FX basics Flashcards
What are FX quotations ??
The exchange rate quotations that are published in news papers normally reflect the ask prices for large transactions
In FX quotations what is a Direct quotation?
Number of units of home currency for one unit of foreign currency
-How much you need to pay for one unit of foreign currency
In FX quotations what is a Indirect quotation?
Number of units of foreign currency per unit of home currency
-How much can you buy with one unit of domestic currency
Can you give an example of a direct quotation if
1CYN = 0.11 GPB
When foreign currency appreciates against the GBP what happens to the exchange rate ?
It increases !
When foreign currency depreciates against the GBP what happens to the exchange rate ?
It decreases
What is the rule when it comes to the GBP appreciating and depreciating ?
Give an example of indirect quotation when
1GBP = 9.09CYN
What can be said about exchange rates and domestic currency when using an indirect quote
Direct and indirect quote conversion
Between 2 countries, ones direct quote is the same as the others country indirect quote
what do you do with your figures to get the converted value if domestic currency is stronger than foreign
MULTIPLY
what do you do with your figures to get the converted value if domestic currency is weaker than foreign
DIVIDE
What is the bid price ?
The bid price is the price a dealer is willing to pay you for something (dealer bids).
What is the ask price ?
The ask price is the amount a dealer wants you to pay for something (dealer asks
What is the bid-ask spread ??
The difference between the ask and the bid price
Bis-Ask spread example
What does the reciprocal nature of bid and ask mean ?
-As a bank, if you are buying one euro for 0.8538 pounds, this also means that in the same transaction, you are selling 0.8538 pounds for one euro.
-So, when you sell a currency, your selling (ask) price needs to be higher than the bid of selling one euro for 0.8538 pounds.
Why do some currency pairs have higher spreads than others ?
Order costs (+)
Inventory costs (+)
Competition (-)
Volume (-)
Currency risk (+)
Volatility (+)
What currency pairs have the lowest spread ?
- The major world currencies are the cheapest to trade as their spread is often the lowest
What does cross rate exchange refer to ??
Refers to the exchange rate between 2 currencies, each of which has an exchange rate quoted against a common currency
Work out the AUD/GDP exchange rate when given:
What can you do with this, if you have £10,000 in hand to make money ?
What is the LAW OF ONE PRICE ? (LOOP)
Identical goods or financial assets with identical risk traded in 2 markets must have the same price in both markets
-This results in equilibrium relationships and the price that emerges is called equilibrium price
-If this price deviates from equilibrium it will give rise to arbitrage opportunities
What is arbitrage ??
Can be described as capitalizing on a discrepancy in quoted prices to make a riskless profit
Explain arbitrage in terms of FX
Simply put, the presence of arbitrage opportunity will lead arbitrageurs to buy and sell currencies, so that the exchange rates would realign, and no risk-free profits can be made
What is locational arbitrage ?
Locational arbitrage is possible when one bank’s price is different from another bank’s price for the same currency
Or when a banks ask and bid price is lower than another banks bid price, for the same currency
What is Triangular Arbitrage ?
This is possible when a cross exchange rate quote differs from the quoted spot rate quotes
Can you show graphically triangular arbitrage when we have these 3 quotes
Step by step example of triangular arbitrage
What is the first most important thing about triangular arbitrage ?
to be an effective arbitrage, the transactions must all be conducted simultaneously. Because it is not possible to do all three transactions simultaneously, there is some risk involved in any attempted triangular arbitrage because prices might change (converge to equilibrium) between transactions.
What is the second most important thing about triangular arbitrage ?
as traders place orders to conduct the arbitrage, market forces are created that brings the quoted direct cross-rate back into alignment with indirect cross-rate
What is the 3rd most important thing about triangular arbitrage ?
the arbitrage need not start with a specific currency. The triangular arbitrage could be profitable starting from ANY of the currencies, as long as we trade in the same direction and go completely around the triangle
What does the forward market allow MNC to do ??
Forwards market lets these companies lock in the exchange rate at which it will buy or sell a certain quantity of currency on a specified date
