CH 5: The Market for Foreign Exchange

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17 Terms

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The Spot Market

A financial market where assets such as commodities and securities are bought and sold for immediate payment. Prices are determined by supply and demand.

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Direct quotation

The US dollar equivalent “Japanese yen is worth about a penny”

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Indirect quotation

The price of a US dollar in the foriegn currency “You get 100 yen to the dollar”

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Market mircostructure

refers to the mechanics of how a marketplace operates.

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a)Bid asks spread increase with

b)Decreases with

a) exchange rate volatility

b) decreases with dealer competition

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A forward contract

an agreement to buy or sell an asset in the future at prices agreed upon today

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a)If you agreed to sell anything (spot or forward) you are

b) If you agreed to sell forex forwards you are

a)short

b)short

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a) If you agreed to buy forex forward you are

b) If you agreed to buy forex forward you are

a)Long

b)Long

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Swaps

An agreement to provide a counterparty with something they want such as cash flows, assets, or liabilities over a period of time in exchange for something you want. Commonly used for hedging risks or speculative purposes in financial markets.

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Participants of FX markets can be classified into 5 groups

  1. International banks

  2. Bank customers

  3. Non bank dealers

  4. FX brokers

  5. Central banks

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(SWIFT) The Society for Worldwide Interbank Financial Telecommunication

allows international banks to communicate instructions

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Triangular Arbitrage

The purpose of a triangular arbitrage is to earn an arbitrage profit by trading among 3 currencies when the quoted cross-exchange rate is not in alignment with the implied cross-exchange rate

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Implied cross-rate bid discipline

If the direct quote is not consistent with cross-exchange rates, a triangular arbitrage is possible

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An outright forward transaction is an

uncovered speculative position in a currency.

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Exchange -Traded Currency Funds

ETF is a portfolio of financial assets in which shares representing fractional ownership of the fund trade on an organized exchange. Allows small investors the opportunity to invest in portfolios that would have been difficult to construct individually.

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The Fx market

the largest and most active financial market

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The Retail market

Where international banks service their customers who need foreign exchange to conduct international commerce.