Forex Markets

In FX markets, traders buy and sell national currencies.

Issues in Forex Markets

Bank of England Fixing Reports

Tom Hayes Prosecution

High Frequency Trading Flash Crash

Exchange rates

The price of one currency in terms of another. It is constructed via “Quote currency / base currency” and exchange rates are expressed as bid-offer rates.

Purchasing Power Parities

Explains as how much of a unit of currency would be needed to purchase the same basket of goods and services in two different countries.

PPP

It considers the inflation in different countries and implies that the future spot FX rate should reflect the inflation.

E(S₁) = S₀ x [1 + (h_FC - h_HC)]

IRP

IRP implies that the relation between forward FX rate and current spot FX  rate should include the different countries’ interest rates.

F_t = S₀ x [1 + (R_FC - R_HC)]^t

^{To prevent carry trades and arbitrage}

UFR

It implies that the future expected spot rate should not be different than the forward FX rate for the same time period. Otherwise, there will be arbitrage in FX trading.

F_t = E(S_t)

IFE

IFE states that different countries can have different interest rates and inflation; BUT the difference between these two factors should be the same throughout the countries to prevent arbitrage.

R_HC - h_HC = R_FC -h_FC