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5 - Foreign Exchange Markets (Transactions in FX Market (Swap Transactions…
5 - Foreign Exchange Markets
Foreign exchange
- money of foreign country
Foreign exchange transaction
- agreement between a buyer and seller that a fixed amount of one currency will be delivered for some other currency
Functions of FX market:
1) transfer of purchasing power
2) source of credit
3) minimize FX risk
One of biggest changes in past decade:
shift from two-tier market (interbank or whosale market, and the client or retail market) to a single-tier market
Electronic platforms and the development of sophisticated trading algorithms have facilitated market access by traders of all kinds
Liquidity Seekers
- trading currencies for commercial purposes
Profit Seekers
- trading for profit
categories of institutional participants:
1)bank and non-bank FX dealers
2) individuals and firms conducting commercial or investment transactions
3) speculators and arbitragers
4) central banks and treasuries
5) FX brokers
Geographically the fx market spans the globe, with prices moving and currencies traded somewhere every hour of every business day
Transactions in FX Market
Spot Transactions
- purchase of FX with delivery and pmt between banks taking place normally on the second following business day
Outright Forward Transactions
- requires delivery at a future value date of a specified amount of one currency for a specified amount of another currency.
Pmts is on the second business day after the even-month anniversary of the trade
Swap Transactions
Spot Against Forward
- exchange currencies today but sometime in the future will sell it back
Forward Forward
- Buy in the future and sell it further in the future
NDF - Nondeliverable Forwards
- beegan trading in the 90s; forward traded in foreign currency but settled in US Dollar and outside that country
Size
Instrument
- most widely traded - swap is the largest; spot is number 2
Market
- largest fx market is London - about 41%of the global exchange in the world; then US; then Singapore, Hong Kong, Tokyo
Currency (page 128)
- the dollar is the most traded - 86% if global transactions; US, Euro, Yen, Pound - the most traded currencies
European terms quotations are the foreign currency price of US dollar. American terms quotations are the dollar price of a FX
Direct Quotations
- the price
(home currency)
of a foreign currency
(the unit)
in domestic currency units
Indirect Quotations
- the price of the domestic currency in foreign currency units
Direct and indirect are not synonyms for American and European terms, because the home currency will change depending on who is doing the calculation, while European terms are always the foreign currency price of a dollar
Bid
- the price in one currency at which a dealer will buy another currency
Ask
- the price at which a dealer will sell the other currency
Bid and Ask Spread
- may be quite large for currencies that are traded infrequently, in small volumes, or both
Profit margin that bank and non bank dealer make;
Volume, volatility of currency, liquidity, competition;
Price and the cost
Cross Rates
- exchange rate between two currencies, calculated from their common relationships with a third currency. When cross rates differ from the direct rates between two currencies, intermarket arbitrage is possible
Create a triangle and get a cheaper rate to buy a different currency;
Bid ask price has to be narrow