Unit IV

Foreign Exchange
Markets
Dr. K. Srinivasan
Department of Management Studies
Christ University, Bangalore.

Introduction

The recent trends in LPG has given rise to international

trade and investment to grow tremendous pace in the last
decades.
The flow of goods, services & capital goods across various
national boundaries is possible only if there is a good
functioning monetary system.
FOREX market is the largest financial market in the world
by virtually any standard.
In 2001, triennial central bank survey compiled by the BIS
places worldwide daily trading of spot & forward FOREX
at $1.2 trillion dollars per day.

Continued..

The survey conducted by BIS is equal to nearly $200 in

transactions for every person on earth.
London remains the worlds largest FOREX trading centre.
According to the survey, the U.K & the U.S were the
leading participants with 33% & 17%, respectively.
Broadly defines Foreign Exchange 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, futures
contracts and currency swaps.

Function & Structure of

FOREX Market
Structure of FOREX Market

The main players in FOREX market are Commercial Bank,

FOREX Brokers, Large Corporations & RBI.
Normally, the RBI enter into the market to smoothen out
fluctuations in the exchange rate.
The currency prevailing in FOREX market are numerous in
nature. So, it is very difficult for a player to keep all the
track of all quotes available in the market.
In case of FOREX brokers, they wont buy or sell any
currency. But, they work for bringing buyers & sellers
together.

Continued.

Australia, Europe & North America are the major segments of

FOREX market.

Australia includes the trading centers like Sydney, Tokyo, Hong

Kong, Singapore & Bahrain.
Europe includes Zurich, Frankfurt, Paris, Amsterdam & London.
North America includes New York, Montreal, Toronto, Chicago,
San Francisco & Los Angeles.

Most trading rooms operates over 9 to 12 hours working day,

although some banks experimented with operating three eighthour shifts in order to trade the clock.
Therefore, the trading takes place when the trading hours of the
three centers overlap

Function of FOREX
Market
Function of the FOREX Market
FX Market Participants
Correspondent Banking Relationships
The Spot Market
Spot Rate Quotations
The Bid-Ask Spread
Spot FX Trading
Cross Exchange Rate Quotations
Triangular Arbitrage
Spot Foreign Exchange Market Microstructure

Continued.
The Forward Market
Forward Rate Quotations
Long and Short Forward Positions
Forward Cross-Exchange Rates
Swap Transactions
Forward Premium

FOREX Market Participants

The FOREX market is a two-tiered market:
Interbank Market (Wholesale)
About 700 banks worldwide stand ready to make
a market in Foreign exchange.
There are FX brokers who match buy and sell
orders but do not carry inventory and FX
specialists.
Client Market (Retail)
Market participants include international banks,
their bank customers, nonbank dealers, FOREX
brokers, and central banks.

Continued.
International Banks: Make a Market & Willing to
buy or sell foreign currency for their own retail
customers.
Bank Customers: Making investment in Internationally.
Apart from this, MNCs, Money Managers & Private
Speculator.
Nonbank Dealers: Refers to NBFCs. Nonbank dealers
records about 28% of interbank trading volume. The
main works are inventory position, Arbitrage &
Speculative transactions with Market Psychology.

Continued.
FX Brokers: Match dealers for a fee, but do not take
position. In recent years, their participation in market is
very less.
Central Bank: Intervening the value of one currency
against a trading partner may reduce Export & increase
Import. Central bank intervening in currency market
often lose bank reserves in attempting to achieve their
goal. However, there is a little evidence that massive
intervention can materially affect exchange rates.

Correspondent Banking
Relationships

Large commercial banks maintain demand deposit accounts

with one another which facilitates the efficient functioning
of the forex market.
International commercial banks communicate with one
another with:

SWIFT: The Society for Worldwide Interbank Financial

Telecommunications. Private Nonprofit message transfer
system with headquarters in Brussels, with intercontinental
switching centers in the Netherlands &Virginia.

Continued.

CHIPS: Clearing House Interbank Payments System in

cooperation with U.S Federal Reserve Bank System, called
Fedwire. Provides a clearinghouse for the interbank settlement
of U.S$ payments between international bank.
ECHO: In August 1995, Exchange Clearing House Limited,
the first global clearinghouse for settling interbank FOREX
transactions. ECHO was a multilateral netting system, where
the settlement date of clients payment & receipts are
recorded, this eliminates the risk & inefficiency of individual
settlement. In 1997, CLS Service Ltd merged with ECHO.
Currently, operations of the system has been suspended.

The Spot Market

In case of USD & Non North American currency, the
transaction of cash settlement will be made in two days.
But, the settlement for regular spot trades between the USD
& the Mexican Peso or Canadian Dollar will takes only one
business days.
1.
Spot Rate Quotations
2.
The Bid-Ask Spread
3.
Spot FX trading
4.
Cross Exchange Rate Quotations
5.
Triangular Arbitrage
6.
Spot Foreign Exchange Market Microstructure

Spot Rate Quotations

Direct Quotation:
The U.S. dollar equivalent
Ex: A Japanese Yen is worth about a penny
Indirect Quotation:
The price of a U.S. dollar in the foreign
currency
Ex: You get 100 yen to the dollar.

Spot Rate Quotations

(Direct)
Currency
U.S. $ equiv.
per U.S. $
Country
Wed.
Tues.
Wed.
Tues.
Japan (Yen)
.008639
.008681
115.75
115.20
30-Day Forward
.008676
.008718
115.26
114.71
T he New Y ork forei gn exc hange s el l i ng rates bel ow appl y to
.008750
.008791
114.28
113.76
tradi ng am ong banks i n amounts of $1 m i ll i on and m ore , as quoted 90-Day Forward
Forward
.008865
.008907
112.80
112.28
at 4 p.m. E as tern ti me by Dow J ones T el erate Inc . and other s ourc es180-Day
.
Jordan (Dinar)
1.4075
1.4075
.7105
.7105
Retai l trans ac tions provi de fewer uni ts of forei gn c urrenc y per
Kuwait (Dinar)
3.3367
3.3389
.2997
.2995
dol l ar.
Lebanon
(Pound)
.0006445
.0006445
1551.50
1551.50
Currency
Malaysia (Ringgit)
.4018
.4002
2.4885
2.4990
per U.S. $
U.S. $ equiv.
Malta (Lira)
2.7624
2.7701
.3620
.3610
Country
Wed.
Tues.
Wed.
Tues.
Mexico (Peso)
....
....
....
....
Argentina (Peso)
1.0012
1.0012
.9988
.9988
Floating rate
.1278
.1277
7.8220
7.8330
Australia (Dollar)
.7805
.7902
1.2812
1.2655
Netherland (Guilder)
.5655
.5699
1.7685
1.7547
Austria (Schilling)
.09043
.09101
11.058
10.988
New Zealand (Dollar)
.7072
.7106
1.4140
1.4073
Bahrain (Dinar)
2.6525
2.6525
.3770
.3770
Norway (Krone)
.1540
.1548
6.4926
6.4599
Belgium (Franc)
.03080
.03105
32.470
32.205
Pakistan
(Rupee)
.02529
.02529
39.540
39.540
Brazil (Real)
.9607
.9615
1.0409
1.0401
Peru (new Sol)
.3814
.3840
2.6218
2.6039
Britain (Pound)
1.6880
1.6946
.5924
.5901
Philippines (Peso)
.03800
.03802
26.318
26.300
30-Day Forward
1.6869
1.6935
.5928
.5905
Poland (Zloty)
.3460
.3475
2.8900
2.8780
90-Day Forward
1.6843
1.6910
.5937
.5914
Portugal (Escudo)
.006307
.006369
158.55
157.02
180-Day Forward
1.6802
1.6867
.5952
.5929
Russia
(Ruble)
(a)
.0001787
.0001788
5595.00
5594.00
Canada (Dollar)
.7399
.7370
1.3516
1.3568
Saudi Arabia (Riyal)
.2666
.2667
3.7503
3.7502
30-Day Forward
.7414
.7386
1.3488
1.3539
Singapore (Dollar)
.7116
.7124
1.4053
1.4037
90-Day Forward
.7442
.7413
1.3437
1.3489
Slovak Rep. (Koruna)
.03259
.03259
30.688
30.688
180-Day Forward
.7479
.7450
1.3370
1.3422
South Africa (Rand)
.2141
.2142
4.6705
4.6690
Chile (Peso)
.002352
.002356
425.25
424.40
South
Korea
(Won)
.001184
.001184
844.75
844.65
China (Renminbi)
.1201
.1201
8.3272
8.3276
Spain (Peseta)
.007546
.007603
132.52
131.53
Colombia (Peso)
.0009985
.0009985
1001.50
1001.50
Sweden (Krona)
.1431
.1435
6.9865
6.9697
Czech. Rep (Krouna)
....
....
....
....
Switzerland (Franc)
.7334
.7387
1.3635
1.3537
Commercial rate
.03662
.03677
27.307
27.194
30-Day Forward
.7357
.7411
1.3593
1.3494
Denmark (Krone)
.1663
.1677
6.0118
5.9633
90-Day
Forward
.7401
.7454
1.3511
1.3416
Ecuador (Sucre)
....
....
....
....
180-Day Forward
.7470
.7523
1.3386
1.3293
Floating rate
.0002766
.0002787
3615.00
3587.50
Taiwan (Dollar)
.03638
.03637
27.489
27.493
Finland (Markka)
.2121
.2135
4.7150
4.6841
Thailand
(Baht)
.03902
.03906
25.625
25.605
France (Franc)
.1879
.1893
5.3220
5.2838
Turkey (Lira)
.00000911
.00000915 109755.00 109235.00
30-Day Forward
.1882
.1896
5.3126
5.2741
United Arab (Dirham)
.2723
.2723
3.6720
3.6720
90-Day Forward
.1889
.1903
5.2935
5.2558
Uruguay (New Peso)
....
....
....
....
180-Day Forward
.1901
.1914
5.2617
5.2243
Financial
.1145
.1145
8.7300
8.7300
Germany (Mark)
.6352
.6394
1.5744
1.5639
Venezuela
(Bolivar)
.002098
.002096
476.70
477.12
30-Day Forward
.6364
.6407
1.5714
1.5607
--90-Day Forward
.6389
.6432
1.5652
1.5547
SDR
1.4315
1.4326
.6986
.6980
180-Day Forward
.6430
.6472
1.5552
1.5450
ECU
1.2308
1.2404
.......... ...........
Greece (Drachma)
.004049
.004068
246.98
245.80
Hong Kong (Dollar)
.1292
.1292
7.7390
7.7390
Special Drawing Rights (SDR) are based on exchange rates for
Hungary (Forint)
.006139
.006164
162.89
162.23
the U.S., German, British, French, and Japanese currencies. Source:
India (Rupee)
.02787
.02786
35.875
35.890
International Monetary Fund.
Indonesia (Rupiah)
.0004233
.0004233
2362.15
2362.63
European Currency Unit (ECU) is based on a basket of community
Ireland (Punt)
1.6664
1.6714
.6001
.5983
currencies.
Israel (Shekel)
.3079
.3085
3.2474
3.2412
a-fixing, Moscow Interbank Currency Exchange.
Italy (Lira)
.0006483
.0006510
1542.50
1536.00

W ednes day, J anuary 8, 1997

EXCH ANGE RAT ES

The Direct
Quote for
British Pound
is:
1 = $1.688

Spot Rate Quotations

(Indirect)
Currency
U.S. $ equiv.
per U.S. $
Country
Wed.
Tues.
Wed.
Tues.
Japan (Yen)
.008639
.008681
115.75
115.20
30-Day Forward
.008676
.008718
115.26
114.71
T he New Y ork forei gn exc hange s el l i ng rates bel ow appl y to
.008750
.008791
114.28
113.76
tradi ng am ong banks i n amounts of $1 m i ll i on and m ore , as quoted 90-Day Forward
Forward
.008865
.008907
112.80
112.28
at 4 p.m. E as tern ti me by Dow J ones T el erate Inc . and other s ourc es180-Day
.
Jordan (Dinar)
1.4075
1.4075
.7105
.7105
Retai l trans ac tions provi de fewer uni ts of forei gn c urrenc y per
Kuwait (Dinar)
3.3367
3.3389
.2997
.2995
dol l ar.
Lebanon
(Pound)
.0006445
.0006445
1551.50
1551.50
Currency
Malaysia (Ringgit)
.4018
.4002
2.4885
2.4990
per U.S. $
U.S. $ equiv.
Malta (Lira)
2.7624
2.7701
.3620
.3610
Country
Wed.
Tues.
Wed.
Tues.
Mexico (Peso)
....
....
....
....
Argentina (Peso)
1.0012
1.0012
.9988
.9988
Floating rate
.1278
.1277
7.8220
7.8330
Australia (Dollar)
.7805
.7902
1.2812
1.2655
Netherland (Guilder)
.5655
.5699
1.7685
1.7547
Austria (Schilling)
.09043
.09101
11.058
10.988
New Zealand (Dollar)
.7072
.7106
1.4140
1.4073
Bahrain (Dinar)
2.6525
2.6525
.3770
.3770
Norway (Krone)
.1540
.1548
6.4926
6.4599
Belgium (Franc)
.03080
.03105
32.470
32.205
Pakistan
(Rupee)
.02529
.02529
39.540
39.540
Brazil (Real)
.9607
.9615
1.0409
1.0401
Peru (new Sol)
.3814
.3840
2.6218
2.6039
Britain (Pound)
1.6880
1.6946
.5924
.5901
Philippines (Peso)
.03800
.03802
26.318
26.300
30-Day Forward
1.6869
1.6935
.5928
.5905
Poland (Zloty)
.3460
.3475
2.8900
2.8780
90-Day Forward
1.6843
1.6910
.5937
.5914
Portugal (Escudo)
.006307
.006369
158.55
157.02
180-Day Forward
1.6802
1.6867
.5952
.5929
Russia
(Ruble)
(a)
.0001787
.0001788
5595.00
5594.00
Canada (Dollar)
.7399
.7370
1.3516
1.3568
Saudi Arabia (Riyal)
.2666
.2667
3.7503
3.7502
30-Day Forward
.7414
.7386
1.3488
1.3539
Singapore (Dollar)
.7116
.7124
1.4053
1.4037
90-Day Forward
.7442
.7413
1.3437
1.3489
Slovak Rep. (Koruna)
.03259
.03259
30.688
30.688
180-Day Forward
.7479
.7450
1.3370
1.3422
South Africa (Rand)
.2141
.2142
4.6705
4.6690
Chile (Peso)
.002352
.002356
425.25
424.40
South
Korea
(Won)
.001184
.001184
844.75
844.65
China (Renminbi)
.1201
.1201
8.3272
8.3276
Spain (Peseta)
.007546
.007603
132.52
131.53
Colombia (Peso)
.0009985
.0009985
1001.50
1001.50
Sweden (Krona)
.1431
.1435
6.9865
6.9697
Czech. Rep (Krouna)
....
....
....
....
Switzerland (Franc)
.7334
.7387
1.3635
1.3537
Commercial rate
.03662
.03677
27.307
27.194
30-Day Forward
.7357
.7411
1.3593
1.3494
Denmark (Krone)
.1663
.1677
6.0118
5.9633
90-Day
Forward
.7401
.7454
1.3511
1.3416
Ecuador (Sucre)
....
....
....
....
180-Day Forward
.7470
.7523
1.3386
1.3293
Floating rate
.0002766
.0002787
3615.00
3587.50
Taiwan (Dollar)
.03638
.03637
27.489
27.493
Finland (Markka)
.2121
.2135
4.7150
4.6841
Thailand
(Baht)
.03902
.03906
25.625
25.605
France (Franc)
.1879
.1893
5.3220
5.2838
Turkey (Lira)
.00000911
.00000915 109755.00 109235.00
30-Day Forward
.1882
.1896
5.3126
5.2741
United Arab (Dirham)
.2723
.2723
3.6720
3.6720
90-Day Forward
.1889
.1903
5.2935
5.2558
Uruguay (New Peso)
....
....
....
....
180-Day Forward
.1901
.1914
5.2617
5.2243
Financial
.1145
.1145
8.7300
8.7300
Germany (Mark)
.6352
.6394
1.5744
1.5639
Venezuela
(Bolivar)
.002098
.002096
476.70
477.12
30-Day Forward
.6364
.6407
1.5714
1.5607
--90-Day Forward
.6389
.6432
1.5652
1.5547
SDR
1.4315
1.4326
.6986
.6980
180-Day Forward
.6430
.6472
1.5552
1.5450
ECU
1.2308
1.2404
.......... ...........
Greece (Drachma)
.004049
.004068
246.98
245.80
Hong Kong (Dollar)
.1292
.1292
7.7390
7.7390
Special Drawing Rights (SDR) are based on exchange rates for
Hungary (Forint)
.006139
.006164
162.89
162.23
the U.S., German, British, French, and Japanese currencies. Source:
India (Rupee)
.02787
.02786
35.875
35.890
International Monetary Fund.
Indonesia (Rupiah)
.0004233
.0004233
2362.15
2362.63
European Currency Unit (ECU) is based on a basket of community
Ireland (Punt)
1.6664
1.6714
.6001
.5983
currencies.
Israel (Shekel)
.3079
.3085
3.2474
3.2412
a-fixing, Moscow Interbank Currency Exchange.
Italy (Lira)
.0006483
.0006510
1542.50
1536.00

W ednes day, J anuary 8, 1997

EXCH ANGE RAT ES

The Indirect
Quote for
British Pound
is:
.5924 = $1

Quoted Spot Rate

Currency
U.S. $ equiv.
per U.S. $
Country
Wed.
Tues.
Wed.
Tues.
Japan (Yen)
.008639
.008681
115.75
115.20
30-Day Forward
.008676
.008718
115.26
114.71
T he New Y ork forei gn exc hange s el l i ng rates bel ow appl y to
.008750
.008791
114.28
113.76
tradi ng am ong banks i n amounts of $1 m i ll i on and m ore , as quoted 90-Day Forward
Forward
.008865
.008907
112.80
112.28
at 4 p.m. E as tern ti me by Dow J ones T el erate Inc . and other s ourc es180-Day
.
Jordan (Dinar)
1.4075
1.4075
.7105
.7105
Retai l trans ac tions provi de fewer uni ts of forei gn c urrenc y per
Kuwait
(Dinar)
3.3367
3.3389
.2997
.2995
dol l ar.
Lebanon (Pound)
.0006445
.0006445
1551.50
1551.50
Currency
Malaysia
(Ringgit)
.4018
.4002
2.4885
2.4990
per
U.S.
$
U.S. $ equiv.
Malta (Lira)
2.7624
2.7701
.3620
.3610
Country
Wed.
Tues.
Wed.
Tues.
Mexico (Peso)
....
....
....
....
Argentina (Peso)
1.0012
1.0012
.9988
.9988
Floating
rate
.1278
.1277
7.8220
7.8330
Australia (Dollar)
.7805
.7902
1.2812
1.2655
Netherland (Guilder)
.5655
.5699
1.7685
1.7547
Austria (Schilling)
.09043
.09101
11.058
10.988
New Zealand (Dollar)
.7072
.7106
1.4140
1.4073
Bahrain (Dinar)
2.6525
2.6525
.3770
.3770
Norway (Krone)
.1540
.1548
6.4926
6.4599
Belgium (Franc)
.03080
.03105
32.470
32.205
Pakistan (Rupee)
.02529
.02529
39.540
39.540
Brazil (Real)
.9607
.9615
1.0409
1.0401
Peru
(new
Sol)
.3814
.3840
2.6218
2.6039
Britain (Pound)
1.6880
1.6946
.5924
.5901
Philippines (Peso)
.03800
.03802
26.318
26.300
30-Day Forward
1.6869
1.6935
.5928
.5905
Poland (Zloty)
.3460
.3475
2.8900
2.8780
90-Day Forward
1.6843
1.6910
.5937
.5914
Portugal (Escudo)
.006307
.006369
158.55
157.02
180-Day Forward
1.6802
1.6867
.5952
.5929
Russia (Ruble) (a)
.0001787
.0001788
5595.00
5594.00
Canada (Dollar)
.7399
.7370
1.3516
1.3568
Saudi
Arabia
(Riyal)
.2666
.2667
3.7503
3.7502
30-Day Forward
.7414
.7386
1.3488
1.3539
Singapore (Dollar)
.7116
.7124
1.4053
1.4037
90-Day Forward
.7442
.7413
1.3437
1.3489
Slovak Rep. (Koruna)
.03259
.03259
30.688
30.688
180-Day Forward
.7479
.7450
1.3370
1.3422
South
Africa
(Rand)
.2141
.2142
4.6705
4.6690
Chile (Peso)
.002352
.002356
425.25
424.40
South Korea (Won)
.001184
.001184
844.75
844.65
China (Renminbi)
.1201
.1201
8.3272
8.3276
Spain (Peseta)
.007546
.007603
132.52
131.53
Colombia (Peso)
.0009985
.0009985
1001.50
1001.50
Sweden (Krona)
.1431
.1435
6.9865
6.9697
Czech. Rep (Krouna)
....
....
....
....
Switzerland (Franc)
.7334
.7387
1.3635
1.3537
Commercial rate
.03662
.03677
27.307
27.194
30-Day
Forward
.7357
.7411
1.3593
1.3494
Denmark (Krone)
.1663
.1677
6.0118
5.9633
90-Day Forward
.7401
.7454
1.3511
1.3416
Ecuador (Sucre)
....
....
....
....
180-Day Forward
.7470
.7523
1.3386
1.3293
Floating rate
.0002766
.0002787
3615.00
3587.50
Taiwan (Dollar)
.03638
.03637
27.489
27.493
Finland (Markka)
.2121
.2135
4.7150
4.6841
Thailand (Baht)
.03902
.03906
25.625
25.605
France (Franc)
.1879
.1893
5.3220
5.2838
Turkey
(Lira)
.00000911
.00000915
109755.00
109235.00
30-Day Forward
.1882
.1896
5.3126
5.2741
United Arab (Dirham)
.2723
.2723
3.6720
3.6720
90-Day Forward
.1889
.1903
5.2935
5.2558
Uruguay (New Peso)
....
....
....
....
180-Day Forward
.1901
.1914
5.2617
5.2243
Financial
.1145
.1145
8.7300
8.7300
Germany (Mark)
.6352
.6394
1.5744
1.5639
Venezuela (Bolivar)
.002098
.002096
476.70
477.12
30-Day Forward
.6364
.6407
1.5714
1.5607
--90-Day Forward
.6389
.6432
1.5652
1.5547
SDR
1.4315
1.4326
.6986
.6980
180-Day Forward
.6430
.6472
1.5552
1.5450
ECU
1.2308
1.2404
.......... ...........
Greece (Drachma)
.004049
.004068
246.98
245.80
Hong Kong (Dollar)
.1292
.1292
7.7390
7.7390
Special Drawing Rights (SDR) are based on exchange rates for
Hungary (Forint)
.006139
.006164
162.89
162.23
the U.S., German, British, French, and Japanese currencies. Source:
India (Rupee)
.02787
.02786
35.875
35.890
International Monetary Fund.
Indonesia (Rupiah)
.0004233
.0004233
2362.15
2362.63
European Currency Unit (ECU) is based on a basket of community
Ireland (Punt)
1.6664
1.6714
.6001
.5983
currencies.
Israel (Shekel)
.3079
.3085
3.2474
3.2412
a-fixing, Moscow Interbank Currency Exchange.
Italy (Lira)
.0006483
.0006510
1542.50
1536.00

W ednes day, J anuary 8, 1997

EXCH ANGE RAT ES

Note that the

Direct Quote
is the
reciprocal of
the indirect
quote:
1.688

1
.5924

The Bid-Ask Spread

FX traders buy currency for inventory at the bid
price and sell from inventory at the higher offer or ask
price
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.

Spot FX Trading

In interbank transaction, the standard amount from one bank to

another will be based on major currencies (i.e.) U.S. $10 million.
Dealers quote both the bid and the ask, willing to either buy or
sell the quoted value. Spot quote are good for only few seconds
& traders should respond immediately
Interbank trading rooms are typically organized with individual
traders dealing in particular currency. So, the trading room is a
noisy, active place.
Currency traders are capable of interpreting new information
quickly & making high stakes decisions. Particularly, the long
term is about 10 minutes.

Cross Rates
Cross exchange rate is an exchange rate between a currency
pair where neither currency is the U.S dollar. Moreover, the
cross-exchange rate can be calculated from the U.S Dollar
exchange rates for the two currencies, using either European or
American term quotations.
Ex: and Cross-rate can be calculated from American term
quotations as follows
Suppose $(/ ) = ($/)/($/)
$
$
DM

,
DM

$1
DM 1
$1

S ($ / ) .01 or $1 100
DM 2 50
100

since

Triangular Arbitrage
Suppose we
observe these
banks posting these
exchange rates.
First calculate the
implied cross rates
to see if an
Arbitrage exists.

$
Barclays

Credit Lyonnais

S(/$)=120

S(/$)=1.50

Credit Agricole
S(/)=85

Continued.
The implied S(/) cross
rate is S(/) = 80

$
Barclays

S(/$)=120

Credit Agricole has

posted a quote of
S(/)=85 so there is an

Credit Lyonnais
1.50 $1
1 S(/$)=1.50

$1
120 80

arbitrage opportunity.

Credit Agricole
S(/)=85

So, how can we make money?

Continued.
As easy as 1 2 3:

1. Sell our $ for ,

Barclays

2. Sell our for ,

S(/$)=120

3. Sell those for $.

Credit Lyonnais
1.50 $1
1 S(/$)=1.50

$1
120 80

Credit Agricole
S(/)=85

Continued.
Sell $100,000 for at S(/$) = 1.50

receive 150,000
Sell 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 basic mechanics of

how a marketplace operates.
Bid-Ask spread in the spot FX market increase with FX
exchange rate volatility and decrease with dealer
competition.
Dealers competition is a fundamental determinant of
the spot FX bid-ask spread.
Private information is an important determinant of
spot exchange rates.

The Forward Market

A forward contract is an agreement to buy or sell an

asset in the future at prices agreed upon today.
Forward exchange rates are quoted on most major
currencies for a variety of maturities.
Bank Quotes for maturities of 1, 3, 6, 9 & 12 months
are readily available.
Quotations on nonstandard or Broken term maturities
are also available
Maturities extending beyond one year are becoming
more frequent and good for the bank customers

Continued

Forward Rate Quotations

Forward Cross Exchange Rates

Forward Premium

Long and Short Forward Positions

Swap Transactions

Forward Rate Quotations

Forward Rate Quotes are either direct or indirect
Direct Quotes:
S ($/SF)
=
.6653
F1($/SF)
=
.6660
F2($/SF)
=
.6670
F3($/SF)
=
.6684
Indirect Quotes:
S (SF/$)
=
1.5030
F1(SF/$)
=
1.5016
F2(SF/$)
=
1.4993
F3(SF/$)
=
1.4961

Spot Rate Quotations

Currency
U.S. $ equiv.
per U.S. $
Country
Wed.
Tues.
Wed.
Tues.
Japan (Yen)
.008639
.008681
115.75
115.20
30-Day Forward
.008676
.008718
115.26
114.71
T he New Y ork forei gn exc hange s el l i ng rates bel ow appl y to
.008750
.008791
114.28
113.76
tradi ng am ong banks i n amounts of $1 m i ll i on and m ore , as quoted 90-Day Forward
Forward
.008865
.008907
112.80
112.28
at 4 p.m. E as tern ti me by Dow J ones T el erate Inc . and other s ourc es180-Day
.
Jordan (Dinar)
1.4075
1.4075
.7105
.7105
Retai l trans ac tions provi de fewer uni ts of forei gn c urrenc y per
Kuwait
(Dinar)
3.3367
3.3389
.2997
.2995
dol l ar.
Lebanon (Pound)
.0006445
.0006445
1551.50
1551.50
Currency
Malaysia
(Ringgit)
.4018
.4002
2.4885
2.4990
per
U.S.
$
U.S. $ equiv.
Malta (Lira)
2.7624
2.7701
.3620
.3610
Country
Wed.
Tues.
Wed.
Tues.
Mexico (Peso)
....
....
....
....
Argentina (Peso)
1.0012
1.0012
.9988
.9988
Floating
rate
.1278
.1277
7.8220
7.8330
Australia (Dollar)
.7805
.7902
1.2812
1.2655
Netherland (Guilder)
.5655
.5699
1.7685
1.7547
Austria (Schilling)
.09043
.09101
11.058
10.988
New Zealand (Dollar)
.7072
.7106
1.4140
1.4073
Bahrain (Dinar)
2.6525
2.6525
.3770
.3770
Norway (Krone)
.1540
.1548
6.4926
6.4599
Belgium (Franc)
.03080
.03105
32.470
32.205
Pakistan (Rupee)
.02529
.02529
39.540
39.540
Brazil (Real)
.9607
.9615
1.0409
1.0401
Peru
(new
Sol)
.3814
.3840
2.6218
2.6039
Britain (Pound)
1.6880
1.6946
.5924
.5901
Philippines (Peso)
.03800
.03802
26.318
26.300
30-Day Forward
1.6869
1.6935
.5928
.5905
Poland (Zloty)
.3460
.3475
2.8900
2.8780
90-Day Forward
1.6843
1.6910
.5937
.5914
Portugal (Escudo)
.006307
.006369
158.55
157.02
180-Day Forward
1.6802
1.6867
.5952
.5929
Russia (Ruble) (a)
.0001787
.0001788
5595.00
5594.00
Canada (Dollar)
.7399
.7370
1.3516
1.3568
Saudi
Arabia
(Riyal)
.2666
.2667
3.7503
3.7502
30-Day Forward
.7414
.7386
1.3488
1.3539
Singapore (Dollar)
.7116
.7124
1.4053
1.4037
90-Day Forward
.7442
.7413
1.3437
1.3489
Slovak Rep. (Koruna)
.03259
.03259
30.688
30.688
180-Day Forward
.7479
.7450
1.3370
1.3422
South
Africa
(Rand)
.2141
.2142
4.6705
4.6690
Chile (Peso)
.002352
.002356
425.25
424.40
South Korea (Won)
.001184
.001184
844.75
844.65
China (Renminbi)
.1201
.1201
8.3272
8.3276
Spain (Peseta)
.007546
.007603
132.52
131.53
Colombia (Peso)
.0009985
.0009985
1001.50
1001.50
Sweden (Krona)
.1431
.1435
6.9865
6.9697
Czech. Rep (Krouna)
....
....
....
....
Switzerland (Franc)
.7334
.7387
1.3635
1.3537
Commercial rate
.03662
.03677
27.307
27.194
30-Day
Forward
.7357
.7411
1.3593
1.3494
Denmark (Krone)
.1663
.1677
6.0118
5.9633
90-Day Forward
.7401
.7454
1.3511
1.3416
Ecuador (Sucre)
....
....
....
....
180-Day Forward
.7470
.7523
1.3386
1.3293
Floating rate
.0002766
.0002787
3615.00
3587.50
Taiwan (Dollar)
.03638
.03637
27.489
27.493
Finland (Markka)
.2121
.2135
4.7150
4.6841
Thailand (Baht)
.03902
.03906
25.625
25.605
France (Franc)
.1879
.1893
5.3220
5.2838
Turkey
(Lira)
.00000911
.00000915
109755.00
109235.00
30-Day Forward
.1882
.1896
5.3126
5.2741
United Arab (Dirham)
.2723
.2723
3.6720
3.6720
90-Day Forward
.1889
.1903
5.2935
5.2558
Uruguay (New Peso)
....
....
....
....
180-Day Forward
.1901
.1914
5.2617
5.2243
Financial
.1145
.1145
8.7300
8.7300
Germany (Mark)
.6352
.6394
1.5744
1.5639
Venezuela (Bolivar)
.002098
.002096
476.70
477.12
30-Day Forward
.6364
.6407
1.5714
1.5607
--90-Day Forward
.6389
.6432
1.5652
1.5547
SDR
1.4315
1.4326
.6986
.6980
180-Day Forward
.6430
.6472
1.5552
1.5450
ECU
1.2308
1.2404
.......... ...........
Greece (Drachma)
.004049
.004068
246.98
245.80
Hong Kong (Dollar)
.1292
.1292
7.7390
7.7390
Special Drawing Rights (SDR) are based on exchange rates for
Hungary (Forint)
.006139
.006164
162.89
162.23
the U.S., German, British, French, and Japanese currencies. Source:
India (Rupee)
.02787
.02786
35.875
35.890
International Monetary Fund.
Indonesia (Rupiah)
.0004233
.0004233
2362.15
2362.63
European Currency Unit (ECU) is based on a basket of community
Ireland (Punt)
1.6664
1.6714
.6001
.5983
currencies.
Israel (Shekel)
.3079
.3085
3.2474
3.2412
a-fixing, Moscow Interbank Currency Exchange.
Italy (Lira)
.0006483
.0006510
1542.50
1536.00

W ednes day, J anuary 8, 1997

EXCH ANGE RAT ES

Clearly the
market
participants
expect that
the yen will
be worth
MORE in
dollars in six
months.

Forward Cross Exchange

Rates
Forward cross - exchange rate quotations are
calculated in an analogous manner to spot cross - rates.
Its just an delayed example of the spot cross rate
discussed above. In generic terms
FN (German / Japan)

FN ($ / Japan)
FN ($ / German)

and
FN ( Japan / German)

FN ($ / German)
FN ($ / Japan)

Forward Premium

The interest rate differential implied by forward

exchange is termed as premium or discount.
Apart from this, the comparison is useful for interest
rate differential between two countries.
The forward premium can be expressed in American or
European terms

f180, DMv$

F180 ($ / DM ) S ($ / DM ) 360 .5307 .5235

.01375
S ($ / DM )
180
.5235

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.

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.
S180($/)

F180($/) = .009524

Loss

If you agree to sell anything in the

future at a set price and the spot price
Short Position
later rises then you Lose.

Payoff Profiles
Profit
Short Position

S180(/$)

F180(/$) = 105
-F180(/$)
Loss

The payoff profile slopes up or

down depends upon whether you
use the Direct or Indirect quote:
F180(/$) = 105 or F180($/) =
.009524.

Payoff Profiles
Profit
Short Position

S180(/$)

F180(/$) = 105
-F180(/$)
Loss

When the short entered into this forward contract, he

agreed to sell in 180 days at F180(/$) = 105

Payoff Profiles
Profit
Short Position

15

S180(/$)

F180(/$) = 105
-F180(/$)
Loss

120

If, in 180 days, S180(/$) = 120, the short will make a

profit by buying at S180(/$) = 120 and delivering
at F180(/$) = 105.

Payoff Profiles
Profit
F180(/$)

Since this is a zero-sum game, the Short Position

long position payoff is the opposite
of the short.
S180(/$)

F180(/$) = 105
-F180(/$)
Loss

Long position

Payoff Profiles
Profit
-F180(/$)

The long in this forward contract agreed to BUY 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.
S180(/$)

0
120

F180(/$) = 105
15
Loss

Long Position

SWAPS
A swap is an agreement to provide a counterparty
with something he wants in exchange for something
that you want.
Swap transactions account for approximately 51
percent of interbank FX trading, whereas outright
trades are less than 9 percent.
A swap can be viewed as a portfolio of spot and
forward positions.

Comparative Advantage on
Swaps
Consider two firms A and B: Firm A is a U.S Based
multinational and firm B is a U.K Based multinational.
Both firms wish to finance a project in each others
country of the same size. Their borrowing
opportunities are given in the table below.
Company A
Company B

8.0%
10.0%

11.6%
12.0%

Continued
A is the more credit-worthy of the two firms.
A pays 2% less to borrow in dollars than B and A pays
.4% less to borrow in pounds than B:
$

Company A

8.0%

11.6%

Company B

10.0%

12.0%

A has a comparative advantage in borrowing in dollars

B has a comparative advantage in borrowing in pounds.

Feasible Swap
Swap
$8%

$8%

Company
A

$10.0%

Bank

12%
11.6%

Company
B

Company A

8.0%

11.6%

Company B

10.0%

12.0%

12%

Continued
Swap
$8%

$8%

Company
11.6%
A
As net position is to
borrow at 11.6%

$10.0%

Bank

12%

Company
B

Company A

8.0%

11.6%

Company B

10.0%

12.0%

12%

Continued
Swap
$8%

$8%

Company
A

$10.0%

Bank

12%

Company

11.6%

12%

B
Bs net position is to
borrow at $10.0%

Company A

8.0%

11.6%

Company B

10.0%

12.0%

Continued
Swap
$8%

$8%

Company
A

$10.0%

Bank

12%

Company

11.6%

A saves 1.6%
$

Company A

8.0%

11.6%

Company B

10.0%

12.0%

12%

Continued
Swap
$8%

$8%

Company
A

$10.0%

Bank

12%

Company

11.6%

12%

A saves 1.6%
$

Company A

8.0%

11.6%

Company B

10.0% 12.0%

B saves $4.0%

Continued
The Swap Bank
makes money too.

Swap
$8%

$8%

Company
A

$10.0%

Bank

12%

Company

11.6%

12%

A saves 1.6%
$

Company A

8.0%

11.6%

Company B

10.0% 12.0%

B saves $4.0%

Problem: 1
Determine the spread in the two currencies and
and determine which currency is the better currency.
Currency

Bid Rate

Ask Rate

$ 1.55
$0.0070

1.60
0.0075

Problem: 2
The following are the quotes given by SBI Bank in Delhi.
Find out the bid rate, Ask (Offer) rate, spread and spread in %
a) INR/$
48.70 48.90
b) INR/GBP
78.80 78.90

Problem: 3
Given the following forward rate is 1.030 1$ and the
spot rate is 1.0200 1$. Find the forward premium or discount for
3 months.

Problem: 4
The USD is quoted at GBP 1.1125/1.2225 and the INR
is quoted at GBP 0.5225/0.5325. What is the direct quote
between USD and INR?

Problem: 5
Assume the following spot exchange rate exists.
$0.60/DM
$0.15/FFr
FFr 4/DM
Assuming no transaction costs, based on these
exchange rates, can triangular is used to earn profit
Explain.