spt,cross,forward

8/3/2019 spt,cross,forward

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Welcome to the Sessionon

Foreign Exchange Market

Operations: Spot, Cross and ForwardTransactions


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Foreign Exchange Market

Foreign exchange is the trading of currencies.

The foreign exchange market is not a single placelike the NY Stock Exchange (NYSE). It is a widelydecentralized 24-hour-a-day market, made up of

banks and traders communicating electronically.

The retail market is between individuals,nonfinancial companies, nonbank financialinstitutions, and other customers of banks.

The wholesale or interbank market is the tradingbetween banks. This accounts for 60% or more ofthe total trading.


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Scope of the Market

About half the daily foreign exchange

trading is done between banks in London

and New York.

Most of the trading involves U.S. currency.

Sometimes the intent is to trade one foreign

currency for another, and the U.S. currency

is only involved as an intermediate step.When this is done, the dollar is called a

vehicle currency.


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Size of the Market

A. Largest in the world

2004: US$1.9 trillion daily

or

US$475 trillion a year


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Size of the Market

Market Centers (2004):

#1: London = $753 billion daily

#2: New York= $461 billion daily

#3: Tokyo = $199 billion daily


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Exchange Rate : Some Basics

The exchange rateis the price of one countrys money interms of another countrys money.

The spot exchange rate is the price for immediateexchange. (Immediate usually means within two workingdays.) This amounts to about 33% of all trading.

The forward exchange rate is the price for exchange totake place at some specific time in the future, often 30, 90,180 days. This amounts to about 11% of all trading.

A swap is a package trade that includes both a spot

exchange of two currencies and a contract to the reverseforward exchange a short time later. This is useful when theparties to the swap have only a short-term need for thecurrency. This amounts to about 56% of all trading.


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Examples of Currencies

Country Currency Symbol ISO Code

US Dollar $ USD

UK Pound GBP

Canada Dollar C$ CAD

Mexico Peso Ps MXP

Japan Yen JPY

EU Euro EUR


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Exchange Rate : Some Basics

The exchange rate can be given as the price

of the foreign currency in terms of the

domestic currencythis is the usual way,

and the way well use in this session. Or as the price of the domestic currency in

terms of the foreign currency.


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Exchange Rate Quotation

Quoted Currency means the currency that

is variable in an exchange rate quotation.

Base Currency means the currency that is

fixed.

Thus if1 = Tk.130.00, sterling is the base

currency and the BDT is the quoted

currency.


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In Direct Quotation Base Currency is the

Foreign Currency and the Quoted Currency is

the Domestic Currency.($1= Tk.69.50)

In Indirect Quotation Base Currency is the

Domestic Currency and the Quoted Currency

is the Foreign Currency. (Tk.1= $0.0144)


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In American Terms Base Currency is any

Currency other than USD and the Quoted

Currency is USD (Tk.1= $0.0144).

In European Terms Base Currency is the USD

and the Quoted Currency is any Currency

other than USD ($1= Tk.69.50).


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Reciprocal Quotations

Currencies can be quoted in terms of the

number of units of A per unit of B or,

alternatively, the number of units of B per

unit of A. The two rates represent equal valueand are reciprocals of each other. To convert

from one method to the other, one simply

divides the number 1 by the rate.


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Reciprocal Quotations

USD 1/Tk.69.50 =

= 0.0143 BDT/USD

1

69.50BDT/USD


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Example: Spot Market Transaction

1. Bangladeshi firm buys a U.S. product from a U.S.firm, which requires payment in U.S. dollars ($).

2. The Bangladeshi firm contacts its bank, gets aquote on the dollar-taka exchange rate, and

approves it.

3. The Bangladeshi firm instructs its bank to take takafrom its checking account, convert these to dollars,and transfer the amount to the U.S. producer.

4. The Bangladeshi bank instructs its correspondentbank in New York to take U.S. dollars from itsaccount and pay the U.S. producer by transferringthem to the producers bank.


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Spot Market Transaction

USD $ 1= Tk.69.10/15

In the above quotation, market maker iswilling to buy 1 U.S. dollar at Tk. 69.10and sell U.S. dollar at Tk. 69.15.


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Spot Market Transaction

Transactions Costs

1. Bid-Ask Spreadused to calculate the fee

charged by the bank

Bid = the price at which the bank is willing tobuy

Ask = the price it will sell the currency


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Percent Spread Formula (PS):

100xAsk

BidAskPS


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Quoting Spot Rate to Customers

The basic principle1. Ascertain the going exchange rate in the

wholesale market (inter-bank market)

2. Load a margin and make a customer quoteExample

Market Rate: USD1= Tk. 69.50/60

Required margin: 0.10 Tk.So, the rate will be USD1= Tk.69.40/69.70


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Cross Rates

A cross-rate may be defined as an

exchange rate that is calculated from

two other rates.

In practice, cross-rate is the exchange

rate between 2 non - US$ currencies.


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Calculating Cross Rates

If both currencies involved in the cross

transaction are quoted in the same

form(American or European) divide the

spot rate of one currency by the the spot

rate of the other currency.


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Calculating Cross Rate: Example

$/Tk. : 69.35

$/ : 0.7828

Then,

/Tk. : 69.35/.7828= Tk.88.5922

$

$$$

TkTk

Tk

Or /Tk.


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Calculating Cross Rates

If one currency is quoted in one form

and the other currency is quoted in

another form, multiply the spot rate.


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Calculating Cross Rate: Example

$/Tk. : 69.35

/ $ : 1.2774

Then,

/Tk. : 69.35

1.2774= Tk.88.5876

$

$

Tk

Tk


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Calculating Cross Rates: Both European

USD/EUR 0.7828 - 0.7848

Divide by

USD/GBP 0.5246 - 0.5266

GBP/ EUR = 1.4865-1.4959


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Calculating Cross Rates: Both American

EUR/USD 1.2742 1.2774

Divide by

GBP/USD 1.9042 1.9062

EUR/ GBP = 0.6684-0.6708


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Calculating Cross Rates: One American-One European

EUR/USD 1.2742 1.2774

Multiply by

USD/ GBP 0.5246 0.5251

EUR/ GBP = 0.6684-0.6708


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Forward Rates

It is an ER for the transaction to be happened

at some future date , but agreement for the

transaction is to be done today. Forward rateis quoted either at premium(+) or at discount

rate(-) over spot rate. In case of direct

quotation, premium will be added to and

discount will be subtracted from spot rate. The

reverse is for indirect quotation.


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Quotation of Forward Rates

Forward at Premium (pm)

Forward at Discount (dis)

Forward at par meaning the Forward

Rate at a Parity with the Spot Rate.


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Premium and Discount

The quoted currency is said to stand at a

premium in the forward market if it is more

expensive in the future than it is now in termsof the base currency. Conversely, the base

currency may be said to stand at a discount

relative to the quoted currency.


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Forward/SWAP Points

SWAP Points (Low - High)

USD/EUR 1 Month SWAP 30/40

SWAP Points (High -Low)

USD/EUR 1 Month SWAP 40/30


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Forward/SWAP Points

SWAP Points (Low - High)

Forward Rate at Premium for the base

currency

SWAP Points (High -Low)

Forward Rate at Discount for the base

currency


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Treatment of Forward Margin

High/Low = Subtract

Low/High = Add

Low High = Add

High Low = Subtract


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Basis for Forward Rate

Forward Points Represent the interest Rate

Differential between the Two Currencies

involved in the TransactionMethod

Spot RateInterest Rate Differential Period Annualized

=360100

..

TimeinDaysDiffINtSpot


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Calculating Forward Rate

Spot Rate: GBP/USD = 1.90

Interest Rate in USA : 8%

Interest Rate in UK: 16%


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Forward Points =

= 0.032

So, 90 days forward rate will beGBP/USD= 1.868

360100

90890.1


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The currency with relatively higher

interest rate will be cheaper in the forward

market and the currency with relatively

lower interest rate will be expensive in the

forward market.


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Calculating Interest RateDifferential from Forward Points

Interest Diff.=

FP- Forward Points

RB-Rate Basis

SR-Spot Rate

TermSR

RBFP

100


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CALCULATING THE FORWARD PREMIUMOR DISCOUNT

= F-S x 12 x 100S n

where F = the forward rate of exchange

S = the spot rate of exchangen = the number of months in the

forward contract

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