1. Chapter 2: The Foreign Exchange Market
Power Points created by:
Joseph F. Greco Ph. D.,
California State University, Fullerton
Mihaylo College of Business and Economics
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2. Chapter 2: The Foreign Exchange Market
2.1 The Organization of the Foreign Exchange Market
2.2 Currency Quotes and Prices
2.3 Inside the Interbank Market I: Bid-Ask Spreads and Bank Profits
2.4 Inside the Interbank Market II: Communications and Fund Transfers
2.5 Describing Changes in Exchange Rates
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3. 2.1 The Organization of the Foreign Exchange Market
The Organization: Overview
Size of the Market
Types of Contracts Traded
Foreign Exchange Brokers
Computerized Trading Systems
The Competitive Marketplace
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4. Exhibit 2.1 The Structure of the Foreign Exchange Market
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5. 2.1 The Organization of the Foreign Exchange Market
Size of the Market
Largest financial market in the world,measured by dollar volume of trade
Types of Contracts Traded
Focus in this chapter is on a spot market contract that is settled in 48 hours
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6. Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall
London、NewYork、Paris等市场 at the third day;香港市场，HongKong dollars exchange for dollars at the trading day for delivery;HongKong dollars exchange for JPY at the next day.
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7. Exhibit 2.2 Foreign Exchange Trading Activity Around the World
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8. 2.1 The Organization of the Foreign Exchange Market
Foreign Exchange Dealers
Foreign exchange dealers
Market makers
Liquidity
Easy to match buyers and sellers
Low transaction costs
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9. Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall
Foreign Exchange brokers
market matching
financial intermediary
Easy to match buyers and sellers
Low transaction costs
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10. 2.1 The Organization of the Foreign Exchange Market
Computerized Trading Systems
Dealing 3000
EBS
The Competitive Marketplace
low cost
no abnormal profits
no single dealer dorminates market
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11. Exhibit 2.3 The Top 20 Dealers in the Foreign Exchange Market
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12. 2.2 Currency Quotes and Prices
Currency Quotes and Prices: Overview
Exchange Rates
Exchange Rate Quotes
Vehicle Currencies and Currency Cross-Rates
Example:
Trading currency in the New York market where both currencies are not expressed in U.S. dollars
Triangular Arbitrage
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13. Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall
Example of cross rate
1.USD/DEM=1.8421/28,USD/HKD=7.8085/95
so,DEM/HKD
Answer:
bid price of DEM=7.8085/1.8428=4.2373
ask price of DEM=7.8095/1.8421=4.2395
DEM/HKD=4.2373/95
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14. Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall
2.GBP/USD=1.6125/35,AUD/USD=0.7120/30
so,GBP/AUD
Answer
bid price of GBP=1.6125/0.7130=2.2616
ask price of GBP=1.6135/0.7120=2.2662
GBP/AUD=2.2616/62
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15. Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall
3.GBP/USD=1.6125/35,USD/JPY=150.80/90
so,GBP/JPY
Answer
bid price of GBP=1.6125*150.80=243.17
ask price of GBP=1.6135*150.90=243.48
GBP/JPY=243.17/48
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16. 2.2 Currency Quotes and Prices
Exchange Rates
Exchange Rate Quotes
Direct quotes
Indirect Quotes
European Quote
American Quote
Dollar price of a foreign currency
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17. Exhibit 2.4 Currencies and Currency Symbols
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18. Exhibit 2.5 Currency Quotes in the Wall Street Journal
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19. 2.2 Currency Quotes and Prices
Vehicle Currencies and Currency Cross-Rates
Vehicle currency
Cross-rates
Example:
Trading currency in the New York market where both currencies are not expressed in U.S. dollars
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20. Exhibit 2.6 Cross-rates Quotes in the Wall Street Journal
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21. 2.2 Currency Quotes and Prices
Triangular Arbitrage
An arbitrage process involving three currencies
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22. Exhibit 2.7 Triangular Arbitrage Diagram
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23. Exhibit 2.8 Good and Bad Triangular Arbitrages
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24. Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall
NewYork:USD/DEM,1.5020/30
NewYork:USD/GBP,0.5875/0.5885
London:GBP/DEM,2.5610/2.5620
if customer holding 1000,000,first NewYork *0.5875=£587500
London587500*2.5610=DM
NewYork /1.503=
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25. Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall
customer hold 1000,000 Pound, London *2.5610=DM
NewyorkDM /1.503=＄
Newyork＄ *0.5875=£
customer hold DM,
NewYork /1.503=＄665336
NewYork＄665336*0.5875=£390885
London£390885*2.5610=DM
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26. 2.3 Inside the Interbank Market I: Bid-Ask Spreads and Bank Profits
The Interbank Market: Overview
Introduction
Bid-Ask Spreads
The difference between the ask rate and the bid rate
The Magnitude of Bid-Ask Spreads
Bid-Ask Spreads All Day Around the Work
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27. 2.3 Inside the Interbank Market I: Bid-Ask Spreads and Bank Profits
Introduction
Bid rate
Ask Rate
Bid-Ask Spread
Bid-Ask Spreads
Offer Price
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28. 2.3 Inside the Interbank Market I: Bid-Ask Spreads and Bank Profits
The Magnitude of Bid-Ask Spreads
Pip
Fourth decimal place in a dealer’s quote
percentage spread=100*(ask-bid)/ask
ask rate is ＄1.1895/*,bid rate is ＄1.1891/*
the spread is 100* /1.1895=0.03%
Bid-Ask Spreads
The difference between the bid and the ask rates
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29. 2.4 Inside the Interbank Market II: Communications and Fund Transfers
Communication Systems
Society of Worldwide Interbank Financial Telecommunications (SWIFT)
Clearing House Interbank Payments System (CHIPS)
Trans-European Automated Real-time Gross Settlement Express Transfer (TARGET)
Fedwire
Cross-Currency Settlement (Herstatt Risk)
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30. Exhibit 2.9 The Reciprocal Nature of Bid and Ask Exchange Rates
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31. the reciprocal nature of bid ask spread
from the picture, we can see in selling yen for dollars , the seller will receive the bid price of ＄/¥ which is the reciprocal of the bank's ask yen price per dollar 1/(¥/＄), in selling dollar for yen, receive bank' s bid price of yen to dollar is the reciprocal of bank's ask price of dollars for yen.
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32. Exhibit 2.10 Communication Systems in the Forex Market
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33. 2.4 Inside the Interbank Market II: Communications and Fund Transfers
Cross-Currency Settlement (or Herstatt) Risk
The risk that a financial institution may not deliver the currency on one side of a completed transaction
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34. 2.5 Describing Changes in Exchange Rates
Introduction
Appreciation
Depreciation
Devaluations
Revaluations
Rates of Appreciation and Depreciation are used to describe changes in exchange rates when exchange rates are allowed to be flexible
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35. Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall
devalution and revaluation means some country use fixed or peg exchange rate system if the monetary authorities increase the demestic currency price of foreign exchange , they are devaluating their money , or is revaluating
P61
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36. Exhibit 2.11 Netting Arrangements
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37. Exhibit 2.11 Netting Arrangements
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