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4. The FX Market

4. The FX Market. The FX market encompasses the conversion of purchasing power from one currency to another. The FX Market: Largest Financial Market in the World. FX Market: Function and Structure. Market Participants (2-tiers) Wholesale/Interbank and Retail/Client. Banking Relationships.

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4. The FX Market

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  1. 4. The FX Market The FX market encompasses the conversion of purchasing power from one currency to another.

  2. The FX Market: Largest Financial Market in the World

  3. FX Market: Function and Structure

  4. Market Participants (2-tiers)Wholesale/Interbank and Retail/Client

  5. Banking Relationships

  6. FX Transaction Breakdown * One trillion (tr) dollars = $1,000,000,000,000

  7. The Spot MarketBuy/Sell “Now”

  8. Spot FX Trading

  9. Notation: No Bid-Ask Spread

  10. Notation: With Bid-Ask Spread

  11. Two ways of describing each of the possible two transactions Clarifying FX Quotes Example: The US$ (dollar) and the THB (baht). Traders making quotes can only either (a) receive US$ and give THB; or (b) receive THB and give US$. (a) can either be quoted as “selling” THB or as “buying” US$, but they are the same thing. Only two possible transactions! (b) can either be quoted as “selling” US$ or as “buying” THB, but they are the same thing. The quote can be either US$ per 1 THB S($/THB) or as THB per 1 US$ S(THB/$), but these are just two ways of saying one price! SUMMARY: Two (2) possible transactions, each with one (1) price!

  12. Two Transactions, Each Quoted Two Ways The customer can either….. (a) Come with US$ and leave with THB… The bank will quote a rate to BUY US$ (as $/THB or THB/$) or (b) come with THB and leave with US$ The bank will quote a rate to SELL US$ (as $/THB or THB/$)

  13. Cross Quotes (with no b-a spread) Quotes of one non-$ currency against another non-$ currency are called “cross quotes”. For example, the euros per pound fx rate is determined by the euro/dollar and pound/dollar fx rates. With dollar fx rates established, the Nx(N-1)/2 cross fx rates can be calculated.

  14. Cross Quotes Rewritten Cross quotes can be re-written using one direct quote and one indirect quote:

  15. Cross Quotes: Buying and Selling Example: Suppose someone wants to sell 100 Swedish krona (SEK) to buy Thai baht. The exchange rates are: Think of buying or selling cross currencies as a 2-step process going through the USA. Going from THB to SEK… S(FX/$) is for the customer asking “How much FX can I get for my $1?” S($/FX) is for the customer asking “How many $ will you give me for my 1 FX?” 100 SEK x 0.155 = $15.50 x 29.412 = 456 THB 95.84 SEK = 6.369 x $15.05 = 0.033 x 456 THB

  16. Direct Cross-Rates Some specialist banks trade directly in non-$ foreign exchange. Their rates should be slightly better than the 2-step rates described earlier. Example….

  17. Triangular Arbitrage If cross-rates are not compatible with one another, triangular arbitrage may be possible.

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