Determination of
Exchange Rates
BBA(IB)-FEO-
3.1
What Is Forex Market?
The foreign exchange market is the "place" where currencies are
traded. Currencies are important to most people around the
world, because currencies need to be exchanged in order to
conduct foreign trade and business.
If you are living in the U.S. and want to buy cheese from France,
either you or the company that you buy the cheese from has to
pay the French for the cheese in Euros (EUR). This means that
the U.S. importer would have to exchange the equivalent value of
U.S. dollars (USD) into Euros.
The same goes for traveling. A French tourist in Egypt can't pay
in Euros to see the pyramids because it's not the locally accepted
currency. As such, the tourist has to exchange the Euros for the
local currency, in this case the Egyptian pound, at the current
exchange rate.
What Is Forex Market?
The need to exchange currencies is the primary
reason why the Forex market is the largest,
most liquid financial market in the world.
It dwarfs other markets in size, even the stock
market, with an average traded value of
around U.S. $2,000 billion per day.
The total volume changes all the time, but as
of August 2012, the
Bank for International Settlements (BIS)
reported that the Forex market traded in
excess of U.S. $4.9 trillion per day.
What Is Forex Market?
The Indian stats, are as follows:
Equity markets – Daily Turnover USD 31
Billion
Commodities markets – Daily Turnover USD
12 Billion
Forex markets – Daily Turnover USD 57
Billion
What Is Forex Market?
One unique aspect of this international market is that
there is no central marketplace for foreign exchange.
Rather, currency trading is conducted electronically
over-the-counter (OTC), which means that all
transactions occur via computer networks between
traders around the world, rather than on one centralized
exchange.
The market is open 24 hours a day, five and a half days a
week, and currencies are traded worldwide in the major
financial centers of London, New York, Tokyo, Zurich,
Frankfurt, Hong Kong, Singapore, Paris and Sydney -
across almost every time zone.
This means that when the trading day in the U.S. ends,
the Forex market begins a new in Tokyo and Hong Kong.
What Is Forex Market?
The foreign exchange market (Forex or FX for
short) is one of the most exciting, fast-paced
markets around.
Until recently, Forex trading in the currency
market had been the domain of large financial
institutions, corporations, central banks, hedge
funds and extremely wealthy individuals.
The emergence of the internet has changed all of
this, and now it is possible for average investors
to buy and sell currencies easily with the click of a
mouse through online brokerage accounts.
What Is Forex Market?
Daily currency fluctuations are usually very small. Most
currency pairs move less than one cent per day, representing
a less than 1% change in the value of the currency.
This makes foreign exchange one of the least volatile financial
markets around.
Therefore, many currency speculators rely on the availability
of enormous leverage to increase the value of potential
movements. In the retail Forex market, leverage can be as
much as 250:1.
Higher leverage can be extremely risky, but because of
round-the-clock trading and deep liquidity, foreign exchange
brokers have been able to make high leverage an industry
standard in order to make the movements meaningful for
currency traders.
What Is Forex Market?
Extreme liquidity and the availability of high
leverage have helped to spur the market's rapid
growth and made it the ideal place for many
traders.
Positions can be opened and closed within
minutes or can be held for months.
Currency prices are based on objective
considerations of supply and demand and cannot
be manipulated easily because the size of the
market does not allow even the largest players,
such as central banks, to move prices at will.
Forex Quote
When a currency is quoted, it is done in
relation to another currency, so that the
value of one is reflected through the value
of another.
Therefore, if you are trying to determine the
exchange rate between the U.S. dollar
(USD) and the Indian Rupee (INR), the Forex
quote would look like this:
USD/INR = 61.80
Forex Quote
This is referred to as a currency pair.
The currency to the left of the slash is the base
currency, while the currency on the right is called
the quote or counter currency.
The base currency (in this case, USD) is always
equal to one unit (in this case, US$1), and the
quoted currency (in this case,INR) is what that one
base unit is equivalent to in the other currency.
The quote means that US$1 = 61.80 INR.
In other words, US$1 can buy INR 61.80.
The Forex quote includes the currency abbreviations
for the currencies in question.
Direct Currency vs. Indirect
Currency Quote
There are two ways to quote a currency pair, either directly or
indirectly.
A direct currency quote is simply a currency pair in which the
domestic currency is the base currency; while an indirect quote,
is a currency pair where the domestic currency is the quoted
currency.
So if you were looking at the Canadian dollar as the domestic
currency and U.S. dollar as the foreign currency, a direct quote
would be CAD/USD, while an indirect quote would be USD/CAD.
The direct quote varies the foreign currency, and the quoted, or
domestic currency, remains fixed at one unit.
In the indirect quote, on the other hand, the domestic currency
is variable and the foreign currency is fixed at one unit.
Direct Currency vs. Indirect
Currency Quote
For example, if Canada is the domestic
currency, a direct quote would be
CAD/USD = 0.85
Which means with C$1, you can purchase
US$0.85.
The indirect quote for this would be the
inverse (1/0.85), which is
USD/CAD = 1.18
Which means that USD$1 will purchase
C$1.18.
Direct Currency vs. Indirect
Currency Quote
In the Forex market, most currencies are traded
against the U.S. dollar, and the U.S. dollar is
frequently the base currency in the currency pair.
In these cases, it is called a direct quote.
This would apply to the above USD/INR currency
pair, which indicates that US$1 is equal to 61.80
Indian Rupees.
Dominance of Forex market- USD 65%,Euro-25%
and all others combined – 10%
Most currency exchange rates are quoted out to
four digits after the decimal place
Direct Currency vs. Indirect
Currency Quote
However, not all currencies have the U.S. dollar as the
base.
The Queen's currencies - those currencies that historically
have had a tie with Britain, such as the British pound,
Australian Dollar and New Zealand dollar - are all quoted
as the base currency against the U.S. dollar.
The euro, which is relatively new, is quoted the same way
as well.
In these cases, the U.S. dollar is the counter currency,
and the exchange rate is referred to as an indirect quote.
EUR/USD quote is given as 1.25,because it means that
one euro is the equivalent of 1.25 U.S. dollars.
Cross Currency
When a currency quote is given without the
U.S. dollar as one of its components, this is
called a cross currency.
The most common cross currency pairs are
the EUR/GBP, EUR/CHF and EUR/JPY.
These currency pairs expand the trading
possibilities in the Forex market, but it is
important to note that they do not have
much volumes (for example, not as actively
traded) as pairs that include the U.S. dollar,
which also are called the majors.
Bid and Ask
As with most trading in the financial markets,
when you are trading a currency pair there is a
bid price (buy) and an ask price (sell). Again,
these are in relation to the base currency.
When buying a currency pair , the ask price
refers to the amount of quoted currency that has
to be paid in order to buy one unit of the base
currency,
or how much the market will sell one unit of the
base currency for in relation to the quoted
currency.
Bid and Ask
The bid price is used when selling a currency
pair and reflects how much of the quoted
currency will be obtained when selling one unit
of the base currency,
or how much the market will pay for the quoted
currency in relation to the base currency.
The quote before the slash is the bid price, and
the two digits after the slash represent the ask
price (only the last two digits of the full price
are typically quoted). Note that the bid price is
always smaller than the ask price.
Bid and Ask
Definition of 'Bid Price'
The price a buyer is willing to pay for a
security.
The opposite of the bid is the ask price,
which is the price a seller is looking to get
for his or her shares.
Bid and Ask
The Bid is the price at which a broker will buy your current day trading
position from you.
The Ask is the price at which the broker will sell you the position you
require.
This is why prices you see will have 2 numbers which you can see on your
computer - IBM might be quoted as 110 - 112. This means that if you want
to BUY a single share, it will cost you 112 dollars,
but if you want to SELL a share, you will only get 110 dollars for it.
In the morning papers, usually only 1 price is shown, and this is the MID
price .
Think of it like exchanging foreign currency when you are abroad - when
you go into a Money exchange counter - they will give you only £60 for
your $100, but if you want to sell them that £60 back, you will be lucky to
get $95.
Note - the “Bid" for a stock means the highest price that a buyer is willing
to pay for that stock
The " Ask" is the lowest price that a seller is willing to accept for a stock at
that time.
Ask Price
USD/CAD = 1.2000/05
Bid = 1.2000
Ask= 1.2005
If you want to buy this currency pair, this means
that you intend to buy the base currency and are
therefore looking at the ask price to see how
much (in Canadian dollars) the market will
charge for U.S. dollars.
According to the ask price, you can buy one U.S.
dollar with 1.2005 Canadian dollars.
Bid Price
USD/CAD = 1.2000/05
Bid = 1.2000
Ask= 1.2005
However, in order to sell this currency pair, or
sell the base currency in exchange for the
quoted currency, you would look at the bid
price.
It tells you that the market will buy US$1 base
currency (you will be selling the market the
base currency) for a price equivalent to 1.2000
Canadian dollars, which is the quoted currency.
Forex trading
Whichever currency is quoted first (the base
currency) is always the one in which the
transaction is being conducted.
You either buy or sell the base currency.
Depending on what currency you want to
use to buy or sell the base with, you refer to
the corresponding currency pair
spot exchange rate to determine the price.
Spreads and Pips
The difference between the bid price and the ask
price is called a spread.
EUR/USD = 1.2500/03, the spread would be
0.0003 or 3 pips, also known as points.
Although these movements may seem
insignificant, even the smallest point change can
result in thousands of dollars being made or lost
due to leverage.
Again, this is one of the reasons that speculators
are so attracted to the Forex market; even the
tiniest price movement can result in huge profit.
Spreads and Pips
The pip is the smallest amount a price can
move in any currency quote.
In the case of the U.S. dollar, euro, British
pound or Swiss franc, one pip would be
0.0001.
So, in a Forex quote of USD/CHF, the pip
would be 0.0001 Swiss francs. Most
currencies trade within a range of 100 to
150 pips a day.
What is Pip in FOREX Trading?
A “pip” stands for “Percentage in Point”. A
pip is the smallest price movement of a
traded currency. It is also referred to as a
“point”.
For most currencies a pip is 0.0001 or 1/100
of a cent.
However, take into account that most
currencies are traded in lots of $100 000.
For that amount a pip is $10.
What is Pip in FOREX Trading?
Definition of 'Pip'
The smallest price change that a given exchange
rate can make. Since most major currency pairs are
priced to four decimal places, the smallest change is
that of the last decimal point - for most pairs this is
the equivalent of 1/100 of one percent, or one basis
point.
For example, the smallest move the USD/CAD
currency pair can make is $0.0001, or one basis
point. The smallest move in a currency does not
always need to be equal to one basis point, but this
is generally the case with most currency pairs.
What is Pip in FOREX Trading?
There is an exception for quotations for Japanese
Yen against other currencies.
For currencies in relation to Japanese Yen a pip is
0.01 or 1 cent.
Then if you are trading USD/JPY in $100 000 lots,
one pip will be equivalent to $1000.
A lot is the minimal traded amount for each
currency transaction.
For the Regular Accounts one lot equals 100 000
units of the base currency.
You can also open a Mini Account and trade in mini
lot sizes that are 10 000 units of the base currency.
Currency Quote Overview
USD/CAD = 1.2232/37
Base Currency Currency to the left (USD)
Quote/Counter Currency Currency to the right (CAD)
Price for which the market maker will buy the
Bid Price 1.2232
base currency. Bid is always smaller than ask.
Price for which the market maker will sell the
Ask Price 1.2237
base currency.
One point move, in USD/CAD it is .0001 and 1 The pip/point is the smallest movement a price
Pip
point change would be from 1.2231 to 1.2232 can make.
Spread in this case is 5 pips/points; difference
Spread
between bid and ask price (1.2237-1.2232).
The pip spread is your cost of doing business here. It means you
sustain a paper loss equal to 3 pips at the moment you enter the
trade. Your contract has to appreciate by 3 pips before you break
even. The lower the pip spread the easier is it for you to profit.
Generally the more active and bigger the market, the lower the pip
spread. The smaller and exotic markets tend to have a higher
spread. Most brokers will be offering different spreads for different
currencies. Smaller accounts will generally have higher spreads than
bigger regular accounts.
Key Currencies
Symbol Bid Ask High Low Time(GMT)
USDJPY 92.4900 92.5200 92.6400 91.6200 11:44:26
USDCHF 0.9033 0.9036 0.9108 0.9024 11:44:26
GBPUSD 1.5744 1.5748 1.5878 1.5730 11:44:26
EURUSD 1.3696 1.3698 1.3711 1.3574 11:44:26
AUDUSD 1.0413 1.0414 1.0445 1.0362 11:44:26
USDCAD 0.9993 0.9998 1.0004 0.9968 11:44:26
EURCHF 1.2372 1.2376 1.2414 1.2308 11:44:26
EURJPY 126.6900 126.7600 126.9700 124.4200 11:44:27
NZDJPY 78.2660 78.3099 78.2469 76.8860 11:44:26
AUDCHF 0.9407 0.9408 0.9496 0.9378 11:44:27
AUDNZD 1.2301 1.2304 1.2431 1.2300 11:44:26
CADJPY 92.5085 92.5848 92.7237 91.8367 11:44:26