FX basics

Question 1

What are FX quotations ??

Answer 1

The exchange rate quotations that are published in news papers normally reflect the ask prices for large transactions

Question 2

In FX quotations what is a Direct quotation?

Answer 2

Number of units of home currency for one unit of foreign currency
-How much you need to pay for one unit of foreign currency

Question 3

In FX quotations what is a Indirect quotation?

Answer 3

Number of units of foreign currency per unit of home currency
-How much can you buy with one unit of domestic currency

Question 4

Can you give an example of a direct quotation if
1CYN = 0.11 GPB

Answer 4

Question 5

When foreign currency appreciates against the GBP what happens to the exchange rate ?

Answer 5

It increases !

Question 6

When foreign currency depreciates against the GBP what happens to the exchange rate ?

Answer 6

It decreases

Question 7

What is the rule when it comes to the GBP appreciating and depreciating ?

Answer 7

Question 8

Give an example of indirect quotation when
1GBP = 9.09CYN

Answer 8

Question 9

What can be said about exchange rates and domestic currency when using an indirect quote

Answer 9

Answer 10

Question 11

Direct and indirect quote conversion

Answer 11

Between 2 countries, ones direct quote is the same as the others country indirect quote

Question 12

what do you do with your figures to get the converted value if domestic currency is stronger than foreign

Answer 12

MULTIPLY

Question 13

what do you do with your figures to get the converted value if domestic currency is weaker than foreign

Answer 13

DIVIDE

Question 14

What is the bid price ?

Answer 14

The bid price is the price a dealer is willing to pay you for something (dealer bids).

Question 15

What is the ask price ?

Answer 15

The ask price is the amount a dealer wants you to pay for something (dealer asks

Question 16

What is the bid-ask spread ??

Answer 16

The difference between the ask and the bid price

Question 17

Bis-Ask spread example

Answer 17

Question 18

What does the reciprocal nature of bid and ask mean ?

Answer 18

-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.

Question 19

Why do some currency pairs have higher spreads than others ?

Answer 19

Order costs (+)
Inventory costs (+)
Competition (-)
Volume (-)
Currency risk (+)
Volatility (+)

Question 20

What currency pairs have the lowest spread ?

Answer 20

• The major world currencies are the cheapest to trade as their spread is often the lowest

Question 21

What does cross rate exchange refer to ??

Answer 21

Refers to the exchange rate between 2 currencies, each of which has an exchange rate quoted against a common currency

Question 22

Work out the AUD/GDP exchange rate when given:

Answer 22

Question 23

What can you do with this, if you have £10,000 in hand to make money ?

Answer 23

Question 24

What is the LAW OF ONE PRICE ? (LOOP)

Answer 24

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

Question 25

What is arbitrage ??

Answer 25

Can be described as capitalizing on a discrepancy in quoted prices to make a riskless profit

Question 26

Explain arbitrage in terms of FX

Answer 26

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

Question 27

What is locational arbitrage ?

Answer 27

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

Question 28

What is Triangular Arbitrage ?

Answer 28

This is possible when a cross exchange rate quote differs from the quoted spot rate quotes

Question 29

Can you show graphically triangular arbitrage when we have these 3 quotes

Answer 29

Question 30

Step by step example of triangular arbitrage

Answer 30

Question 31

What is the first most important thing about triangular arbitrage ?

Answer 31

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.

Question 32

What is the second most important thing about triangular arbitrage ?

Answer 32

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

Question 33

What is the 3rd most important thing about triangular arbitrage ?

Answer 33

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

Question 34

What does the forward market allow MNC to do ??

Answer 34

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