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时间：2023-03-23
28/02/2023 CRICOS code 00025B
FINM 7406
Lecture 2:
The Foreign Exchange Market
Instructor: Dr Khoa Hoang
Reading: Eun Resnick Chapter 5
28/02/2023 CRICOS code 00025B 2
Characteristics of FX Markets
Largest of all financial markets with average daily turnover of over
$1.8 Trillion! ($360 trillion/year) in 2004. $4 Trillion in 2010. $5.3
Trillion in 2013. $5.07 Trillion in 2016. $6.59 Trillion in 2019.
62% of all foreign exchange transactions involves cross-border
counterparties
Only ≈11% of daily spot transactions involve non-financial customers.
London is the largest FX market.
US dollar involved in 89% of all transactions.
Australian $ was the 5th most traded currency in 2019.
Source: BIS (Bank for International Settlements), April 2019.
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Currency Distribution of Global Foreign Exchange Market Turnover
(percentage shares of average daily turnover in April)
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Source: Bank for International Settlements, “Triennial Central Bank Survey of Foreign Exchange ,” April 2019, www.bis.org.
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Characteristics of FX Markets
Not an organised exchange
No fixed opening hours, centralised clearing mechanism,
standardized contracts, etc.
Loosely organised in two tiers
RETAIL: where individuals buy and sell foreign exchange.
WHOLESALE: informal network of approx. 2000 dealer institutions,
banks and currency brokers. Linked through SWIFT with over 10,000
financial institutions in more than 200 countries(Society for Worldwide
Interbank Financial Telecommunication).
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Characteristics of the Wholesale Market
Participants in the market:
International banks
Bank customers engaged in commercial and Investment transactions
Non-bank dealers
FX brokers
Central banks
Settlement of transactions – No real money changes hands (e.g. CLS
Bank)
Extremely deep and liquid market
A 24-hour market
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Geographic Extent of the Market
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0
5,000
10,000
15,000
20,000
25,000
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24
Tokyo
opens
Asia
closing
10 AM
In Tokyo
Afternoon
in America
London
closing
6 pm
In NY
Americas
open
Europe
opening
Lunch
In Tokyo
Measuring FOREX Market Activity: Average Electronic Conversations Per Hour
Source: Eiteman et al (Figure 5.1)
28/02/2023 CRICOS code 00025B 7
Types of Activities
Hedging
It allows the firm to transfer exchange rate risk inherent in foreign
currency transactions
Speculation
An activity that leaves one open to exchange rate fluctuations and
one aims to make a profit
Arbitrage
take advantage of inconsistent prices to make risk free profits.
These profits are unlikely to last long.
Spatial (or Locational) Arbitrage
Triangular Arbitrage
Covered Interest Arbitrage – Lecture 3
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Foreign Exchange Rates and Quotations
A foreign exchange rate is the price of one currency
expressed in terms of another currency.
E.g: AUD 2.3337 – 2.3901/GBP
A foreign exchange quotation (or quote) is a statement of
willingness to buy or sell at an announced rate.
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A Little Terminology
Spot Rate: The exchange rate at which trades are executed immediately in the interbank
market. About a third of all FX trading is done in this market.
Value Date for a spot transaction is the date on which parties actually receive the funds
they have purchased — usually occurs two business days after the deal is made.
Foreign currency dealers provide two quotes:
Bid Price: Price at which the dealer is willing to buy foreign currency from you
Ask Price: Price at which the dealer is willing to sell foreign currency to you
It is always the case that the Ask Price > Bid Price. The difference is the Bid-Ask spread.
The less traded and more volatile a currency, the greater is the spread.
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Spot Market Convention
Direct Quote: Home currency per unit of Foreign currency (FC) - e.g.
AUD/€ quote is 1.6003 – 1.6499
Indirect Quote: Foreign currency per unit of Home currency – e.g.
€/AUD quote is 0.6061 – 0.6249
Note that in all cases, the reciprocal of a direct quote is an indirect quote.
Also, you might encounter an exchange rate quotation in American terms
(US$/FC) or European terms (FC/US$).
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AUD
EUREUR
AUD 1
=
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Bid – Ask Prices
Consider the DIRECT quote:
Bid Price (Dealer buys) -- Ask Price (Dealer sells)
AUD 2.3337 – 2.3901/GBP
[AUD/GBP]bid = 2.3337 – the rate at which the bank will buy
GBP in exchange for AUD.
[AUD/GBP]ask = 2.3901 – the rate at which the bank will sell
GBP for AUD.
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Bid and Ask Quotations
Bid and Ask prices mixed with alternative quotations methods
can lead to confusion. Try to remember:
The dealer buys the denominator currency at the BID
(client buys the numerator currency at the bid)
The dealer sells the denominator currency at the ASK
(client sells the numerator currency at the ask)
AUD 2.3337 – 2.3901/GBP
When all else fails, remember that the commercial client always,
ALWAYS gets the worse end of the deal!!!
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Another Example
American terms: (e.g., British pound)
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Bid Offer (Ask)
$/£ 1.4482 1.4484
Bid: Dealer buys £ for $ at the Bid,
Client sells £ for $
(i.e., dealer will buy £1,000,000 for $1,448,200)
Ask: Dealer sells £ for $ at the Ask,
Client buys £ for $
(i.e., dealer will sell £1,000,000 for $1,448,400)
(Dealer buys) (Dealer sells)
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Bid/Ask Example
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Bid
1.4482
$/£
Ask
1.4484
Bid
0.6904
£/$
Ask
0.6905
A direct bid is the reciprocal
of an indirect ask.
A direct ask is the reciprocal
of an indirect bid.
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Bid/Ask Example
FINM7406
Bid
1.4482
$/£ £/$
Ask
0.6905
Dealer is
willing to buy
£1 for
$1.4482
Dealer is
willing to sell
$1 for
£0.6905
When the dealer is
willing to buy (bid) £1
for $1.4482, he is
implicitly also willing to
sell (offer) $1 for
£0.6905.
£1
$1.4482= 0.6905£/$
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Bid/Ask Example
FINM7406
£1
$1.4484 = 0.6904£/$
When the dealer is
willing to sell (offer) £1
for $1.4484, he is
implicitly also willing to
buy (bid) $1 for
£0.6904.
$/£
Ask
1.4484
Bid
0.6904
£/$
Dealer is
willing to sell
£1 for
$1.4484
Dealer is
willing to buy
$1 for
£0.6904
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Bid – Ask Spread
Banks act as market makers and realise their profits from the
spread
Consider the DIRECT quote of $ 1.4482 – 1.4484/£
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( ) point basis 38.1100
4484.1
4482.14484.1% =×−=spread
( )
Ask
BidAskspread −=%
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Cross Rates
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Source: Bank for International Settlements, “Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity in 2019” www.bis.org.
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Cross Rates
Many currency pairs are only inactively traded, so their exchange rate is
determined through their relationship to a widely traded third currency.
For example, an Australian importer needs Danish currency to pay for
purchases in Copenhagen.
The Australian dollar (symbol A$) is not widely quoted against the Danish
kroner (symbol DKr).
However, both currencies are quoted against the U.S. dollar.
Assume the following quotes:
Australian dollar A$1.5431/US$
Danish kroner DKr7.0575/US$
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Cross Rates (Mid Rate)
The Australian importer can buy one U.S. dollar for A$1.5431
and with that one U.S. dollar buy DKr7.0575.
The cross-rate calculation would be:
FINM7406
A$/DKr 0.2186
US$DKr7.0575/
S$A$1.5431/U
dollar .kroner/U.SDanish
dollar .dollar/U.S Australian
==
The cross rate could also be calculated as the reciprocal.
Australian dollar A$1.5431/US$
Danish kroner DKr7.0575/US$
28/02/2023 CRICOS code 00025B 21
Cross Rates (Bid – Ask Rate)
Bid (Banks buy) Ask (Banks sell)
A$1.5455 – A$1.7158/USD
DKr7.0680 – DKr8.1280/USD
The cross-rate calculation for A$/Dkr would be:
FINM7406
A$/DKr 0.1901
USDDKr8.1280/
/USDA$1.5455
dollar .kroner/U.SDanish
dollar .dollar/U.S Australian
==
For A$/Dkr
Bid Rate for Denominator Currency means banks buy Dkr and Sell A$
Or = banks sell USD wrt Dkr and Buy USD wrt A$
A$/DKr 0.2428
USDDKr7.0680/
/USDA$1.7158
dollar .kroner/U.SDanish
dollar .dollar/U.S Australian
==
Ask Rate (A$/Dkr) means banks sell Dkr and Buy A$
Or = banks buy USD wrt Dkr and Sell USD wrt A$
28/02/2023 CRICOS code 00025B 22
Triangular Arbitrage
Cross rates can be used to check on opportunities for intermarket
arbitrage. Suppose the following exchange rates are available:
Barclays Bank: Australian dollars per pound sterling: A$1.8410/£
Westpac Bank: Australian dollars per Euro: A$1.2223/€
Deutsche Bank: Euro per pound sterling: €1.5100/£
The synthetic cross rate between Euro
and Pound and is:
A$1.8410/£
A$1.2223/€
Strategy: Buy Low Sell High = Buy € and Sell £
FINM7406
You get more
Euro from and
sell Pound to
Deutsche Bank
= € 1.5062/ £
£ Overvalued
28/02/2023 CRICOS code 00025B 23
Triangular Arbitrage - An Example (Figure 5.5a)
FINM7406
Barclays Bank: Australian dollars per pound sterling: A$1.8410/£
Westpac Bank: Australian dollars per Euro: A$1.2223/€
Deutsche Bank: Euro per pound sterling: €1.5100/£
Westpac,
Sydney,
AUD
Barclays,
London
£
*€1.5100/£
Deutsche,
Frankfurt
€
End with AUD1,002,538 Start with AUD1,000,000
Risk-Free Profit AUD2,538
£543,183€820,206
Strategy:
Buy € and
Sell £
28/02/2023 CRICOS code 00025B 24
Multiple Choice Quiz
Barclays Bank: Australian dollars per pound: A$1.8410/£
Westpac Bank: Australian dollars per Euro: A$1.2223/€
Deutsche Bank: Euro per pound sterling: €1.5100/£
If I can change the quoted rate of €1.5100/£ to another number, so that there would be
no more risk-free profit, what would that number be?
a) €1.4700/£
b) €1.5100/£
c) €1.5300/£
d) €1.5062/£
e) I don’t know the answer
24
FINM7406
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Try this one on your own
Find the arbitrage opportunity here if you start with $1,000,000:
Citibank: US$ per euro $1.2223/€
Barclays Bank: US$ per pound sterling $1.8410/£
Dresdner Bank: Euros per pound sterling €1.5062/£
Hint: You should get a profit of $0. Prove it!
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28/02/2023 CRICOS code 00025B 26
Triangular Arbitrage - An Example (Figure 5.5a)
FINM7406
Barclays Bank: Australian dollars per pound sterling: A$1.8410/£
Westpac Bank: Australian dollars per Euro: A$1.2223/€
Deutsche Bank: Euro per pound sterling: €1.51062/£
A$1.8410/£
A$1.2223/ €
Westpac,
Sydney,
AUD
Barclays,
London
£
*€1.5062/£
Deutsche,
Frankfurt
€
End with AUD1,000,000 Start with AUD1,000,000
£543,183€818,142
= € 1.5062/ £ Synthetic Cross Rate
A$1.8410/£
A$1.2223/€
X
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Forward Contracts
Forward transactions require delivery at a future date of a
specified amount of one currency for a specified amount of
another currency.
This is a rate that is agreed upon today, but settled further into
the future.
Forward contracts are traded on the inter-bank market. They
can be tailored for
contract sizes
currency
delivery dates
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Ways to Express Forward Rates
There are three ways to express
forward rates:
• Outright quotes (either direct or indirect)
• Via points to be added or subtracted
from spot rate
• As an annualized percentage forward premium or discount
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(1st way) Outright Quotes
Forward: If the value date is much longer than 2 days, like 30, 90 or more
days
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$/£ £/$
$/FC FC/$
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(1st way cont) Spot vs. Forward Exchange Rates
Currencies which are more (less) expensive to buy forward are at a
premium (discount).
For the denominator currency, Forward > Spot implies
a premium of foreign currency forward.
e.g., S = 0.9077 $/SF, F6 Months = 0.9129 $/SF
The forward Swiss franc is more expensive to buy. Therefore, the
forward Swiss franc is trading at a
premium to the spot Swiss franc (relative to the dollar).
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(2nd way) Forward Quotes – Swap Rates
Among themselves, foreign exchange traders usually quote
forward rates in terms of points, also referred to as “swap rates”
A point is the last digit of a quotation
A point is equal to 0.0001 of most currencies.
Some currencies, such as the Japanese yen, are quoted only to
two decimal places (0.01).
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Forward Quotes – Swap Rates
A forward quotation expressed in points is not a foreign
exchange rate as such.
Rather, it is the difference between the forward rate and the spot
rate.
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European Terms, Sfr/$
Bid Offer
Spot 1.5625 1.5635
Points Quotations:
One month forward 58-56
Three months forward 175-169
Six months forward 342-334
If Bid Pts > Ask Pts
forward discount
Subtract from spot
28/02/2023 CRICOS code 00025B 33
Forward Quotes – Swap Rates
When the Bid Points > Ask Points, you subtract the points
from the spot rate to get the outright forward quote:
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European Terms, Sfr/$
Bid Ask
F1 mo: 1.5625 − 0.0058 = 1.5567 1.5635 − 0.0056 = 1.5579
F3 mo: 1.5625 − 0.0175 = 1.5450 1.5635 − 0.0169 = 1.5466
F6 mo: 1.5625 − 0.0342 = 1.5283 1.5635 − 0.0334 = 1.5301
These are the outright
forward quotes
28/02/2023 CRICOS code 00025B 34
Forward Quotes – Swap Rates
On the other hand, if the Bid Points < Ask Points, there is a
forward premium and you add the points to the spot rate to get
the outright forward quote:
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American Terms, $/Sfr
Bid Offer
Spot 0.6396 0.6400
Points Quotations:
One month forward 23-24
Three months forward 70-72
Six months forward 140-143
If Bid Pts < Ask Pts
Forward Premium
Add to spot
28/02/2023 CRICOS code 00025B 35
Forward Quotes – Swap Rates
If the Bid Points < Ask Points, you add the points to the spot
rate to get the outright forward quote:
FINM7406
American Terms, $/Sfr
Bid Ask
F1 mo: 0.6396 + 0.0023 = 0.6419 0.6400 + 0.0024 = 0.6424
F3 mo: 0.6396 + 0.0070 = 0.6466 0.6400 + 0.0072 = 0.6472
F6 mo: 0.6396 + 0.0140 = 0.6536 0.6400 + 0.0143 = 0.6543
These are the outright
forward quotes
28/02/2023 CRICOS code 00025B 36
Foreign Exchange Rates and Quotations
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Eiteman (Page 145)
Outright Quotation
Means
0.09
Means
0.0004
What is the ask price for the 5 yrs forward rate between Yen/AUD?
28/02/2023 CRICOS code 00025B 37
3rd way: Annualized Percentage Forward Premium/Discount
Forward premium (discount) exists when a currency purchases
more (less) of the 2nd currency in the future than it does
presently.
Note:
p > (<) 0 is the annualised premium (discount) of the denominator currency
N – maturity of the forward contract (or number of days forward)
FINM7406
×
−
=
NSpot
SpotForwardp 360
28/02/2023 CRICOS code 00025B 38
3rd way: Annualized Percentage Forward Premium/Discount
(cont)
For exchange rate: USD/AUD
If F > S then the currency is trading at a premium
E.g. One AUD buys more USD in the forward market than in the spot market
If ascending between bid/offer (i.e., 23 -24 one-month swap points) then
forward price will be higher than the current spot price
If F < S then the currency is trading at a discount
E.g. One AUD buys less USD in the forward market than in the spot market
If descending between bid/offer (i.e., 58 - 56 one-month swap points) then
forward price will be lower than the current spot price
If F = S then market is relatively flat
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Forward Premium/Discount – An Example
Euro quotes from The Financial Times:
FINM7406
Spot = 0.8772 $/€
F30 = 0.8785 $/€
F90 = 0.8806 $/€
F360 = 0.8891 $/€
Note that the Euro is more expensive in
the forward market
The forward Euro is at a premium
tSpot
SpotForward
ft
360
×
−
=
%8.1
30
360
8772.0
8772.08785.0
30
=×
−
=Eurof
%6.1
90
360
8772.0
8772.08806.0Euro
90f =×
−
=
%4.1
360
360
8772.0
8772.08891.0
360
=×
−
=Eurof
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Measuring a Change in the Spot Exchange Rates
The percentage appreciation/depreciation (R) of the
denominator currency from t-1 to t equals:
FINM7406
t-1,t
-1t
-1tt
Spot
SpotSpot R=−
t-1,t
-1t
t
Spot
Spot R+=1
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An Example
The Australian dollar was quoted against USD.
• At t-1 : A$1.8445/$
• At t : A$1.335/$.
What is the appreciation/depreciation of the $ (USD)?
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An Example
Thus, the appreciation/depreciation of the $, relative to the A$
from t-1 to t is:
Then, what is the appreciation/depreciation of the A$ relative to
$? By how much (%)?
FINM7406
1
1,
1
A$1.335/$ $1.8445 27.6%
$1.8445
t t
t t
t
S S A /$R
S A /$
−
−
−
− −
= = = −
Thus, the U.S.$ has depreciated
relative to the A$ by 27.62%
28/02/2023 CRICOS code 00025B 43
An Example
To calculate the appreciation/depreciation of the Australian
dollar, relative to the US dollar, we want the denominator
currency to be the A$:
At t-1 : A$1.8445/$ = $0.5422/A$
At t : A$1.335/$ = $0.7491/A$
FINM7406
1
1,
1
$0.7491 $0.5422 / $ 38.2%
$0.5422 / $
t t
t t
t
S S AR
S A
−
−
−
− −
= = =
Thus, the A$ has appreciated
relative to the USD by 38.2%
28/02/2023 CRICOS code 00025B 44
$ depreciation, A$ appreciation not equal
In general, the percentage appreciation in one currency is not equal to the
percentage depreciation in the other currency. Instead…
1+R$0,1= 1/(1+RA$0,1) or 1+RA$0,1= 1/(1+R$0,1)
For previous example:
1+RA$0,1 = 1/(1+RUS$0,1)
1+RA$0,1 =1/(1-0.2762)
RA$0,1 = 38.2%
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$ 1
0,1 $
10 0,1
0
( $ / $) 1 11 ($ / $)( $ / $) 1
($ / $)
A
S AR S AS A R
S A
+ = = =
+
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Additional Problem
• On July 2, 1997, the Thai Baht fell 17% against the U.S.$. By how much
has the $ appreciated against the Baht?
FINM7406
1 1 1
0,1
0 0 0
1 1
0 0
1 ( .17) 0.83
$ /1 0.83
$ /
/ $ 1/ 0.83 1.2048
/ $
,20.48%
S BahtR
S Baht
Baht
Baht
Thus
+ − =
+ = = =
= =
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Glossary of Terms
Spot rate – The current market price of one currency in terms of another.
Direct quote – domestic currency per unit of foreign currency (AUD/CHF –
Swiss franc)
Indirect quote – foreign currency per unit of domestic currency.
American terms – Direct quote from the perspective of the US dollar.
European terms – Indirect quote from the perspective of the US dollar.
Bid (Ask) rate – Rate at which the bank is willing to buy (sell) a currency.
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Glossary of Terms (cont.)
Arbitrage – The ability to make riskless profits by purchasing a commodity
where it is cheap and simultaneously selling it where it trades at a higher
price.
Cross rate – An exchange rate that does not involve the domestic currency.
Forward contract – It is contract to buy or sell a specific amount of a
commodity at a specific price and at a specific time in the future.
Forward premium – When one currency purchases more of a 2nd currency
in the future, than it does today.
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28/02/2023 CRICOS code 00025B
Thank you
FINM 7406
Lecture 2:
The Foreign Exchange Market
Instructor: Dr Khoa Hoang
Reading: Eun Resnick Chapter 5
28/02/2023 CRICOS code 00025B 2
Characteristics of FX Markets
Largest of all financial markets with average daily turnover of over
$1.8 Trillion! ($360 trillion/year) in 2004. $4 Trillion in 2010. $5.3
Trillion in 2013. $5.07 Trillion in 2016. $6.59 Trillion in 2019.
62% of all foreign exchange transactions involves cross-border
counterparties
Only ≈11% of daily spot transactions involve non-financial customers.
London is the largest FX market.
US dollar involved in 89% of all transactions.
Australian $ was the 5th most traded currency in 2019.
Source: BIS (Bank for International Settlements), April 2019.
FINM7406
28/02/2023 CRICOS code 00025B 3
Currency Distribution of Global Foreign Exchange Market Turnover
(percentage shares of average daily turnover in April)
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Source: Bank for International Settlements, “Triennial Central Bank Survey of Foreign Exchange ,” April 2019, www.bis.org.
28/02/2023 CRICOS code 00025B 4
Characteristics of FX Markets
Not an organised exchange
No fixed opening hours, centralised clearing mechanism,
standardized contracts, etc.
Loosely organised in two tiers
RETAIL: where individuals buy and sell foreign exchange.
WHOLESALE: informal network of approx. 2000 dealer institutions,
banks and currency brokers. Linked through SWIFT with over 10,000
financial institutions in more than 200 countries(Society for Worldwide
Interbank Financial Telecommunication).
FINM7406
28/02/2023 CRICOS code 00025B 5
Characteristics of the Wholesale Market
Participants in the market:
International banks
Bank customers engaged in commercial and Investment transactions
Non-bank dealers
FX brokers
Central banks
Settlement of transactions – No real money changes hands (e.g. CLS
Bank)
Extremely deep and liquid market
A 24-hour market
FINM7406
28/02/2023 CRICOS code 00025B 6
Geographic Extent of the Market
FINM7406
0
5,000
10,000
15,000
20,000
25,000
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24
Tokyo
opens
Asia
closing
10 AM
In Tokyo
Afternoon
in America
London
closing
6 pm
In NY
Americas
open
Europe
opening
Lunch
In Tokyo
Measuring FOREX Market Activity: Average Electronic Conversations Per Hour
Source: Eiteman et al (Figure 5.1)
28/02/2023 CRICOS code 00025B 7
Types of Activities
Hedging
It allows the firm to transfer exchange rate risk inherent in foreign
currency transactions
Speculation
An activity that leaves one open to exchange rate fluctuations and
one aims to make a profit
Arbitrage
take advantage of inconsistent prices to make risk free profits.
These profits are unlikely to last long.
Spatial (or Locational) Arbitrage
Triangular Arbitrage
Covered Interest Arbitrage – Lecture 3
FINM7406
28/02/2023 CRICOS code 00025B 8
Foreign Exchange Rates and Quotations
A foreign exchange rate is the price of one currency
expressed in terms of another currency.
E.g: AUD 2.3337 – 2.3901/GBP
A foreign exchange quotation (or quote) is a statement of
willingness to buy or sell at an announced rate.
FINM7406
28/02/2023 CRICOS code 00025B 9
A Little Terminology
Spot Rate: The exchange rate at which trades are executed immediately in the interbank
market. About a third of all FX trading is done in this market.
Value Date for a spot transaction is the date on which parties actually receive the funds
they have purchased — usually occurs two business days after the deal is made.
Foreign currency dealers provide two quotes:
Bid Price: Price at which the dealer is willing to buy foreign currency from you
Ask Price: Price at which the dealer is willing to sell foreign currency to you
It is always the case that the Ask Price > Bid Price. The difference is the Bid-Ask spread.
The less traded and more volatile a currency, the greater is the spread.
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28/02/2023 CRICOS code 00025B 10
Spot Market Convention
Direct Quote: Home currency per unit of Foreign currency (FC) - e.g.
AUD/€ quote is 1.6003 – 1.6499
Indirect Quote: Foreign currency per unit of Home currency – e.g.
€/AUD quote is 0.6061 – 0.6249
Note that in all cases, the reciprocal of a direct quote is an indirect quote.
Also, you might encounter an exchange rate quotation in American terms
(US$/FC) or European terms (FC/US$).
FINM7406
AUD
EUREUR
AUD 1
=
28/02/2023 CRICOS code 00025B 11
Bid – Ask Prices
Consider the DIRECT quote:
Bid Price (Dealer buys) -- Ask Price (Dealer sells)
AUD 2.3337 – 2.3901/GBP
[AUD/GBP]bid = 2.3337 – the rate at which the bank will buy
GBP in exchange for AUD.
[AUD/GBP]ask = 2.3901 – the rate at which the bank will sell
GBP for AUD.
FINM7406
28/02/2023 CRICOS code 00025B 12
Bid and Ask Quotations
Bid and Ask prices mixed with alternative quotations methods
can lead to confusion. Try to remember:
The dealer buys the denominator currency at the BID
(client buys the numerator currency at the bid)
The dealer sells the denominator currency at the ASK
(client sells the numerator currency at the ask)
AUD 2.3337 – 2.3901/GBP
When all else fails, remember that the commercial client always,
ALWAYS gets the worse end of the deal!!!
FINM7406
28/02/2023 CRICOS code 00025B 13
Another Example
American terms: (e.g., British pound)
FINM7406
Bid Offer (Ask)
$/£ 1.4482 1.4484
Bid: Dealer buys £ for $ at the Bid,
Client sells £ for $
(i.e., dealer will buy £1,000,000 for $1,448,200)
Ask: Dealer sells £ for $ at the Ask,
Client buys £ for $
(i.e., dealer will sell £1,000,000 for $1,448,400)
(Dealer buys) (Dealer sells)
28/02/2023 CRICOS code 00025B 14
Bid/Ask Example
FINM7406
Bid
1.4482
$/£
Ask
1.4484
Bid
0.6904
£/$
Ask
0.6905
A direct bid is the reciprocal
of an indirect ask.
A direct ask is the reciprocal
of an indirect bid.
28/02/2023 CRICOS code 00025B 15
Bid/Ask Example
FINM7406
Bid
1.4482
$/£ £/$
Ask
0.6905
Dealer is
willing to buy
£1 for
$1.4482
Dealer is
willing to sell
$1 for
£0.6905
When the dealer is
willing to buy (bid) £1
for $1.4482, he is
implicitly also willing to
sell (offer) $1 for
£0.6905.
£1
$1.4482= 0.6905£/$
28/02/2023 CRICOS code 00025B 16
Bid/Ask Example
FINM7406
£1
$1.4484 = 0.6904£/$
When the dealer is
willing to sell (offer) £1
for $1.4484, he is
implicitly also willing to
buy (bid) $1 for
£0.6904.
$/£
Ask
1.4484
Bid
0.6904
£/$
Dealer is
willing to sell
£1 for
$1.4484
Dealer is
willing to buy
$1 for
£0.6904
28/02/2023 CRICOS code 00025B 17
Bid – Ask Spread
Banks act as market makers and realise their profits from the
spread
Consider the DIRECT quote of $ 1.4482 – 1.4484/£
FINM7406
( ) point basis 38.1100
4484.1
4482.14484.1% =×−=spread
( )
Ask
BidAskspread −=%
28/02/2023 CRICOS code 00025B 18
Cross Rates
FINM7406
Source: Bank for International Settlements, “Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity in 2019” www.bis.org.
28/02/2023 CRICOS code 00025B 19
Cross Rates
Many currency pairs are only inactively traded, so their exchange rate is
determined through their relationship to a widely traded third currency.
For example, an Australian importer needs Danish currency to pay for
purchases in Copenhagen.
The Australian dollar (symbol A$) is not widely quoted against the Danish
kroner (symbol DKr).
However, both currencies are quoted against the U.S. dollar.
Assume the following quotes:
Australian dollar A$1.5431/US$
Danish kroner DKr7.0575/US$
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Cross Rates (Mid Rate)
The Australian importer can buy one U.S. dollar for A$1.5431
and with that one U.S. dollar buy DKr7.0575.
The cross-rate calculation would be:
FINM7406
A$/DKr 0.2186
US$DKr7.0575/
S$A$1.5431/U
dollar .kroner/U.SDanish
dollar .dollar/U.S Australian
==
The cross rate could also be calculated as the reciprocal.
Australian dollar A$1.5431/US$
Danish kroner DKr7.0575/US$
28/02/2023 CRICOS code 00025B 21
Cross Rates (Bid – Ask Rate)
Bid (Banks buy) Ask (Banks sell)
A$1.5455 – A$1.7158/USD
DKr7.0680 – DKr8.1280/USD
The cross-rate calculation for A$/Dkr would be:
FINM7406
A$/DKr 0.1901
USDDKr8.1280/
/USDA$1.5455
dollar .kroner/U.SDanish
dollar .dollar/U.S Australian
==
For A$/Dkr
Bid Rate for Denominator Currency means banks buy Dkr and Sell A$
Or = banks sell USD wrt Dkr and Buy USD wrt A$
A$/DKr 0.2428
USDDKr7.0680/
/USDA$1.7158
dollar .kroner/U.SDanish
dollar .dollar/U.S Australian
==
Ask Rate (A$/Dkr) means banks sell Dkr and Buy A$
Or = banks buy USD wrt Dkr and Sell USD wrt A$
28/02/2023 CRICOS code 00025B 22
Triangular Arbitrage
Cross rates can be used to check on opportunities for intermarket
arbitrage. Suppose the following exchange rates are available:
Barclays Bank: Australian dollars per pound sterling: A$1.8410/£
Westpac Bank: Australian dollars per Euro: A$1.2223/€
Deutsche Bank: Euro per pound sterling: €1.5100/£
The synthetic cross rate between Euro
and Pound and is:
A$1.8410/£
A$1.2223/€
Strategy: Buy Low Sell High = Buy € and Sell £
FINM7406
You get more
Euro from and
sell Pound to
Deutsche Bank
= € 1.5062/ £
£ Overvalued
28/02/2023 CRICOS code 00025B 23
Triangular Arbitrage - An Example (Figure 5.5a)
FINM7406
Barclays Bank: Australian dollars per pound sterling: A$1.8410/£
Westpac Bank: Australian dollars per Euro: A$1.2223/€
Deutsche Bank: Euro per pound sterling: €1.5100/£
Westpac,
Sydney,
AUD
Barclays,
London
£
*€1.5100/£
Deutsche,
Frankfurt
€
End with AUD1,002,538 Start with AUD1,000,000
Risk-Free Profit AUD2,538
£543,183€820,206
Strategy:
Buy € and
Sell £
28/02/2023 CRICOS code 00025B 24
Multiple Choice Quiz
Barclays Bank: Australian dollars per pound: A$1.8410/£
Westpac Bank: Australian dollars per Euro: A$1.2223/€
Deutsche Bank: Euro per pound sterling: €1.5100/£
If I can change the quoted rate of €1.5100/£ to another number, so that there would be
no more risk-free profit, what would that number be?
a) €1.4700/£
b) €1.5100/£
c) €1.5300/£
d) €1.5062/£
e) I don’t know the answer
24
FINM7406
28/02/2023 CRICOS code 00025B 25
Try this one on your own
Find the arbitrage opportunity here if you start with $1,000,000:
Citibank: US$ per euro $1.2223/€
Barclays Bank: US$ per pound sterling $1.8410/£
Dresdner Bank: Euros per pound sterling €1.5062/£
Hint: You should get a profit of $0. Prove it!
FINM7406
28/02/2023 CRICOS code 00025B 26
Triangular Arbitrage - An Example (Figure 5.5a)
FINM7406
Barclays Bank: Australian dollars per pound sterling: A$1.8410/£
Westpac Bank: Australian dollars per Euro: A$1.2223/€
Deutsche Bank: Euro per pound sterling: €1.51062/£
A$1.8410/£
A$1.2223/ €
Westpac,
Sydney,
AUD
Barclays,
London
£
*€1.5062/£
Deutsche,
Frankfurt
€
End with AUD1,000,000 Start with AUD1,000,000
£543,183€818,142
= € 1.5062/ £ Synthetic Cross Rate
A$1.8410/£
A$1.2223/€
X
28/02/2023 CRICOS code 00025B 27
Forward Contracts
Forward transactions require delivery at a future date of a
specified amount of one currency for a specified amount of
another currency.
This is a rate that is agreed upon today, but settled further into
the future.
Forward contracts are traded on the inter-bank market. They
can be tailored for
contract sizes
currency
delivery dates
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Ways to Express Forward Rates
There are three ways to express
forward rates:
• Outright quotes (either direct or indirect)
• Via points to be added or subtracted
from spot rate
• As an annualized percentage forward premium or discount
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(1st way) Outright Quotes
Forward: If the value date is much longer than 2 days, like 30, 90 or more
days
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$/£ £/$
$/FC FC/$
28/02/2023 CRICOS code 00025B 30
(1st way cont) Spot vs. Forward Exchange Rates
Currencies which are more (less) expensive to buy forward are at a
premium (discount).
For the denominator currency, Forward > Spot implies
a premium of foreign currency forward.
e.g., S = 0.9077 $/SF, F6 Months = 0.9129 $/SF
The forward Swiss franc is more expensive to buy. Therefore, the
forward Swiss franc is trading at a
premium to the spot Swiss franc (relative to the dollar).
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28/02/2023 CRICOS code 00025B 31
(2nd way) Forward Quotes – Swap Rates
Among themselves, foreign exchange traders usually quote
forward rates in terms of points, also referred to as “swap rates”
A point is the last digit of a quotation
A point is equal to 0.0001 of most currencies.
Some currencies, such as the Japanese yen, are quoted only to
two decimal places (0.01).
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Forward Quotes – Swap Rates
A forward quotation expressed in points is not a foreign
exchange rate as such.
Rather, it is the difference between the forward rate and the spot
rate.
FINM7406
European Terms, Sfr/$
Bid Offer
Spot 1.5625 1.5635
Points Quotations:
One month forward 58-56
Three months forward 175-169
Six months forward 342-334
If Bid Pts > Ask Pts
forward discount
Subtract from spot
28/02/2023 CRICOS code 00025B 33
Forward Quotes – Swap Rates
When the Bid Points > Ask Points, you subtract the points
from the spot rate to get the outright forward quote:
FINM7406
European Terms, Sfr/$
Bid Ask
F1 mo: 1.5625 − 0.0058 = 1.5567 1.5635 − 0.0056 = 1.5579
F3 mo: 1.5625 − 0.0175 = 1.5450 1.5635 − 0.0169 = 1.5466
F6 mo: 1.5625 − 0.0342 = 1.5283 1.5635 − 0.0334 = 1.5301
These are the outright
forward quotes
28/02/2023 CRICOS code 00025B 34
Forward Quotes – Swap Rates
On the other hand, if the Bid Points < Ask Points, there is a
forward premium and you add the points to the spot rate to get
the outright forward quote:
FINM7406
American Terms, $/Sfr
Bid Offer
Spot 0.6396 0.6400
Points Quotations:
One month forward 23-24
Three months forward 70-72
Six months forward 140-143
If Bid Pts < Ask Pts
Forward Premium
Add to spot
28/02/2023 CRICOS code 00025B 35
Forward Quotes – Swap Rates
If the Bid Points < Ask Points, you add the points to the spot
rate to get the outright forward quote:
FINM7406
American Terms, $/Sfr
Bid Ask
F1 mo: 0.6396 + 0.0023 = 0.6419 0.6400 + 0.0024 = 0.6424
F3 mo: 0.6396 + 0.0070 = 0.6466 0.6400 + 0.0072 = 0.6472
F6 mo: 0.6396 + 0.0140 = 0.6536 0.6400 + 0.0143 = 0.6543
These are the outright
forward quotes
28/02/2023 CRICOS code 00025B 36
Foreign Exchange Rates and Quotations
FINM7406
Eiteman (Page 145)
Outright Quotation
Means
0.09
Means
0.0004
What is the ask price for the 5 yrs forward rate between Yen/AUD?
28/02/2023 CRICOS code 00025B 37
3rd way: Annualized Percentage Forward Premium/Discount
Forward premium (discount) exists when a currency purchases
more (less) of the 2nd currency in the future than it does
presently.
Note:
p > (<) 0 is the annualised premium (discount) of the denominator currency
N – maturity of the forward contract (or number of days forward)
FINM7406
×
−
=
NSpot
SpotForwardp 360
28/02/2023 CRICOS code 00025B 38
3rd way: Annualized Percentage Forward Premium/Discount
(cont)
For exchange rate: USD/AUD
If F > S then the currency is trading at a premium
E.g. One AUD buys more USD in the forward market than in the spot market
If ascending between bid/offer (i.e., 23 -24 one-month swap points) then
forward price will be higher than the current spot price
If F < S then the currency is trading at a discount
E.g. One AUD buys less USD in the forward market than in the spot market
If descending between bid/offer (i.e., 58 - 56 one-month swap points) then
forward price will be lower than the current spot price
If F = S then market is relatively flat
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Forward Premium/Discount – An Example
Euro quotes from The Financial Times:
FINM7406
Spot = 0.8772 $/€
F30 = 0.8785 $/€
F90 = 0.8806 $/€
F360 = 0.8891 $/€
Note that the Euro is more expensive in
the forward market
The forward Euro is at a premium
tSpot
SpotForward
ft
360
×
−
=
%8.1
30
360
8772.0
8772.08785.0
30
=×
−
=Eurof
%6.1
90
360
8772.0
8772.08806.0Euro
90f =×
−
=
%4.1
360
360
8772.0
8772.08891.0
360
=×
−
=Eurof
28/02/2023 CRICOS code 00025B 40
Measuring a Change in the Spot Exchange Rates
The percentage appreciation/depreciation (R) of the
denominator currency from t-1 to t equals:
FINM7406
t-1,t
-1t
-1tt
Spot
SpotSpot R=−
t-1,t
-1t
t
Spot
Spot R+=1
28/02/2023 CRICOS code 00025B 41
An Example
The Australian dollar was quoted against USD.
• At t-1 : A$1.8445/$
• At t : A$1.335/$.
What is the appreciation/depreciation of the $ (USD)?
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An Example
Thus, the appreciation/depreciation of the $, relative to the A$
from t-1 to t is:
Then, what is the appreciation/depreciation of the A$ relative to
$? By how much (%)?
FINM7406
1
1,
1
A$1.335/$ $1.8445 27.6%
$1.8445
t t
t t
t
S S A /$R
S A /$
−
−
−
− −
= = = −
Thus, the U.S.$ has depreciated
relative to the A$ by 27.62%
28/02/2023 CRICOS code 00025B 43
An Example
To calculate the appreciation/depreciation of the Australian
dollar, relative to the US dollar, we want the denominator
currency to be the A$:
At t-1 : A$1.8445/$ = $0.5422/A$
At t : A$1.335/$ = $0.7491/A$
FINM7406
1
1,
1
$0.7491 $0.5422 / $ 38.2%
$0.5422 / $
t t
t t
t
S S AR
S A
−
−
−
− −
= = =
Thus, the A$ has appreciated
relative to the USD by 38.2%
28/02/2023 CRICOS code 00025B 44
$ depreciation, A$ appreciation not equal
In general, the percentage appreciation in one currency is not equal to the
percentage depreciation in the other currency. Instead…
1+R$0,1= 1/(1+RA$0,1) or 1+RA$0,1= 1/(1+R$0,1)
For previous example:
1+RA$0,1 = 1/(1+RUS$0,1)
1+RA$0,1 =1/(1-0.2762)
RA$0,1 = 38.2%
FINM7406
$ 1
0,1 $
10 0,1
0
( $ / $) 1 11 ($ / $)( $ / $) 1
($ / $)
A
S AR S AS A R
S A
+ = = =
+
28/02/2023 CRICOS code 00025B 45
Additional Problem
• On July 2, 1997, the Thai Baht fell 17% against the U.S.$. By how much
has the $ appreciated against the Baht?
FINM7406
1 1 1
0,1
0 0 0
1 1
0 0
1 ( .17) 0.83
$ /1 0.83
$ /
/ $ 1/ 0.83 1.2048
/ $
,20.48%
S BahtR
S Baht
Baht
Baht
Thus
+ − =
+ = = =
= =
28/02/2023 CRICOS code 00025B 46
Glossary of Terms
Spot rate – The current market price of one currency in terms of another.
Direct quote – domestic currency per unit of foreign currency (AUD/CHF –
Swiss franc)
Indirect quote – foreign currency per unit of domestic currency.
American terms – Direct quote from the perspective of the US dollar.
European terms – Indirect quote from the perspective of the US dollar.
Bid (Ask) rate – Rate at which the bank is willing to buy (sell) a currency.
FINM7406
28/02/2023 CRICOS code 00025B 47
Glossary of Terms (cont.)
Arbitrage – The ability to make riskless profits by purchasing a commodity
where it is cheap and simultaneously selling it where it trades at a higher
price.
Cross rate – An exchange rate that does not involve the domestic currency.
Forward contract – It is contract to buy or sell a specific amount of a
commodity at a specific price and at a specific time in the future.
Forward premium – When one currency purchases more of a 2nd currency
in the future, than it does today.
FINM7406
28/02/2023 CRICOS code 00025B
Thank you
