Foreign Exchange Flashcards
1
Q
FX dealers
A
- buy at a low rate and sell at a higher rate for profit
- e.g. commercial banks, investment banks, brokerage firms
2
Q
Market makers
A
- they make it easier for buyers and sellers to come together, providing liquidity
3
Q
Liquidity
A
- ease with which one can sell an asset at its fair value
- low tx costs
4
Q
FX brokers
A
- intermediaries: match buyers and sellers for a commission
5
Q
Other participants in the fx market
A
- central banks
- multinational corporations
- smaller banks representing customers
6
Q
Direct exchange rate quote
A
- quoting fx rate with domestic currency first i.e. numerator of fraction
7
Q
Indirect exchange rate quote
A
- quoting foreign currency first
8
Q
Relationship between direct and indirect quotes
A
Inverse i.e. direct = 1/indirect
9
Q
$ per £ (In the US)
A
Direct (American quote)
10
Q
£ per $ (In the US)
A
Indirect (European quote)
11
Q
Vehicle currency
A
- currency actively used in many international financial transactions
- used due to tx costs of making markets in certain currencies being too high
- USD primary vehicle currency (89% of tx)
12
Q
Cross-rates
A
- trading currency in the New York market where both currencies are not expressed in USD
- Trend toward cross-rate tx
13
Q
Triangular arbitrage
A
- keeps cross-rates in line with exchange rates quoted relative to USD
- occurs when one can trade three currencies and still make a profit i.e. €/£ < €/$ * $/£
- arbitrage possible if cross-rates are inconsistent
14
Q
Arbitrage
A
- earning riskless profits by simultaneously buying and selling equivalent assets
15
Q
Bid
A
- rate at which banks will buy the base currency
16
Q
Ask
A
- rate at which banks will sell the base currency
17
Q
Interbank market
A
- the wholesale part of the foreign exchange and external currency markets where major banks trade
18
Q
Interbank bid-ask spread
A
- within 5 pips
- 0.05%-0.07% for major currencies
- lower for extremely liquid currencies like USD i.e. 0.03% for $/€ exchange rate quote
- higher for less liquid currencies
19
Q
Physical exchange bid-ask spread
A
- 3% or more
- banks must hold inventory so it’s not interest bearing
- banks must transact with brokers
20
Q
SWIFT
A
- Society of Worldwide Interbank Financial Telecommunications
- Links more than 7500 banks in 200 countries-
21
Q
CHIPS
A
- Clearing House Interbank Payments System
- clearing house in US for dollars
22
Q
Fedwire
A
- links computers of more than 7500 institutions that have deposits with the federal reserve
23
Q
TARGET
A
- Trans-European Automated Real-time Gross Settlement Express Transfer
- Euro counterpart to Fedwire
24
Q
CHAPS
A
- Clearing House Automated Payment System
- Operated by BoE involving 30 direct participants and over 5000 financial institutions
25
Cross-currency settlement risk (Herstatt)
- risk that a financial institution may not deliver the currency on one side of a completed transaction
26
Currency appreciation
- strengthening or an increase in value of one currency relative to another
27
Currency depreciation
- weakening or a decrease in value of one currency relative to another
28
Revaluation
- currency value 'allowed' to rise by government
29
Devaluation
- currency value 'allowed' to fall by government
30
Types of Fx tx
- spot, swaps and forward contracts, futures and options
31
Factors influencing exchange rates
- relative inflation rates, relative interest rates, relative income levels, government controls, expectations, information asymmetry
