FX Markets

5/25/2018 FX Markets

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FX and money Markets

Adrian Codirlasu, CFA, PhD


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Money market

All interbank and other wholesale market

transactions which involve the loan or

deposit of a currency for an agreed periodor for repayment after an agreed period of

notice at an agreed rate of interest

Maturity up to one year (generally)


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Eurocurrencies

The particular currency dealt is not the local

domestic currency of the country in which the

deposit is placed Eurocurrency markets consist of international

and other commercial banks in a number of

financial centers, which perform the wholesale

function of matching the supply of and demandfor currencies on a loan/deposit basis between

interbank and other market participants


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Exchange rate definition

Exchange rates express the value of a unit

of one currency in other currency

Example, USDCHF 1.3950 shows theprice of one dollar in Swiss francs


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FX market

All transactions which involve the

exchange of one currency for another on

an agreed value date at an agreed rate ofexchange

Types of transactions: spot, short date and

outright forwards and foreign exchangeswaps


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ISO 4217 standard

Currencies should always be abbreviated

using their International Standards

Organization (ISO) codesAs a general rule they are made up of two

letters for the country and one for the

currency abbreviation, i.e. United States(US) dollar (D) = USD, Japanese (JP) yen

(Y) = JPY


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Currency pairs

One currency in any quoted currency pair

remains constant and is referred to as the base

currency (or the certain currency in Bank of

England terminology) The second currency is the quoted or

countercurrency (or the uncertain currency in

Bank of England terminology)

The exchange rate is quoted as the number ofunits of the uncertain currency to be exchanged

for one unit of the certain currency


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Currency pairs

XXXYYY

XXX certain currency

YYY uncertain currency

Exception YYY:

USD certain currency

YYY uncertain currency


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Market participants Central banks

Commercial banks

Investment banks

Other financial institutions (insurance

companies)

Multinational corporations

International trading companies

Private clients Hedge funds

Brokers

Electronic matching systems


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Central banks

Role to control and ensure the smooth

operation of the foreign exchange and

money markets in their local currency, with

the institutions of the major centrescollaborating in times of market turbulence


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Exchange rate regimes

Floating

Managed floating

Target zone

Crawling (peg, band)

Fixed Currency board

Monetary union


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Commercial banks

Institutions which, rather than acting as

market makers in the interbank market,

are happy to quote their own customers

dealing rates for transactions in various

markets and products and then, acting as

market users, contact their correspondent

banks to cover such transactions, perhapspreferring to make a small margin per deal

rather than run a risk position


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Investment banks

Major operators in the worlds financial

markets.

They are constantly seeking opportunitiesto improve investment returns and use the

foreign exchange and money markets and

associated products to this end


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Multinational corporations

Many worldwide commercial enterprises which

have over the years grown into operations

spanning many different industries and countries Many of these are able to operate in similar

fashion to banks in the markets and some have

even diversified into the financial services

industry using foreign exchange and moneymarket activities to add value to their other

commercial operations


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International trading companies

Involve themselves in the financial

markets only to support their mainstream

commercial activities, i.e. entering themarkets only when it is necessary to

repatriate foreign currency earnings or

provide foreign currency cover for theirongoing business


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Private clients

Transactions done by high net worth

individuals (some in multi-million currency

units) switching currencies in theirconstant search for the best return on

global investments


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Hedge funds

Are able to enter the foreign exchange and

money markets with consolidated amounts

far in excess of those availableindividually.

These managed funds have over recent

years caused high market activity andhave on occasions been blamed for

periods of speculation and currency unrest


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Traditional/voice brokers

Brokers in the foreign exchange and moneymarkets and associated treasury derivative

markets are intermediaries only

These brokers do not operate on their own

account, merely on-quoting their clientinstitutions bid and offer prices to all market

participants with the express intention of

achieving the finest (closest) spread between

bid and offer in an attempt to encourage

participants to deal through their offices, thereby

earning a commission on each transaction

closed


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Electronic matching system

Electronic matching systems such as Reuters

2000/2, EBS and Bloomberg now provide

dealers with a further alternative to close

exchange transactions.

The market penetration of these electronic

matching systems has increased dramatically in

recent years and their scope has become morediverse.

A wide range of currency pairs and products are

now available via these means.


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FX market

OTC

Deregulated

Brokers

Matching platforms: EBS, Reuters,

Bloomberg

Banks individual platforms


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Participants

Market makers (financial institutions)

Market takers (financial institutions,

corporates, hedge funds)


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Market making

The custom for the calling counterparty

(market user) to ask the market maker for

his two-way price (to buy/sell in foreign

exchange markets and to borrow/lend in

interest rate markets)

The market maker dictates the two-way

price and gets the benefit of the spread


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Quotation methods

Spot foreign exchange: bidoffer for the

base currency

Forward foreign exchange: bidoffer forthe base currency

Money market: bidoffer for the cash (low

high in interest rate terms)


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Money markets


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Money market

Cash-based transactions involving the

lending and borrowing of funds which are

paid away/received on the start date andrepaid on a fixed date or determinable

maturity


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Interest payment

The payment of interest on fixed deposits

and loans up to one years duration occurs

at maturity along with repayment of theprincipal amount invested.

If the deposit/loan is for a longer period

than 12 months then interest is payableannually on the anniversary and at final

maturity


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Base

Money market actual/360

Sterling money market - actual/365

Government bonds actual/actual Eurobonds 30/360

actual refers to the actual number ofdays in any period for which interest is

being calculated


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Translations


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Exercise

What is the equivalent of a money market

yield of 6.00 percent in terms of a

eurobond coupon rate?A: 6.0000%

B: 6.0833%

C: 5.9178%

D: 5.8750%


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Exercise

Which of the following rates represents the

best yield?

A: Semi-annual money market yield of4.50%

B: Semi-annual bond yield of 4.50%

C: Annual bond yield of 4.50%

D: Annual money market rate of 4.50%


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Annual vs. semiannual yield


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Exercise

A semi-annual CHF rate is 5 percent.

What is the effective annual yield?

A: 4.939%

B: 4.945%

C: 5.0000%

D: 5.0625%


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Exercise

An annual DKK rate is 5 percent. What is

the effective semi-annual yield?

A: 4.939%

B: 4.945%

C: 5.0000%

D: 5.0625%


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Time value of money


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LIBOR

LIBOR (London Interbank Offered Rate) is the moneymarket benchmark interest rate

BBA LIBOR offered rates per period for the major

currencies are obtained from 16 reference banks in

London selected by the BBA on the basis of private

nominations and discussions with advisory panels of

senior market practitioners

These banks are selected to reflect the balance of the

market in terms of country of origin and type of institutionand on the basis of reputation, scale of market activity

and perceived expertise in the currency


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EURIBOR

European Banking Association (EBA) fixes

a similar daily benchmark rate by

reference to a panel of 57 banks Because of the wider spread of reference

banks (some perhaps with a lesser credit

rating or market standing than for the BBAEuro LIBOR fixing), EURIBOR is typically

always higher than EUR LIBOR


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FX markets


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Dates

Trade date date of the trade

Value date date of the settlement


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Value dates

Spot (T + 2, exceptionally T + 1)

Ante-spot dates (TDY, TOM)

Forward


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Quotation

EURCHF 1.2500/10

How many Swiss francs for one euro

1.25 big figure

bid/ask 00/10 pips

CHF 0.9590/95

How many Swiss francs for one USD


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Direct vs. indirect quotation

Direct XXX: how many XXX per USD

Most of the currencies

RON 10 Mio means USDRON 10 Mio

Indirect YYY: how many USD per YYY

EUR, GBP, AUD, NZD means EURUSD,

GBPUSD, AUDUSD, NZDUSD

EUR 10 Mio means EURUSD 10 Mio


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Spot trade - confirmation

Pair

Rate

Direction buy/sell

Amount (in first currency)

Bank for bought currency


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Exposure

EURUSD, 1.3750, notional EUR 1 Mio

Long: buyEUR, sell USD, at 1.3750,

notional of the trade EUR 1 Mio

Short: sell EUR, buy USD, at 1.3750,

notional EUR 1 Mio


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Spot trade - confirmation

At 1.3750 I buy EURUSD

Amount EUR 1 Mio

My EUR to Deutsche Bank


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Orders

Limit (take profit)

Stop loss

One cancel another OCO

If done


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Exercise

Four banks in the international market

quote you spot USD/JPY. Which is the

best quote for you as a buyer of JPY?A: 121.49 53

B: 121.45 51

C: 121.50 57

D: 121.47 52


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Cross currencies

Cross currency rates are traditionally

those exchange rate quotations which

neither include the US dollar nor thepound sterling as one of the currencies


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Cross currency calculation rules

One direct (to a USD base) and one indirect (to a non-

USD base) quoted currency against the US dollar:

condition 1 multiply the same sides (left-hand side by left-hand side and right-hand

side by right-hand side)

Both direct quoted currencies against the US dollar (to a

USD base): condition 2

or

both indirect quoted currencies against the US dollar (toa non-USD base): condition 3 cross divide opposite sides (left-hand side by right-hand side and right-

hand side by left-hand side)


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Exercise

A client wants to sell CHF against GBP.

The USD/CHF rate is 1.4915/20, the

GBP/USD rate is 1.4628/33. What rate do

you quote to the client?

A: 2.18 24

B: 2.18 32C: 2.18 17

D: 2.18 47


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Exercise

USD/CHF is 1.52 50/55 and USD/JPY is

120.20/25. What price would you quote to

a customer who wishes to sell JPY against

CHF?

A: 78.79

B: 78.82

C: 78.81

D: 78.85


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Exercise

USD/CHF is quoted 1.5005/15 and

GBP/USD as 1.6120/30. At what rate

could you buy GBP and sell CHF?A: 2.4188

B: 2.4203

C: 2.4219

D: 1.0742


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Outright forward

One-way transaction to buy or sell one

currency against another (like a spot

transaction) except that it is for a fixedforward value date


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FX swap

Money market transactionAn exchange of cash flows in the two

currencies of the swap over a period

ranging from one day (overnight ortom/next) to a number of months,

sometimes years

Consists of two transactions reversingeach other, one date against a further

forward date, most frequently spot against

a forward date


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Quotations

Forward rates are quoted as a two-way

price in forward swap points

These points are adjustments to be madeto the spot price to achieve the forward

exchange rate applicable to the dates in

question


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EURRON Forward prices

EUR/RON Swap Forward

spot rate points rate

1 Month 4.3000 645 4.3645

3 Months 4.3000 1940 4.4940

6 Months 4.3000 3150 4.6150


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Forward trade - confirmation

Pair (EURUSD)

Forward rate 1.3760: spot rate 1.3750,

swap points 10 Buy/sell

Settlement date

Amount EUR 1 Mio Settlement place (my EUR/USD to)


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Swap points


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Implied rates


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Exercise

Spot EUR/USD is quoted 0.9500 (midpoint). If six months (180 days) USD

interest rates are quoted 5.50 percent and

same period EUR are 4.50 percent, what is

the approximate level of the EUR/USD

forward swap points in dealer terms?

A: 45 47

B: 47 45

C: 4.70 4.50

FX Markets

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