Foreign Exchange Market and Rates

• Foreign Exchange Dealers

• Attributes of Banks That provide Foreign Exchange: competitiveness
of quote, special relationship, speed of execution, advice about
current market situation, forecasting advice
• Spot Market and Spot Rate
• Inter Bank Market
• Spot Market Time Zones
• Spot Market Liquidity
• Bid/Ask Spread
• Direct and Indirect Quotations
• Cross Exchange Rates
• Forward, Future and Option Markets
Bid/Ask Spread

• The term bid and ask (also known as bid and offer) refers to a two-
way price quotation that indicates the best price at which a security
can be sold and bought at a given point in time. The bid price
represents the maximum price that a buyer is willing to pay for a
security. The ask price represents the minimum price that a seller is
willing to receive. A trade or transaction occurs after the buyer and
seller agree on a price for the security.
• The difference between bid and ask prices, or the spread, is a key
indicator of the liquidity of the asset. In general, the smaller the
spread, the better the liquidity.
• Bid/Ask Spread = Ask Rate – Bid Rate / Ask Rate
Factors That Affect Bid/Ask Spread

• Order Costs (+)

• Inventory Costs (+)
• Competition (-)
• Volume (-)
• Currency Risk (+)
What is a Direct Quote
A direct quote is a foreign exchange rate involving a
quote in fixed units of foreign currency against
variable amounts of the domestic currency. As of
February 2018, a direct quote of the U.S. dollar
against the Canadian dollar in the United States
was U.S. $0.79394 = C $1 while in Canada, a direct
quote for would be C $1.25953 = U.S. $1.
What is an Indirect Quote
The term indirect quote is a currency quotation in the foreign exchange
market that expresses the amount of foreign currency required to buy or sell
one unit of the domestic currency. An indirect quote is also known as a
“quantity quotation,” since it expresses the quantity of foreign currency
required to buy units of the domestic currency. In other words, the domestic
currency is the base currency in an indirect quote, while the foreign currency
is the counter currency.
An indirect quote is the opposite or reciprocal of a direct quote, also known
as a “price quotation,” since it expresses the price of one unit of a foreign
currency in terms of the domestic currency.
Basics of Direct Quote
The concept of direct quotes versus indirect quotes depends
on the location of the speaker, as that determines which
currency in the pair is domestic and which is foreign. Non-
business publications and other media usually quote foreign
exchange rates in direct terms for the ease of consumers.
However, the foreign exchange market has quoting
conventions that transcend local borders.
A direct quote can be calculated using the following formula:
DQ = 1/IQ
Where:
•DQ = Direct Quote
•IQ = Indirect Quote
Basics of Indirect Quote
As the US dollar is the dominant currency in global foreign exchange
markets, the convention is to generally use direct quotes that have the
US dollar as the base currency and other currencies – like the
Canadian dollar, Japanese yen and Indian rupee – as the counter
currency. Exceptions to this rule are the euro and Commonwealth
currencies like the British pound, Australian dollar and New Zealand
dollar, which are typically quoted in indirect form (for example GBP 1 =
USD 1.30).
Consider the example of the Canadian dollar (C$), which we assume is
trading at 1.2500 to the US dollar. In Canada, the indirect form of this
quote would be C$1 = US$0.8000 (i.e. 1/1.2500).
Currencies are quoted in pairs, for example the EUR/USD is the euro/U.S. Dollar pair. Using this quotation, the
value of a currency is determined by its comparison to another currency.
The first currency of a currency pair is called the base currency, and the second currency is called
the quote currency. The currency pair shows how much of the quote currency is needed to purchase one
unit of the base currency.
For example, if the EUR/USD currency pair, which is the most popular pair in the forex market, is quoted as being
EUR/USD = 1.0657 and you purchase the pair; this means that for every euro you sell, you purchase (receive)
approximately USD$1.07. If you sell the currency pair, you will receive 0.9384 euros for every US$1 you sell. The
inverse of the currency quote is USD/EUR, and the corresponding price would be USD/EUR = 0.9384, meaning that
approximately €0.94 would buy 1 U.S. dollar.
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 domestic currency is the base currency, while the foreign
currency is the quote currency. An indirect quote is just the opposite: the
foreign currency is the base currency and the domestic currency is the quote
currency. For an American trader, the EUR/USD quote is an indirect one. So,
for example, a quote of 0.80 EUR/USD means that 1 EUR would cost you
$0.80 USD.
In the direct quote, a lower exchange rate implies that the domestic
currency is appreciating or becoming stronger, since the price of the
foreign currency is falling.
Conversely, for an indirect quote, a lower exchange rate implies that
the domestic currency is depreciating or becoming weaker, since it is
worth a smaller amount of foreign currency. Continuing with the
above example, if the Canadian dollar (direct) quotation now
changes to US$1 = C$1.2700, the indirect quote would be C$1 =
US$ 0.7874 = 78.74 US cents.
Cross Currency/Cross Exchange Rates
What about cross-currency rates, which express the price of one currency
in terms of a currency other than the US dollar? A trader or investors
should first ascertain which type of quotation is being used – direct or
indirect – to price the cross-rate accurately.
For example, if the Japanese yen is quoted at US$1 = JPY 100, and
US$1 = C$1.2700, what is the price of yen in Canadian dollars (both
direct and indirect quotations)?
In Canada, the indirect quotation would be: C$1 = US$0.7874 x 100 (yen
per USD) = 78.74 yen. The direct quotation would be: JPY 1 =
C$1.2700/100 = C$ 0.012.
Forward, Future and Option Markets

• Forward Contract, Forward Rate and Forward Market

• Currency Futures Contracts, Future Rates

• Currency Option Contracts, Currency Call Option and

Currency Put Option
International Markets
• International Money Market: European and Asian Money markets,
Standardizing Global Bank Regulations

• International Credit Market: Euro-credit Market, LIBOR, Syndicated

Loans

• International Bond Market: Eurobond Market and Others

• International Stock Markets