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Fundamentals of Financial Services Foreign Exchange Chapter 7.2.1

Key Topic Areas Characteristics of the foreign exchange market Currency trading Exchange rates

By the end of the lesson: Lesson Objectives By the end of the lesson: Everyone MUST know: The basic characteristics of the foreign exchange market Currency trading Exchange rates

Daily foreign exchange activity exceeds $5 trillion Changing a particular quantity of one currency for another currency We mainly know of exchanging currencies when we go on holiday The US dollar is regarded as the most important currency in the world and it is typical for foreign exchange rates to be quoted against the US$. Foreign exchange activity is much larger for businesses who buy and sell things across borders Banks and their dealers offer services to clients arising from international trade and travel with fees earned as a result. Daily foreign exchange activity exceeds $5 trillion

Price at which a pair is bought and sold is the exchange rate Currency Quotes Trading of foreign currencies clearly involves selling one currency and buying another, the two currencies involved are described as ‘pairs’. Price at which a pair is bought and sold is the exchange rate Base Currency The first currency quoted in a pair It is always equal to one unit of that currency Counter or Quote Currency The second currency quoted in a pair 1 : 0.75 In this case $1 is worth £0.75 GBP USD When the exchange rate is being quoted, the name of the each currency is abbreviated to a three letter reference Most commonly quoted currency pairs: USD JPY USD Eur USD CHF GBP USD Eur GBP

Quote 1.1164/66 Currency quotes GBP USD When currency pairs are quoted, the foreign exchange trader will quote a bid and ask price: Quote 1.1164/66 GBP USD When quoting, the base currency is not mentioned as the convention is that the base currency is always 1 In this case: If a client wants to buy £100,000 he will need to pay the higher of the two prices ($1.1166) and deliver $111,660 If a client wants to sell £100,000 he will need to pay the lower of the two prices ($1.1164) and receives $111,640

Currency Trading The forex market is primarily an over-the-counter (OTC) market, where brokers and dealers negotiate directly with each other. London has grown to become the world’s largest forex market due to it’s ideal location between the Asian and American time zones Continually provide the market with both bid (buy) and ask (sell) prices Use the market to try to control money supply, inflation and interest rates. Individual forex traders (i.e. retail investors) are becoming increasingly important in the global forex market.

Exchange Rate Activity Complete the table… ISO 4217 Currency Codes Country Name of currency Symbol £1 = ? AUD GBP CAD CNY DKK EUR HKD INR JPY RUB CHF ZAR SEK USD Working in pairs, follow the instructions to complete the table on your worksheet

Exchange Rate Activity Complete the table… ISO 4217 Currency Codes Country Name of currency Symbol £1 = ? AUD GBP CAD CNY DKK EUR HKD INR JPY RUB CHF ZAR SEK USD Australia Australian Dollar Great Britain British Pound Canada Canadian Dollar China Chinese Yuan Denmark Danish Krone Eurozone Euro Hong Kong Hong Kong Dollar India Indian Rupee Japan Japanese Yen Working in pairs, follow the instructions to complete the table on your worksheet Russia Russian Rouble Switzerland Swiss Franc South Africa South African Rand Sweden Swedish Krona United States United States Dollar

Case Study: Usain Usain is visiting London for a short break. He is normally based in the US, so all of his money is in US dollars. He knows he will need some UK sterling to pay for taxis, buses, food and entertainment. He draws a lot of US dollars out of his US bank and sells them for UK sterling at the foreign exchange dealer’s kiosk at the airport. This means Usain has entered into a currency trade.

Case Study: Usain The amount of UK sterling that Usain receives at the kiosk will be determined by the prevailing exchange rate between US dollars and UK sterling. The quoted rates might be as follows: Dollars per Pound 1.54 – 1.64 Pounds per Dollar 0.61 – 0.65 There are two sets of quotes: The first quote is the number of US dollars per pound. The second quote is the number of UK pounds per dollar. Which of the two rates will be highlighted by the kiosk assistant for Usain?

Case Study: Usain Dollars per Pound 1.54 – 1.64 Pounds per Dollar 0.61 – 0.65 Which of the two rates will be highlighted by the kiosk assistant for Usain? The relevant rate for Usain is the number of UK pounds per US dollar, since he is SELLING DOLLARS FOR UK POUNDS, so the 0.61 – 0.65 is the quote that will be highlighted. Each quote is made up of two figures, a lower figure on the left and a higher figure on the right. The relevant side depends on whether the client at the kiosk is buying or selling the particular currency.

How many pounds will Usain get, assuming he is selling $1,000? Case Study: Usain Dollars per Pound 1.54 – 1.64 Pounds per Dollar 0.61 – 0.65 How many pounds will Usain get, assuming he is selling $1,000?

Case Study: Usain Dollars per Pound 1.54 – 1.64 Pounds per Dollar 0.61 – 0.65 Usain’s holiday break in the UK is now over and he still has £100 in cash. Assuming that the quote at the kiosk is still the same, how many US dollars can Usain expect?

Flipping an exchange rate quote EUROs per £ 1.245 – 1.255 A foreign exchange dealer is quoting the following rate for the number of euros per UK pounds. The foreign exchange dealer’s quote of euros per UK pound needs to be flipped to provide the number of UK pounds per euro. £s per EUR: 1/1.255 = 0.797 – 1/1.245 = 0.803 So the quoted would be £s per EUR: 0.797 – 0.803

Currency Jargon Sell rate This is the rate at which we sell foreign currency in exchange of local currency. For example, if you were heading to Europe, you would exchange British pounds for Euros at the sell rate. Buy rate This is the rate at which we can buy foreign currency back from you into your local currency. For example if you were returning from America, we could exchange your US Dollars back into British pounds at the buy rate of the day. Definitions and examples from: Travelex Ltd Website

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