5014 - Finance of International Trade - Seminar Two FOREX Quiz Flashcards
What is a Fixed Exchange Rate Regime?
A regime applied by a government or central bank that ties the country’s official exchange rate to another country’s currency or, the price of gold. Done to keep value within a narrow band
What is a Pure Floating Exchange Rate Regime?
Set by the market without intervention, based on supply, demand and speculation
What is a Pegged Exchange Rate Regime?
Currency regime in which the country’s currency is tied to another currency, usually the USD or EUR
What is a Dirty Floating Exchange Rate Regime?
Country’s central bank occasionally interferes to change the direction of the currency
What was the Bretton Woods Agreement?
The Bretton Woods Agreement established a system through which a fixed currency exchange rate could be created using gold as the universal standard. The agreement involved representatives from 44 nations and brought about the creation of the International Monetary Fund (IMF) and the World Bank.
What was ERM
The European Exchange rate mechanism
When did the UK leave the ERM?
16th September 1992, leading to what is referred to as black Wednesday after the UK government was forced to leave for failing to keep the pound above the lower currency exchange limit, which was mandated by the ERM
Examples of countries with a fixed exchange rate regime
Fiji
Kuwait
Morocco
Libya
They do this to keep the value of the currency within a specific band to avoid volatility and provide greater certainty during trade
What is a Spot Transaction?
Trading one currency for another based on the current price level in the market. ‘‘On the spot’’
What is a Forward Transaction?
Rate of exchange agreed on one date to be executed at another, specified date. Sort of like a formalised futures contract
What is an Options Transaction?
A contract that gives you the ability, but not the obligation to buy or sell a certain currency at a specified exchange rate on or before a specified date
What is a Futures Transaction?
A legal agreement to buy or sell a particular commodity asset, or security at a predetermined price at a specified time in the future
What is a swap transaction?
Also known as an FX swap, it is an agreement by two foreign parties who both need the others currency so they exchange the equivalent of each currency
Figures for the most traded currencies as of April 2019
US $ = 88.3% Euro = 32.3% Yen = 16.8% Pound = 12.8% Australian $ = 6.8% Canadian $ = 5% Swiss Franc = 5%
Top Currency Traders as of June 2020
JP Morgan - 10.78% UBS - 8.13% XTX - 7.58% Deutsche Bank - 7.38% Citi - 5.50% HSBC - 5.33%
The indirect quote of $/£ is $1.25 - £1, so what is the direct quote
$1.25 = £1
£1 / $1.25 = £0.80
£0.80 therefore = $1
Define Spot and Forward Rate
The spot rate is the market price at the time of trading based on each currencies current price levels, a forward rate is a rate of exchange personally agreed between two entities to be executed on a future date
What does Bid refer to
The highest price a buyer will buy
What does Ask refer to
The lowest price the seller will sell
An exporter is receiving the equivalent of $500,000 in £ today with the spot rate for £/$ quoted at $1.2556 - $1.2676 how much will they receive in pounds
The client has $500,000 to exchange to £
They are selling, so putting in an ask order, therefore paying $1.2676 per pound
$500,000 / $1.2676 =
£39446.20
An importer needs to send $200,000 to a US supplier today, with the spot rate for £/$ quoted at $1.2556 - $1.2676 how much will it cost in £
The client needs to buy $200,000 so therefore are buying meaning…
£1 gets them $1.2556
$200,000 / $1.2556 =
£159286.40 - This being how much it will cost in pounds to get $200,000
the spot rate for £/$ quoted at $1.2556 - $1.2676
What is the spread
Bid = 1.2556 Ask = 1.2676
Ask - Bid
- 2676 - 1.2556=
- 012 - 120 ‘pips’
How is Spread Calculated?
Ask price - Bid Price
If €/US$ = $1.1760 / € and £/US$ = $1.9040 / £
What is the Direct and Indirect quote for the cross rate of €/£
EUR/USD = $1.1760 GBP/USD = $1.9040
1/1.1760 = 0.8503 USD/EUR = 0.8503
1/1.9040 = 0.5252 / $ USD/GBP = 0.5252 / $
Indirect Quote:
USD/GBP / USD/EUR = EUR/GBP
0.5252 / 0.8503 = 0.6176
EUR/GBP = 0.6176
Direct Quote:
USD/EUR / USD/GBP = GBP/EUR
0.8503 / 0.5252 = 1.619
GBP/EUR = 1.619
How do you calculate cross rates
The cross rate should equal the ratio of the 2 corresponding pairs
GBP/USD = 1.57
USD/EUR = 0.93
You want to Find GBP/EUR
USD/EUR = 0.93 so 1/0.93 = EUR/USD 1/0.93 = 1.0753 EUR/USD = 1.0753
GBP/USD Divided by EUR/USD = GBP/EUR
EUR/USD Divided by GBP/USD = EUR/GBP
Cross Rate Formula
GBP/USD = X USD/EUR = Y
1 / Y = EUR/USD
GBP/USD Divided By EUR/USD = GBP/EUR
EUR/USD Divided By GBP/EUR = EUR/GBP
When do Triangular Arbitrage conditions apply
When there is a discrepancy between the exchange rate of three foreign currencies
So say £1 gets me $1.50
Then a Euro gets me $1.25
But one pound gets me 1.6 Euros
Convert £10 to 16 Euros, convert that to Dollars getting you $20, convert the $20 back to Pounds, and you would have £13.33 from the initial £10. This usually happens with much smaller margins than this of a penny or less in some cases but is done thousands of times to make a large risk free profit.
