Welcome to the Session

on
Foreign Exchange Market
Operations: Spot, Cross and Forward
Transactions
Foreign Exchange Market
Foreign exchange is the trading of currencies.
The foreign exchange market is not a single place
like the NY Stock Exchange (NYSE). It is a widely
decentralized 24-hour-a-day market, made up of
banks and traders communicating electronically.
The retail market is between individuals,
nonfinancial companies, nonbank financial
institutions, and other customers of banks.
The wholesale or interbank market is the trading
between banks. This accounts for 60% or more of
the total trading.

Scope of the Market
About half the daily foreign exchange
trading is done between banks in London
and New York.
Most of the trading involves U.S. currency.
Sometimes the intent is to trade one foreign
currency for another, and the U.S. currency
is only involved as an intermediate step.
When this is done, the dollar is called a
vehicle currency.
Size of the Market
A. Largest in the world
2004: US$1.9 trillion daily
or
US$475 trillion a year

Size of the Market
Market Centers (2004):
#1: London = $753 billion daily

#2: New York= $461 billion daily

#3: Tokyo = $199 billion daily

Exchange Rate : Some Basics
The exchange rate is the price of one countrys money in
terms of another countrys money.
The spot exchange rate is the price for immediate
exchange. (Immediate usually means within two working
days.) This amounts to about 33% of all trading.
The forward exchange rate is the price for exchange to
take place at some specific time in the future, often 30, 90,
180 days. This amounts to about 11% of all trading.
A swap is a package trade that includes both a spot
exchange of two currencies and a contract to the reverse
forward exchange a short time later. This is useful when the
parties to the swap have only a short-term need for the
currency. This amounts to about 56% of all trading.

Examples of Currencies
Country Currency Symbol ISO Code
US Dollar $ USD
UK Pound GBP
Canada Dollar C$ CAD
Mexico Peso Ps MXP
Japan Yen JPY
EU Euro EUR
Exchange Rate : Some Basics
The exchange rate can be given as the price
of the foreign currency in terms of the
domestic currencythis is the usual way,
and the way well use in this session.
Or as the price of the domestic currency in
terms of the foreign currency.
Exchange Rate Quotation
Quoted Currency means the currency that
is variable in an exchange rate quotation.
Base Currency means the currency that is
fixed.
Thus if 1 = Tk.130.00, sterling is the base
currency and the BDT is the quoted
currency.
Exchange Rate Quotation
In Direct Quotation Base Currency is the
Foreign Currency and the Quoted Currency is
the Domestic Currency.($1= Tk.69.50)

In Indirect Quotation Base Currency is the
Domestic Currency and the Quoted Currency
is the Foreign Currency. (Tk.1= $0.0144)
Exchange Rate Quotation
In American Terms Base Currency is any
Currency other than USD and the Quoted
Currency is USD (Tk.1= $0.0144).

In European Terms Base Currency is the USD
and the Quoted Currency is any Currency
other than USD ($1= Tk.69.50).
Reciprocal Quotations
Currencies can be quoted in terms of the
number of units of A per unit of B or,
alternatively, the number of units of B per
unit of A. The two rates represent equal value
and are reciprocals of each other. To convert
from one method to the other, one simply
divides the number 1 by the rate.

Reciprocal Quotations

USD 1/Tk.69.50 =

= 0.0143 BDT/USD
1

69.50
BDT/USD
Example: Spot Market Transaction
1. Bangladeshi firm buys a U.S. product from a U.S.
firm, which requires payment in U.S. dollars ($).
2. The Bangladeshi firm contacts its bank, gets a
quote on the dollar-taka exchange rate, and
approves it.
3. The Bangladeshi firm instructs its bank to take taka
from its checking account, convert these to dollars,
and transfer the amount to the U.S. producer.
4. The Bangladeshi bank instructs its correspondent
bank in New York to take U.S. dollars from its
account and pay the U.S. producer by transferring
them to the producers bank.
Spot Market Transaction

USD $ 1= Tk.69.10/15

In the above quotation, market maker is
willing to buy 1 U.S. dollar at Tk. 69.10
and sell U.S. dollar at Tk. 69.15.
Spot Market Transaction
Transactions Costs
1. Bid-Ask Spread
used to calculate the fee
charged by the bank

Bid = the price at which the bank is willing to
buy
Ask = the price it will sell the currency

Percent Spread Formula (PS):

100 x
Ask
Bid Ask
PS

=
Quoting Spot Rate to Customers
The basic principle
1. Ascertain the going exchange rate in the
wholesale market (inter-bank market)
2. Load a margin and make a customer quote
Example
Market Rate: USD1= Tk. 69.50/60
Required margin: 0.10 Tk.
So, the rate will be USD1= Tk.69.40/69.70
Cross Rates

A cross-rate may be defined as an
exchange rate that is calculated from
two other rates.
In practice, cross-rate is the exchange
rate between 2 non - US$ currencies.


Calculating Cross Rates

If both currencies involved in the cross
transaction are quoted in the same
form(American or European) divide the
spot rate of one currency by the the spot
rate of the other currency.


Calculating Cross Rate: Example

$/Tk. : 69.35
$/ : 0.7828
Then, / Tk. : 69.35/.7828
= Tk.88.5922
$
$ $ $ e
=
e

Tk Tk
Tk
e
=
Or / Tk.
Calculating Cross Rates

If one currency is quoted in one form
and the other currency is quoted in
another form, multiply the spot rate.
Calculating Cross Rate: Example

$/Tk. : 69.35
/ $ : 1.2774
Then, / Tk. : 69.35 1.2774
= Tk.88.5876
$
$ e

Tk
Tk
e
Calculating Cross Rates: Both European

USD/EUR 0.7828 - 0.7848
Divide by
USD/GBP 0.5246 - 0.5266
GBP/ EUR = 1.4865-1.4959
Calculating Cross Rates: Both American

EUR/USD 1.2742 1.2774
Divide by
GBP/USD 1.9042 1.9062
EUR/ GBP = 0.6684-0.6708
Calculating Cross Rates: One American-
One European
EUR/USD 1.2742 1.2774
Multiply by
USD / GBP 0.5246 0.5251
EUR/ GBP = 0.6684-0.6708
Forward Rates

It is an ER for the transaction to be happened
at some future date , but agreement for the
transaction is to be done today. Forward rate
is quoted either at premium(+) or at discount
rate(-) over spot rate. In case of direct
quotation, premium will be added to and
discount will be subtracted from spot rate. The
reverse is for indirect quotation.
Quotation of Forward Rates

Forward at Premium (pm)
Forward at Discount (dis)
Forward at par meaning the Forward
Rate at a Parity with the Spot Rate.
Premium and Discount

The quoted currency is said to stand at a
premium in the forward market if it is more
expensive in the future than it is now in terms
of the base currency. Conversely, the base
currency may be said to stand at a discount
relative to the quoted currency.
Forward/SWAP Points
SWAP Points (Low - High)
USD/EUR 1 Month SWAP 30/40
SWAP Points (High -Low)
USD/EUR 1 Month SWAP 40/30

Forward/SWAP Points
SWAP Points (Low - High)
Forward Rate at Premium for the base
currency
SWAP Points (High -Low)
Forward Rate at Discount for the base
currency
Treatment of Forward Margin
High/Low = Subtract
Low/High = Add

Low High = Add

High Low = Subtract
Basis for Forward Rate
Forward Points Represent the interest Rate
Differential between the Two Currencies
involved in the Transaction
Method
Spot Rate Interest Rate Differential Period Annualized

=


360 100
. .

TimeinDays Diff INt Spot

Calculating Forward Rate
Spot Rate: GBP/USD = 1.90
Interest Rate in USA : 8%
Interest Rate in UK: 16%



Calculating Forward Rate

Forward Points =
= 0.032
So, 90 days forward rate will be
GBP/USD= 1.868
(

360 100
90 8 90 . 1
Calculating Forward Rate
The currency with relatively higher
interest rate will be cheaper in the forward
market and the currency with relatively
lower interest rate will be expensive in the
forward market.


Calculating Interest Rate
Differential from Forward Points
Interest Diff.=

FP- Forward Points
RB-Rate Basis
SR-Spot Rate

Term SR
RB FP

100
Calculating Forward Rate
CALCULATING THE FORWARD PREMIUM
OR DISCOUNT

= F-S x 12 x 100
S n
where F = the forward rate of exchange
S = the spot rate of exchange
n = the number of months in the
forward contract