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FX Flashcards

1
Q

What is a Commodity Currency?

A

The one unit of currency being exchanged for varying units of another currency. Also known as the “base or primary” currency.

So base, primary, or commodity.

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2
Q

What is a Term Currency?

A

Varying units of local currency exchanged for one unit of another currency. Also known as the “counter or quote” currency.

Terms, counter or quote.

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3
Q

What is the order to the base currency

A

E = EUR
G = GBP
A = AUD
N = NZD
U = USD

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4
Q

Currency Classification: What are the Major currencies?

A

The 5 major currencies are USD, CHF, JPY, GBP, and EUR.

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5
Q

Currency Classification: What is a Minor?

A

Is a currency available freely in the spot market but occasionally has limited liquidity. Forward markets may have restrictions imposed on maturity. (e.g. HKD, DKK, SEK)

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6
Q

Currency Classification: What is a Major?

A

Available freely in all the spot and forward markets

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7
Q

Currency Classification: What are Exotic/Emerging market currencies?

A

Spot and Forward markets are available but may have restrictions on size and maturity. Markets affected by size, pricing and allocation. (e.g. THB, PHP, MYR, IDR, PLN, RON, HUF)

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8
Q

What is a Market Maker?

A

The term market maker refers to a firm or individual who actively quotes two-sided markets in a particular security by providing bids and offers (known as asks) along with the market size of each.

Most foreign exchange trading firms are market makers and so are many banks. The market maker sells to and buys from its clients and is compensated by means of price differentials (Bid/Ask Spread) for the service of providing liquidity, reducing transaction costs and facilitating trade1.

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9
Q

What is a Price Taker

A

Market participants who seek to either buy or sell currencies. They are usually corporations. There is no reciprocity inasmuch as they won’t quote prices back to the other market participants. 2

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10
Q

How does the Bank become a Maker?

A

By the very nature of its business as a Financial Institution/intermediary.

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11
Q

What are the currency trading basics?

A
  1. Determine what is the commodity (base) and the term (quote) currency.
  2. Determine your transaction – are you selling or buying the commodity (base) currency
  3. 4 B’s – Bank buys the base at BID; and Bank sells the base at ASK.
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12
Q

What is the Eligible Value Dates of Spot Transactions

A

Settlement is within 2 business days of trade date.

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13
Q

What is the Eligible Value Dates of Forward Transactions

A

Settlement is more than 2 business days.

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14
Q

Value dates must be..

A

Business day in the home country of the currency involved, and
Business day in the transacting country

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15
Q

What creates window pricing?

A

It depends on positions taken by banks related to:
- Forecasted currency movements
- Interest rate movements
- Demand and supply from the banks customers
- Reserve requirements, etc.

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16
Q

What is a convertible currency

A

A currency that can be freely bought or sold with no restrictions, or very few restrictions. Most currencies in the industrialized world are convertible or semi-convertible.

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17
Q

What is a pip?

A

Smallest quoted unit of the spot price
- e.g. Suppose Spot USD/CHF = 1.2500
To say it has gone up 1 pip means USD/CHF = 1.2501
A 5-pip decline means USD/CHF = 1.2495

JPY are different. Ex. Spot USD/JPY = 111.00.
1-pip increase means, USD/JPY = 111.01

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18
Q

What is a Big figure?

A

The term big figure refers to the stem, or whole dollar value, of a price quote.
- 1Big = 100 pips
- Ex. Spot USD/CHF = 1.2500. 1 big figure rise = 1.2600
- Ex. Spot USD/JPY = 111.00. 1 big figure rise = 112.00

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19
Q

How are foreign exchange rates quoted?

A

SWIFT convention applies, if a currency pair is written USD/JPY it means how many yen per dollar; if it is written as GBP/JPY, how many yen per pound sterling. It shows how many units of the 2nd currency equal 1 unit of the 1st currency. (Remember EGANU)

20
Q

Why are banks involved with foreign exchange?

A

To make money . As Financial Intermediaries, banks are well equipped to handle all aspects of foreign exchange activities.

21
Q

Is there a formal marketplace?

A

No. Markets consists of trading rooms for both public and private institutions, clients and brokers.

22
Q

Is there a physical exchange of money?

A

Rarely. Majority of the transactions involve electronic transfers where accounts are simultaneously debited/credited.
Money laundering regulations urged banks to ask more questions when the transaction involves the transfer of ‘real’ money or cash.

23
Q

How permanent is the given exchange rate?

A

It varies. Rate is valid until there is another rate available, it can be a millisecond, few seconds. It can also be controlled by the government. In the market, rates fluctuate since they are affected by supply and demand.

24
Q

Financial Instruments: Spot Market

A

The foreign exchange markets revolve around spot (that, is the FX spot market).

Spot FX is generally dealt or transacted today (the dealing/trade date), for value two business days later (the value date); that day must be a business day in each of the two countries to apply.

25
Q

Financial Instruments: What is a Cross-Rate?

A

Cross rate is an exchange rate between currencies which is calculated using a third common currency (usually USD).

A cross-currency deal is one that involves the exchange of two currencies other than the dollar. Historically, the USD has been used as the medium of exchange between currencies, but about 20 years ago, the market has expanded the use of direct cross dealing**

Cross Exchange Rate = The exchange rate between currency A and currency B, given the exchange rate of currency A and currency B with respect to currency C.

26
Q

Financial Instruments: What is a Forward

A

A forward transaction does not have an exchange of currencies now – just later. It is based on market data on the day it is traded (spot + fwd points) but the exchange happens on a future date (more than 2 days).

27
Q

Financial Instruments: What is Forwards primarily used for?

A

More formally, it is a contractual obligation, used primarily for hedging, to buy or sell currency at a pre-determined rate for settlement on a future date.

28
Q

Financial Instruments: What is a forward rate

A

A forward rate is not a forecast or a reflection of market expectation of future spot rates, rather it reflects the interest rate differential of the two currencies.

29
Q

Forward Differentials

A

The interest rate differential component is commonly referred to as forward points (premium or discount) and merely represents borrowing one currency and depositing another.

Forward rates reflect interest rate differentials between currencies. If this wasn’t the case investors could profit from the price differences between the FX markets and the money markets (arbitrage).

30
Q

Financial Instruments: What is a future?

A

Similar to the mechanics of a forward FX contract. Contract to buy/sell currency at a specified price at a future time.

31
Q

Financial Instruments: 3 key differences between forwards and futures:

A

1) Futures are exchange traded contracts or ETDs (exchange traded derivatives). Forwards are OTC (over-the counter)
2) Futures are standardized contracts (pre-determined amounts, maturity and delivery dates, delivery process). Forwards are specifically tailored to fit the needs of both counterparties.
3) Futures contracts are usually closed out prior to settlement date – do not result in settlement. Gains/losses are marked to market daily. Forwards usually results in settlement, no cash flows during contract life.

32
Q

Financial Instruments: What are Swaps?

A

A swap is where two currencies are exchanged for an agreed period of time and re-exchanged at maturity.

A swap consists of two legs:*
A spot foreign exchange transaction (for the short leg)
A forward foreign exchange transaction (for the long leg)

These two legs are executed simultaneously for the same quantity, and therefore offset each other. The Spot converts the currency today and the forward hedges the exposure (i.e. you agree to buy the currency back in the future)

33
Q

Objectives of P&G Trading Protocals?

A

To ensure that Traders transact business with FX business partners in a professional, fair, and consistent manner.

To ensure that Traders execute FX deals in accordance with relevant SAFE standards.

To ensure that Traders get the best available price for P&G entities given the available instruments in the market and P&G’s defined risk parameters.

To govern the resolution of disputes on executed FX transactions.

To establish basic ethical standards for the conduct of financial market transactions.

34
Q

USD/JPY 104.50 – 104.80
P&G wishes to buy JPY 100,000,000.

At what rate will P&G buy YEN?

A

P&G will buy Yen at the Bid rate of 104.50

35
Q

EUR/USD 1.2930-1.3002
P&G wishes to buy EUR 1,000,000

What rate will P&G buy EUR?

A

P&G will buy EUR at the Ask rate of 1.3002

36
Q

JPY/KRW 10.10 – 10.30
P&G will sell KRW

What rate will P&G sell KRW?

A

P&G will sell KRW at the Ask rate of 10.30

37
Q

What is a Spot Rate?

A

The spot rate is the price quoted for immediate settlement on an interest rate, commodity, a security, or a currency.

The spot rate, also referred to as the “spot price,” is the current market value of an asset available for immediate delivery at the moment of the quote.

38
Q

What is Forex?

A

Forex (FX) refers to the global electronic marketplace for trading international currencies and currency derivatives.

It has no central physical location, yet the forex market is the largest, most liquid market in the world by trading volume, with trillions of dollars changing hands every day.

39
Q

What is Inter-company FX?

A
  • Intercompany FX pertains to 2 P&G entities trading currencies without bank intervention in the FX pricing, where local regulations allow.
  • This is a preferred method of FX as compared to dealing externally.
  • Because the FX rate is quoted internally, we need to ensure that the transaction is in line with the arms-length standard.
    The general method of pricing is to use the average of the market rate for bid and ask at the same point in time.
40
Q

What is foreign exchange risk?

A

Foreign exchange risk refers to the losses that an international financial transaction may incur due to currency fluctuations. Also known as currency risk, FX risk, and exchange-rate risk, it describes the possibility that an investment’s value may decrease due to changes in the relative value of the involved currencies.

Foreign exchange risk arises from movements in currency rates on P&G’s exposures in foreign currency. There are 2 types of exposure: Transaction exposures & Translation exposures.

41
Q

What is Transaction Exposure?

A

Transaction exposures refer to the extent to which the future cash transactions may be affected by any changes in foreign exchange rates. There is an exposure any time an entity expects to pay or receive payment in a currency that is not its functional currency.

42
Q

What is Translation Exposure?

A

Translation exposures refers to accounting exposures. It measures the impact of changes in exchange rates on the financial statements of the company.

Translation of foreign subsidiary income statements from local/functional currency into the US dollar for consolidated reporting of the worldwide income statement.
Translation of foreign subsidiary balance sheets into the US dollar for consolidation.

43
Q

What Is a Currency Forward?

A

A currency forward is a binding contract in the foreign exchange market that locks in the exchange rate for the purchase or sale of a currency on a future date. A currency forward is essentially a customizable hedging tool that does not involve an upfront margin payment.

The other major benefit of a currency forward is that its terms are not standardized and can be tailored to a particular amount and for any maturity or delivery period, unlike exchange-traded currency futures.

44
Q

What Is a Currency Option?

A

A currency option (also known as a forex option) is a contract that gives the buyer the right, but not the obligation, to buy or sell a certain currency at a specified exchange rate on or before a specified date. For this right, a premium is paid to the seller.

Currency options are one of the most common ways for corporations, individuals, or financial institutions to hedge against adverse movements in exchange rates.

45
Q

What is the difference between American and European currency options?

A

An American option can be exercised at any time during the life of the option; the European option can only be exercised at the actual expiry date (for delivery T+2 days later)

46
Q

What is a Call option?

A

Call option is the right (not obligation) to buy the currency

47
Q

What is a Put option?

A

Put option is the right (not obligation) to sell the currency.

FX (2 decks)

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