4. FX Mechanics and Applications Flashcards
1
Q
What is FX spot market what is the default settlement days?
A
- market where buyers & sellers transact in convertible currencies for delivery (i.e., settlement) after 2 biz days.
- but some currencies like USD/CAD & USD/PHP spot date is after 1 biz day, T+1.
- Forex transactions, unless specified, are for value spot.
2
Q
Why is the default settlement day T+2?
A
2 days is sufficient time for both the counterparties to prepare & effect the necessary funds flow.
3
Q
How to quote spot prices?
A
- Spot prices are readily available in the market.
- To quote, dealer checks the prevailing ‘interbank’ rate at that time & either adds/subtract a margin (in the form of FX pips) from this rate.
- but FX rates quoted for other delivery dates will have to be adjusted with the ‘forward or backward swap points.
4
Q
Are the rate quoted usually for standard amount and what is the standard amount?
A
- rate quoted is for a standard amount which depends on the currency traded.
- for interbank trading in MYR is normally USD5m
- Standard amounts for major currencies are usually USD5m.
- if the amount to be traded isn’t the standard amount, trader need to specify the amount
- price quoted would normally be the same if it is a marketable amount, otherwise the price may differ if the amount requested is odd, less or more than the standard amount.
5
Q
What is the standard settlement date? And what happens if a settlement date differs from the standard settlement date?
A
- normally a spot date (2 business days from trade date).
- trader need to specify the actual date if the settlement date differs from the standard settlement date when requesting a price.
6
Q
What is pip/point?
A
- The smallest unit by which a price can move
- FX rates move in terms of points or pips.
- eg: if the price had moved to USD/MYR 4.2951 – 61 from USD/MYR 4.2950 – 60 means bid & offer prices moved by 1 pip/point — means USD strengthened against MYR by 1 pip/point, which is a movement of 0.0001.
- If USD strengthens from 4.2960 to 4.2970, then it strengthens by 10 points, which is a 0.0010 movement. If USD strengthens from USD/MYR 4.2960 to 4.3060, then it strengthens by 100 points, a movement of 0.0100 points — market refers to 100 points as ‘one big-figure’.
- if USD weakens against Yen from USD/JPY 114.40 to 114.30, we say that USD weakens against JPY by 10 points (which in this instance is a 0.10-point movement). This means 1 pip or point for the USD/JPY pair is 0.01
7
Q
What is a spread?
A
- range between the bid & offer prices of a quotation
8
Q
What is a choice price?
A
- When buying and selling price is the same aka spread is zero
- will be quoted as a single price, for example “4.2955 choice”.
- In dealing practices, when a trader is quoted a choice price, he is obliged to deal, albeit on the side of his choice.
9
Q
What is a mid rate and what is it normally used for?
A
- determined by adding half the spread to the buying price (aka mid-point between the bid and offer price)
- with a 10 pips spread, the mid-rate would be 4.2950 + 5 pips = 4.2955.
- The mid-rate is generally used for revaluations/fixing the exchange rate of a swap transaction.
10
Q
What is a bid and offer rate?
A
- bid rate: rate at which the market maker is prepared to buy the deal currency against the non-deal
- offer rate: rate at which the market maker is prepared to sell the deal currency against the non-deal.
- bank quoting the price (aka price quoter/price maker) will always have the advantage in that it buys USD at its (lower) bid rate and sells USD at its (higher) offer rate.
11
Q
What are attributes of a good FX price quotation?
A
- quickness with which a bank responds to a customer’s call.
- customer who needs to cover an exposure expects the dealer to respond quickly & give him a price in the soonest time - The FX Bid Offer Spread
- actively traded currencies, spread is between 1 to 5 points in a normal market.
- narrow spread = more attractive — bank which quotes a ‘2 pointer’ price (eg: USD/MYR 4.2950 – 52) is better & more aggressive than one which quotes a ‘5 pointer’ price (eg: USD/MYR 4.2949 – 54). - Honouring the Amount Requested
- no use responding quickly & giving the narrowest spreads if the bank is unable to honour the full amount requested.
12
Q
What are the main types of FX quotations & which is the more popular?
A
- Indirect quotations
- Direct quotations
- Cross quotations
- Indirect quotations are more popular as compared to direct quotations.
- For currencies that are not actively traded, it would be better for a dealer to check with another active bank to see what type of quotation it is before committing a rate to a customer.
13
Q
What is an indirect FX quotation?
A
- quoted using USD as the base currency (i.e. how many units of the third currencies can be exchanged for 1 USD).
- eg: USD/JPY 114.39 means 1USD = 114.39 JPY
14
Q
What are the third currencies?
A
- can be further classified as ‘major’ and ‘non-major’
- major: EUR, JPY, GBP and Swiss Francs — most liquid currencies in the FX market with large number of active traders all the time.
- non-major would include most other currencies like AUD & NZD, African Rand, Indonesian Rupiah, SGD, MYR & Thai Baht.
- Other currency groups/categories include the G10 currencies (Group of 11 industrialized nations) and BRICS (the 5 major emerging economies of Brazil, Russia, India, China, and South Africa).
15
Q
why currencies don’t move in perfect unison?
A
- each currency has its own intrinsic value & fundamentals
- eg: USD strengthens against the SGD and CHF by 10%, but may only strengthen against the MYR by 6% = MYR strengthened against the SGD and CHF by 4% despite weakening against the greenback.
- this give rise to the popularity of cross currencies trading
