 162.89 162.23 Special Draw ing Rights (SDR) are based on exchange rates for
India (Rupee) .02787 .02786 35.875 35.890 the U.S., German, British, French, and Japanese currencies. Source:
Indonesia (Rupiah) .0004233 .0004233 2362.15 2362.63 International Monetary Fund.
Ireland (Punt) 1.6664 1.6714 .6001 .5983 European Currency Unit (ECU) is based on a basket of community
Israel (Shekel) .3079 .3085 3.2474 3.2412 currencies.
Italy (Lira) .0006483 .0006510 1542.50 1536.00 a-fixing, Moscow Interbank Currency Exchange.
LONG AND SHORT FORWARD POSITIONS

 If you have agreed to sell anything (spot or forward), you

are “short”.
 If you have agreed to buy anything (forward or spot), you
are “long”.
 If you have agreed to sell forex forward, you are short.
 If you have agreed to buy forex forward, you are long.
 NEED FOR THE FORWARD MARKET

 Actual need is not speculation

 Today there is no clear cut distinction for hedging and
speculation
 There are couple of characteristics of people who use the
forward market in order to cover time lag
1. Exporters and Importers
2. To preserve the value and nature of their assets without
speculating against future trends
 FORWARD PREMIUM AND DISCOUNTS

 If the forward rate is higher than existing spot rate in the

forward market, the currency is trading at a forward premium.
 If the forward rate is lesser than existing spot rate in the
forward market, the currency is trading at a forward discount
 Forward premium and discount can be expressed in basic
points.
 A foreign exchange rate is generally expressed by way of a
whole number integer
 PREMIUM / DISCOUNT FORMULA


FR- SR
Premium / Discount = n* 100
SR

Where as n is number of months

PAYOFF PROFILES
profit If you agree to sell anything in the future at a
set price and the spot price later falls then you
gain.

0 S180($/¥)

F180($/¥) = .009524
If you agree to sell anything in the future at a
set price and the spot price later rises then you
lose.
loss Short position
PAYOFF PROFILES
profit
short position
Whether the payoff
profile slopes up or
down depends upon
whether you use the
direct or indirect
0 S180(¥/$) quote:

F180(¥/$) = 105 or
F180(¥/$) = 105
F180($/¥) = .009524.

-F180(¥/$)
McGraw-Hill/Irwin
loss Copyright
4-61
© 2001 by The McGraw-Hill
PAYOFF PROFILES
profit
short position

0 S180(¥/$)

F180(¥/$) = 105
When the short entered into this forward contract,
he agreed to sell ¥ in 180 days at F180(¥/$) = 105
-F180(¥/$)
McGraw-Hill/Irwin
loss Copyright
4-62
© 2001 by The McGraw-Hill
PAYOFF PROFILES
profit
short position

15¥

0 S180(¥/$)
120
F180(¥/$) = 105
If, in 180 days, S180(¥/$) = 120, the short will make
a profit by buying ¥ at S180(¥/$) = 120 and
-F180(¥/$)
loss delivering ¥ at F180(¥/$) = 105.
PAYOFF PROFILES
profit Since this is a zero-sum game, the long
F180(¥/$) position payoff is the opposite of the short.
short position

0 S180(¥/$)

F180(¥/$) = 105

-F180(¥/$) Long position

McGraw-Hill/Irwin
loss Copyright
4-64
© 2001 by The McGraw-Hill
PAYOFF PROFILES
profit
The long in this forward contract agreed to BUY ¥
-F180(¥/$)
in 180 days at F180(¥/$) = 105
If, in 180 days, S180(¥/$) = 120, the long will
lose by having to buy ¥ at S180(¥/$) = 120 and
delivering ¥ at F180(¥/$) = 105.

0 S180(¥/$)
120
F180(¥/$) = 105
–15¥
Long position
McGraw-Hill/Irwin
loss Copyright
4-65
© 2001 by The McGraw-Hill
FORWARD CROSS EXCHANGE RATES

 It’s just an “delayed” example of the spot cross rate discussed above.
 In generic terms

FN ($ / k )
FN ( j / k ) =
FN ($ / j )
and
FN ($ / j )
FN ( k / j ) =
McGraw-Hill/Irwin
© 2001 by The McGraw-Hill
FN ($ / k )
Copyright
4-66