International Finance

Foreign Exchange Market (Part 1)

Forex Market: Rational for Existence

Purpose of existence of forex market:

Assist international trade and investment

Facilitates hedging and makes possible
speculation in foreign currency

Most forex transactions channeled through

the worldwide interbank market

Foreign Exchange Trading

Trading done by phone, telex or online on 24-

hour basis (except weekends)

Trading moves from Asia to Europe to North

America
No unified or centrally cleared market for

majority of FX trade and very little crossborder regulation

Foreign Exchange Trading

Main trading center: London.
Other important centers:

NY, Tokyo, HK, Singapore

Top Currencies Traded

Most actively traded currencies:

US$
Euro
Yen
Pound Sterling
Swiss Franc

Top Forex Traders

Top 5 currency traders:
Deutch

Bank
Union Bank of Switzerland
Barclays Capital
Citi
Royal Bank of Scotland

Philippine Forex
Philippine Foreign Exchange

BSP dollar reference dollar exchange rate for

the day represents the weighted average of all
done deals at PDS during the preceding day

KBs give two-way quotes with the normal

interbank bid-offer spread of 0.0005 pesos

Forex Quotes
Spot price
30-day forward quote
90-day forward quote
180-day forward quote

Types of Forex Quotes

American term : US$ per unit of foreign currency

European term : foreign currency unit per US $

Direct quote : domestic currency price of foreign

currency

Indirect quote : foreign price of domestic currency

Forex Conversions : Basic

E.g. SFr 1 = US$ 0.7967 is converted to

Forex Conversions : Bid-Ask

Quotes always given in pairs as a dealer would

not know if a client is in the market to buy or sell
currency
First rate quoted: buy/bid price
Second rate quoted: sell/ask/offer price
E.g. Pound Sterling quote :
: US$ 1.7442 - 53
dealers buying rate
clients selling rate

dealers selling rate

clients buying rate

Sample Dealer Quotes

Quotes by different banks vary and the choice of

clients would depend on the best quote by each

dealer

E.g.: A US portfolio manager wants to buy $10 million

worth of European (French) bonds. He seeks
quotes on the euro/dollar rate from different banks
Bank A
0.80000-20

Bank B
0.79985-05

Bank C
0.79995-15

Bid-Ask Quotes
When direct quotations are converted into

indirect quotations, the bid-ask quotes are

reversed

In US forex market

In UK forex market

US$ 1.7442-53 per UK

UK 0.5730-33 per US$

Transaction Costs
Transaction Costs:

Percent Spread =

Midpoint Price =

Sample Exercise
Given the following quote:

$ 0.9056 0.9065 /
Convert the quote to /$ bid-ask quote

Compute for the $/ spread and midpoint price.

Compute for the /$ spread and midpoint price

Midpoint of a Spread

The midpoint of a spread moves in response to a

dealers position. A dealer with excess supply of
the foreign currency would move the midpoint of
his direct quote downwards rather than adjust the
size of the spread

Assume the ff /$ quotes of different banks:

Bank A
Bank B
Bank C
0.80000-20

0.79985-05

0.79995-15

0.80010

0.79995

0.80005

Cross Exchange Rates

Cross Rates

Using midpoint quotes

Assume FC1 = currency of foreign country 1 ()
FC2 = currency of foreign country 2 (SFr)
DC = currency of domestic country (US$)
If is selling for US$ 1.20/ and the buying rate for SFr
is US$ 0.80/SFr,
what would the SFr/ cross exchange rate be?
what would the /SFr cross exchange rate be?

Cross Exchange Rates

For the SFr/ cross exchange rate

Cross Exchange Rates

For the /SFr cross exchange rate

Cross Exchange Rates

Given the ff. quotes:
Japanese

: 135.62/US$

South Korean Won

W 763.89/US$

Assume : FC1 =
FC2 = W
DC = US$

Cross Exchange Rates

For the /W cross exchange rate

Cross Exchange Rates

For the W/ cross exchange rate