ACI/ FINANCIAL MARKETS

AND DEALING COURSE

FOREIGN EXCHANGE
2018
11/19/2020 UIBFS 1
 Bid and Offers
Bid Rate at which Market Maker will BUY the Base
currency
Offer Rate at which Market Maker will SELL the Base
currency
GBP/USD
USD/JPY
The liquidity of that The more liquid the currency, the narrower the spread
currency
The size of the deal The bigger the transaction, the wider the spread
because the dealer is taking on more risk
The time of the day Spread tends to be widest in the New York afternoon
because both Europe and Asia are closed during the
Asian lunchtime
Market Makers Always trade the BASE CURRENCY

11/19/2020 UIBFS 2
 11/19/2020
FOREIGN EXCHANGE QUOTES

• Market maker quote GBP/USD 1.5355/65

 GBP » 1st currency/ senior currency/ base currency
 USD » 2nd currency/ junior currency/ quoted/ counter currency
• An electronic deal-matching system – is a screen-based electronic matching
system such as:
• Reuters 2000/2 and Electronic Broking Services – EBS owned by ICAP
 Mine » the market user buys £ @ 1.5365
 Yours » the market user sells £ @ 1.5355
• Each market has its own conventions, concerning the acceptable size of a deal.
If a price is put into the market which is smaller than this “market amount”, it
should be qualified in the quote.
• if a dealer in USD/CHF says “I pay 21 for 50”, this would mean that he will
pay CHF1.59 21 per USD1 for a total of USD50,000,000.
UIBFS 3
 FOREIGN CURRENCY QUOTES
• Cross rates are simply any currency quoted against
another currency other than the US $
 Direct quote » USD is base currency
 Indirect quote » USD is quote currency
• Bid and offer prices quote relate to the base currency
 Long -bid transaction is dealt
 Short - offer transaction is dealt
 Long position- more of base currency
 Short position – less of base currency
 Square position – base currency is nil
11/19/2020 UIBFS 4
 Trading position
• Open position
• Square position
• Short position
• Long position
• Unrealised profit
• Realised profit
• FOREIGN EXCHANGE TRADING POSITIO
N.xlsx
11/19/2020 UIBFS 5
 Moving the price
•• Assume the rate USD/JPY124.15 and moves to USD/JPY130 explain
 
• Assume the USD gained 10% against the JPY, on 124.15 explain?
• USD/JPY (124.15 x 1.10) = 136.57
• Assume the JPY lost 10% of its value, what is your view?
 find the value of JPY1 in USD terms, i.e. the reciprocal deduct 10% of
the value and re-expressing as the value of USD1.
• USD1 = JPY 124.15
 JPY 1 =
 = .00805 x 0.9
 JPY 1 = .007245
 USD 1 =
• USD/JPY = 138.03

11/19/2020 UIBFS 6
 Foreign exchange Position
Date Currency Long Short Rate

12/10/2015 GBP/USD $4,546,500 GBP 3,000,000 1.5155

12/10/2015 USD/DEM $5,000,000 DEM 7,450,000 1.4900

12/10/2015 USD/CHF CHF 3,000,000 $2,480,363 1.2095

12/10/2015 USD/ITL $2,500,000 ITL 4,000,000,000 1600

12/10/2015 USD/JPY JPY 1,060,000,000 $10,000,000 106.00

Overall position in USD$ short $ 433,863 – monitoring eased

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 DEALER’S POSITION
• summary report of the traders’ buying and selling
activities in the foreign exchange market
 Long position means more purchases than sales of the
currency
 Short position means more sales than purchases of the
currency
 Square position means purchases and sales of currency
are equal
 Realised profit is result of square position
 Unrealised profit is as result open position end of day
mark to market

11/19/2020 UIBFS 8
 CROSS CURRENCY RATES
• any currency quoted against another
currency other than the US dollar
 GBP/EUR
 EUR/KES
 GBP/DEM
 AUD/DEM
Benefits traders not in need of US $
foreign exchange losses minimised.

11/19/2020 UIBFS 9
 CROSS CURRENCY RATES [Indirect]

• USD/KES
  113.60/70
 USD/UGX 3730/50
 Assume dealer has KES 113,700.00 and need to buy $s
 Sell KES 113,700 and buy $ at selling rate of 113.70.

 Sell $ 1,000.00 to UGX and rate applicable is buying rate

 Implies that KES 113,700 = UGX 3,730,000

 What is the value of UGX for KES?

11/19/2020 UIBFS 10
 CROSS CURRENCY RATES [Indirect]

• USD/KES
  113.60/70
 USD/UGX 3730/50
 Assume dealer has KES 113,700.00 and need to buy $s
 Buy KES 113,700 and sell $ at selling rate of 113.60.

 Sell $ 1,000.88 to UGX and rate applicable is buying rate

 .06
 Implies that KES 113,700 = UGX 3,753,301.06
 What is the value of UGX for KES?
 3.01

11/19/2020 UIBFS 11
 CROSS CURRENCY RATES [Indirect & direct]

• USD/KES
  113.24/30
 GBP/USD 1.2920/25
 Assume dealer has KES 113,300.00 and need to buy $s
 Sell KES 113,300 and buy $ at offer rate of 113.30.

 Sell $ 1,000.00 for GPB and rate applicable is offer rate 1.2925

 Implies that KES 113,300 = GPB 773.69

 What is the value of KES for £?

11/19/2020 UIBFS 12
 CROSS CURRENCY RATES [Indirect & direct]

• USD/KES
  113.24/30
 GBP/USD 1.2920/25
 Assume dealer has KES 113,300.00 and need to buy $s
 Buy KES 113,300 and sell $ at bid rate of 113.24.
 53
 Buy $ 1,000.53 gainst GPB and rate applicable is bid rate 1.2920

 Implies that KES 113,300 = GPB 774.4

 What is the value of KES for £?

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11/19/2020 UIBFS 14
 CROSS CURRENCY RATES [Indirect & direct]

• USD/KES
  113.60/70
 GBP/USD 1.2920/25
 Assume dealer has KES 113,600.00 and need to buy $s
 Sell KES 113,600 and buy $ at bid rate of 113.70.

 Sell $ 1,000.00 for GPB and rate applicable is offer rate

 Implies that KES 101,300 = GPB 688.47

 What is the value of KES for £?

11/19/2020 UIBFS 15
 CROSS CURRENCY RATES [direct]

• USD/ ZAR 7.0525/75
 
 USD/ CHF 1.7535/45
• Deriving bid, the bank will buy CHF and sell USD at bid
 Buy CHF, Sell USD at offer price of 1.7545
 Sell ZAR, buy USD at Bid price of 7.0525. the bank receives CHF
1.7545 per unit USD and pays ZAR 7.0525 per unit USD
 the bid price 7.0525 1.7545= 4.0197
• Deriving offer, the bank will sell CHF and buy ZAR at offer
 Sell CHF, buy USD at Bid price of 1.7535
 Buy ZAR, sell USD at Offer price of 7.0575. the bank pays CHF1.7535
per unit of USD and receives ZAR 7.0575 per unit of USD.
 the offer price 7.05751.7535= 4.0248
• CHF/ ZAR 4.0197/248

11/19/2020 UIBFS 16
 CROSS CURRENCY RATES [indirect & direct]
 GBP/USD 1.4462/67
 USD/ CHF 1.6688/93
• Deriving bid, the bank will buy GBP and sell CHF at bid
 Buy GBP, Sell USD at BID price of 1.4462
 Sell CHF, Buy USD at Bid price of 1.6688.
 the bank pays CHF 1.6688 per unit USD and requires USD 1.4462
per unit of GBP.
 the bid price 1.4462 x 1.6688 = 2.4134
• Deriving offer, the bank will sell GBP and buy CHF at offer
 Sell GBP, buy USD at offer price of 1.4467
 Buy CHF, sell USD at offer price of 1.6693. the bank receives CHF
1.6693 per unit USD and receives USD 1.4467 per unit of GBP. the
offer price 1.4467 x 1.6693 = 2.4150
• GBP/CHF 2.4134/50
11/19/2020 UIBFS 17
 CROSS CURRENCY RATES
• Both quotes are indirect
• Divide (÷) opposite sides making the stronger
currency base currency of the quote
• Both quotes are direct
• Divide (÷) opposite sides making the stronger
currency base currency of the quote
• One quote is direct and the other indirect
• multiply (×) the same sides of the two way price
quotes making the stronger currency base
currency of the quote
11/19/2020 UIBFS 18
 FORWARD OUTRIGHT EXCHANGE RATES

• outright purchase or sale of one currency in

exchange for another for settlement on fixed
future date
• calendar standard periods
 If end of date ending falls on the weekend, adjust the
maturity date to the last working day of the month
 If the last business day of the month is not the last
calendar day of the month due to public holiday, the last
business day will be regarded as month end

11/19/2020 UIBFS 19
 FORWARDS
Trade where a bank agrees to sell sterling to a
customer and buy deutsche marks in return
 The bank could fix the rate now based on the
current spot rate, nut that may well move in the
next 12 months. The bank however, is
committed to handover sterling in 12 months
time, but may end up receiving less Deutsche
Marks than it needs to buy sterling at the then
prevailing rates. This could lead to a foreign
exchange loss on the deutsche marks. How does
the bank hedge itself?
11/19/2020 UIBFS 20
 FORWARDS
 The FX risk on the forward sale of sterling can be offset by
a purchase of sterling now. This ensures that the bank has
the sterling available and has fixed the exchange rate with
which to buy them. But what should they do with the
sterling as it is not required for the 12 months?
 Firstly, the resulting sterling must be put on deposit in the
money markets for 12 months, yielding an interest income.
 Secondly, with what do we fund the purchase of the
sterling? The bank must borrow deutsche marks from the
money market for 12 months, to buy the sterling spot. The
deutsche marks will be repaid by the customer’s funds in 12
months time. There will be a funding cost for this position
or transaction.
11/19/2020 UIBFS 21
 1. SPOT
[1-4] are Spot MARKET
transactions £
£ DEM

2. BANK
Buys GBP DEM
£ Sells DEM spot

3. Deposit 4. Borrow
GBP for 12 DEM for 12
months months
£
5. Customer
DEM
[5] are Forward Buys GBP
transaction Sells DEM
11/19/2020 UIBFS 22
 Forward points
• forward points is the difference between the
outright forward rate and the current spot rate.
• given the following information calculate the
forward points:
 USD/ZAR 6.75/80
 USD 6 month (182 days) interest = 1.5%
 ZAR 6 month (182 days) interest rate 9%
 USD 360day and ZAR 365day convention.
 Use the borrowing method used earlier
11/19/2020 UIBFS 23
 Forward points
•  

 When the left hand side (bid) of the price is lower

than the right hand side (offer) the points are
positive. Add to the spot rate to get the forward rate
 When the left hand side (bid) of the price is greater
than the right hand side (offer) the points are
negative. Subtract from the spot rate to get the
forward rate

11/19/2020 UIBFS 24
 Forward points
•  

 When the left hand side (bid) of the price is lower

than the right hand side (offer) the points are
positive. Add to the spot rate to get the forward rate
 When the left hand side (bid) of the price is greater
than the right hand side (offer) the points are
negative. Subtract from the spot rate to get the
forward rate

11/19/2020 UIBFS 25
 PREMIUM/ DISCOUNT
• Spot rate: GBP/USD 1.5235 1.5245
• 3 months points 30 25
• Forward outright 1.5205 1.5220
 Us$ is at premium to sterling (cable)
 Forward prices will always exhibit a larger bid-offer
spread than spot prices
 When base currency is at premium, the forward points
are added and vice versa
 High/low subtract the forward points (145-135)
 Low/high add the forward points (20-23)

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 PREMIUM/ DISCOUNT
 The swap rate or forward rate reflects the interest rate
differential between the two currencies. The change in
inflation rate will increase or decrease the number of
forward points (domestic rate increase or decrease)
 Negative points implies the base currency interest rates
is higher than the quote currency, hence base currency is
at discount and forward rate will be lower than the
current spot rate
 positive points implies the base currency interest rates is
lower than the quote currency, hence base currency is at
premium and forward rate will be greater than the
current spot rate
11/19/2020 UIBFS 27
 Forward differentials
•  
i. Borrow ZAR 100 at rate of A%:
ii. Sell ZAR 100 for USD at the spot rate to give USD
iii. Invest USD at B%:
iv. Sell forward (iii) above at forward rate
v. (i) and (iv)

11/19/2020 UIBFS 28
 Forward differentials
•   Forward differentials= (Forward outright – spot )
i.

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11/19/2020 UIBFS 30
 Barclays Bank PLC London
1715 BARCLAYS BANK PLC LONDON 283 0909 TX 887841 BAST
SPOT 1 MTH 2MTHS 3MTHS 6MTHS 12MTHS

STG 1.5392/02 13/11 24/21 34/31 68/63 153/143

DEM 2.2321/52 55/48 108.99 157/147 304/289 588/558

CHF 1.8168/96 72.66 143/136 209/200 394/378 753/722

NLG 2.4996/29 65/59 128/119 189/179 364/347 691/661

FRF 7.6590/718 131/113 252/227 339/308 622/566 1219/1124

JPY 160.50/77 77/72 152/145 224/217 428/417 808/790

ITL 2375.4/9.4 67/82 147/168 223/248 416/463 754/832

BEF 45.88/98 13/9 24/19 34/29 65/55 127/108

ESP 187/96/25 37/47 79/93 118/135 220/243 399/444

XEU 1.2099/15 16/13 31/26 44/39 87/77 170/155
SOURCS: Reuters (courtesy Barclays Bank plc)

11/19/2020 UIBFS 31
 PREMIUM/ DISCOUNT
Premium is when the swap points are
positive » offer rate is higher than the bid
rate
Discount the swap points are in negative »
offer rate is lower than the bid rate

11/19/2020 UIBFS 32
 Value dates
 When calculating forwards dates with value date
shorter than spot, reverse the swap points and proceed
exactly as for a longer dated transaction.
Spot USD/DEM 1.4505 - 10

Overnight swap 1- ¾

Tom – next swap ½-¼ 1.4505 - 1.4510

+¼ +½
1.450525 1.45105

1- week swap 7 -5

11/19/2020 UIBFS 33
 CROSS CURRENCY RATES [direct]

• USD/DEM
  1.5337 – 1.5342
 USD/ ITL 1535 – 1536
 client sells ITL and buys DEM
 client buys ITL and Sells DEM
 DEM/ITL 1000.50 – 1001.52

11/19/2020 UIBFS 34
 CROSS CURRENCY RATES [Indirect]

• GBP/USD
  1.5400 – 1.5405
 AUD/USD 0.7914 – 0.7919
 bank buys AUD and Sells GBP
 bank sells AUD and buys GBP
 GBP/AUD 1.9447 – 1.9465

11/19/2020 UIBFS 35