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The Spot market

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Spot Rate Quotations

Cross-Exchange Rate Quotations

Direct quotation: the U.S. dollar equivalent

Indirect Quotation: the price of a U.S. dollar in the foreign currency

An exchange rate between a currency pair where neither
currency is the U.S. dollar.

Ignore the transaction costs of trading temporarily while develop the concept of a cross-rate.

Can be calculated from the U.S. dollar exchange rates for the two
currencies: European or American term quotations.

Alternative Expressions for
the Cross-Exchange Rate

The Bid-Ask Spread

Spot FX Trading

The Cross-Rate Trading Desk: In dealer jargon, a nondollar trade such as this is referred to as a currency against currency trade.

Triangular Arbitrage

Spot Foreign Exchange
Market Microstructure

The ask price: the amount the dealer wants you to pay for the thing.

The bid-ask spread: the difference between the bid and ask prices.

The bid price: the price a dealer is willing you to pay for something.

The bid-ask spread represents the dealer’s expected profit.

The stakes are high.

The “long term” is about 10 minutes.

A bank trading room is a noisy, active place.

In the interbank market, the standard size trade is about U.S. $10 million.

The process of trading out of the U.S. dollar into a second currency, then trading it for a third currency, which is in turn traded for U.S. dollars.

The purpose is to earn an arbitrage profit via trading from the second to the third currency when the direct exchange rate between the two is not inalignment with the cross-exchange rate.

Bid-Ask spreads in the spot FX market

Private information is an important determinant of spot exchange rates.

Market Microstructure refers to the mechanics of how a marketplace operates.

◦ increase with FX exchange rate volatility

decrease with dealer competition.