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Characteristics and Kinds of Spot Transactions: Currency Conversions and Currency Arbitrage

Characteristics and Kinds of Spot Transactions: Currency Conversions and Currency Arbitrage. Lucia Desetová. Miriam Uhrová. Menu of Main Points. Basics of Foreign Exchange Market Spot Transactions Types of Spot Transactions. Basics of FOREX. Exchange Market

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Characteristics and Kinds of Spot Transactions: Currency Conversions and Currency Arbitrage

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  1. Characteristics and Kinds of Spot Transactions:Currency Conversions and Currency Arbitrage Lucia Desetová Miriam Uhrová

  2. Menu of Main Points • Basics of Foreign Exchange Market • Spot Transactions • Types of Spot Transactions

  3. Basics of FOREX • Exchange Market • a place, where the supply of foreign currencies meets the demand for them • Market participants • Banks • Commercial companies • Central banks • Hedge funds as speculators • Investment management firms • Retail foreign exchange brokers • Types of trades in the FOREX • Forward trades • Swap • Spot trades

  4. Spot Transaction • a foreign exchange transaction in which each party promises to pay a certain amount of currency to the other on the same day or within one or two days • the spot rate • a trade day Pricing Spot Transactions • 2 prices: 1. the buying price (bid) 2. the selling price (offer) • the spread

  5. Exchange Rates • is the price of one currency expressed in other currency, it’s the relative price of two national currencies Quotation • Direct: x home currency units = 1 foreign currency unit (e.g. in US – 1.25 USD = 1 EUR) • Indirect: x foreign currency units = 1 home currency unit (e.g. in US - 0.80 EUR = 1 USD) • Term currency • Base currency • e.g. EURUSD exchange rate is 1.3 (1.3 USD per EUR) term base

  6. Types of Spot Transactions • Currency Arbitrage • Two-currency arbitrage • Three-currency arbitrage • Arbitrage between prompt and term market • Currency Conversions

  7. Currency Arbitrage • purchase of one currency in one financial EM and its selling in other • the aim - reach the profit from the price difference in two or three financial exchange markets • involves: - no negative cash-flow at any probabilistic or temporal state - a positive cash-flow in at least one state Conditions for Arbitrage • the law of one price • 2 A with identical cash-flows do not trade at the same price • A with a known price in the future does not today trade at its future price discounted at the risk-free interest rate

  8. Types of Arbitrage • Two-currency • Three-currency • Arbitrage between prompt and term market • two-currency arbitrage • two different brokers offering different spreads • at least one quote which differs between the brokers, either the bid, the ask, or both • A. between prompt & term market • Influenced by: - the size of prompt & term rates - the size of interest rates between 2 currencies

  9. three way forex arbitrage • the exchange rates of three currencies don't match all ratios, and there is a gap between expectation and reality • the process of converting one currency to another, converting it again to a third currency and, finally, converting it back to the original currency within a short time span.

  10. Currency Conversions • prompt spot transaction, in which is one currency changed for another one and vice versa

  11. Thank you for your attention

  12. Classification of ERs • Types of trade - prompt - forward - futures - option • Time point of view - prompt - term • Financial tools - foreign exchange (devízové, valutové)

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