1. Foreign Exchange Market Overview Convention and Terminology Mechanics and Operations Instruments ปริทรรศน์ เหลืองอุทัย, CFA, FRM 9 August 2006

2. © 2006 ปริทรรศน์ เหลืองอุทัย, CFA, FRM 2 Historical Perspective 1880-1914 : Gold Standards 1918-1939 : The War Periods 1944-1970 : The Gold Exchange Standard 1971-1973 : The Collapse of Bretton Woods 1985 : The Plaza Accord 1997 : Floatation of Thai Baht 1999 : Introduction of the Euro 2002 : Continuous Linked Settlement (CLS)

3. © 2006 ปริทรรศน์ เหลืองอุทัย, CFA, FRM 3 Settlement Every trade executed has to be settled. Settlement risk is the risk that one side to a transaction pays out its obligation in one time zone but the counterparty to the transaction fails to make the corresponding payment in a different time zone. A number of initiatives : FXNET, the oldest and the most successful, provides an automated bilateral netting solution, which is a legally binding agreement between pairs of counterparties in which transactions are netted continually throughout the trading day. Today around 20% of all FX transaction obligations are netted via FXNET.

4. © 2006 ปริทรรศน์ เหลืองอุทัย, CFA, FRM 4 Continuous Linked Settlement In September 2002, the CLS Bank was launched to provide a solution called Continuous Linked Settlement. CLS operates by linking all of the world’s settlement periods and indeed, truncating them, into a period of just five hours. Acting in effect as a clearing hours, CLS receives payments in but does not pay them out until the correspondent payments are also received. Hence, CLS settles FX transaction on a payment- versus-payment (PVP) basis in the book of CLS Bank. CLS eliminates settlement risk and reduces the liquidity needed.

5. The Foreign Exchange Market

6. © 2006 ปริทรรศน์ เหลืองอุทัย, CFA, FRM 6 Financial Market Structure Equity Markets Bond Markets Foreign Exchange Markets Derivatives Markets Money Markets Capital Markets

7. © 2006 ปริทรรศน์ เหลืองอุทัย, CFA, FRM 7 Basic Definition A Currency is a medium of exchange, coins or notes, used to buy goods or services. Most countries have their own currency, issued by an official agency called a central bank or a monetary authority. Foreign Exchange (F/X or Forex) is the transaction that involves the purchase of one currency against the sale of another currency for settlement or delivery on a specified date. The Exchange Rate is the price per unit of one of the currencies expressed in units of the other currency.

8. © 2006 ปริทรรศน์ เหลืองอุทัย, CFA, FRM 8 Foreign Exchange Markets A complex network of global over-the-counter institutions and structures 3 Key functions : –Exchange of one currency for another (transfer of purchasing power) –Management of exchange rate risk (transfer of risk) –Exchange rate determination The market is geographically dispersed. The U.S. dollar makes up the highest percentage of the total daily turnover shares. Currency2001 USD90.4 EUR37.6 JPY22.7 GBP13.2 CHF6.1 CAD4.5 AUD4.2 SEK2.6 HKD2.3 SGD1.1 Emerging Markets5.2 Other10.1 TOTAL200 Percentage Shares of Daily Turnover Source : Bank for International Settlements (BIS)

9. © 2006 ปริทรรศน์ เหลืองอุทัย, CFA, FRM 9 Market Overview The Foreign Exchange Market allows market participants to exchange one currency for another. It is a communication network linking all participants. Foreign exchange market is the single largest market in the world. More than USD 1.2 trillion is traded in the FX market each day. London (38%) is the largest trading center in the world, followed by New York (22%), Tokyo (10%), and Singapore (9%).

10. Foreign Exchange Instruments

11. © 2006 ปริทรรศน์ เหลืองอุทัย, CFA, FRM 11 Foreign Exchange Instruments FX Transactions Spot FXForward FX Forward OutrightFX Swaps FX Derivatives

12. © 2006 ปริทรรศน์ เหลืองอุทัย, CFA, FRM 12 Foreign Exchange Transaction A foreign exchange transaction is composed of spot, outright forward, and swaps. Average daily turnover for all currencies in April 1998 was $1.4415 trillion (in 2001 was $1.210 trillion). Transaction breakdown in 2001 was : –32 percent spot transactions, –11 percent over-the- counter forwards, and –54 percent foreign exchange swaps. Instruments Daily Averages (Billion of USD) Spot Transactions387 Outright Forwards131 Foreign Exchange Swaps 656 TOTAL Turnover1,210 Percentage Shares of Daily Turnover Source : Bank for International Settlements (BIS)

13. © 2006 ปริทรรศน์ เหลืองอุทัย, CFA, FRM 13 Spot Transactions A spot transaction involves the exchange of one currency for another at an agreed exchange rate to be settled in cash in two business days between two counterparties. Spot transactions account for about 32 percent of all transactions in the foreign exchange market. A spot transaction is intended to transfer purchasing power from one party to another. 1M + Spot Today Spot ON TN 1M 6M + Spot 1Y + Spot 6M 1Y Time Tom

14. © 2006 ปริทรรศน์ เหลืองอุทัย, CFA, FRM 14 Spot Foreign Exchange The normal settlement period for “spot” deals is two working or business days. About one-third of all the business transacted in the foreign exchange market is for settlement or “value date” spot. For example, if the deal is done on Thursday, then the spot date would be Monday.

15. © 2006 ปริทรรศน์ เหลืองอุทัย, CFA, FRM 15 Example : Spot Quotation USD/THB Spot rate : USD/THB 38.600/620 Base currency is US dollar. Counter currency is Thai baht. 38.600 (bid) Bank bids for USD against THB Client sells USD and buys THB 38.620 (offer) Bank offers USD against THB Client buys USD and sells THB

16. © 2006 ปริทรรศน์ เหลืองอุทัย, CFA, FRM 16 Example : Spot Transaction A Thai company receives $100,000 and needs to convert this money into Thai baht. USA Thai Company $100,000 Bank Spot FX Deal @ 38.600 Thai Company Bank $100,000 Thai Company Bank THB 3,860,000 SPOT TODAY

17. © 2006 ปริทรรศน์ เหลืองอุทัย, CFA, FRM 17 Outright Forwards An outright forward is an over-the-counter transaction involving the exchange of one currency at the forward exchange rate determined today for the delivery to take place for cash settlement in more than two business days. About 11 percent of all transactions in the foreign exchange market are forward contracts. A forward transaction is intended to transfer risk from one party to another. Transferring risk is hedging that is intended to reduce the exposure to foreign exchange risk.

18. © 2006 ปริทรรศน์ เหลืองอุทัย, CFA, FRM 18 Forward Outright An outright forward exchange deal is a contract to buy or sell a given amount of currency for settlement at some future date, at a rate of exchange which is agreed at the time of dealing. No money changes hand until the settlement date. Generally it is possible to obtain a forward rate of exchange for up to one year for most traded currencies. The purpose of obtaining a forward rate of exchange is simply to establish and fix the cost of exchange for a known foreign currency commitment at some future date.

19. © 2006 ปริทรรศน์ เหลืองอุทัย, CFA, FRM 19 Forward Outright = Spot FX Rate +/- Forward Points Forward F/X Rates Forward Points = Forward Outright – Spot FX Rate

20. © 2006 ปริทรรศน์ เหลืองอุทัย, CFA, FRM 20 Foreign Exchange Swaps A foreign exchange swap (a spot/forward swap) is a contract to exchange currencies in principal amount only in two business days (the short leg) and reversal of the exchange of the same two currencies at a date in the future (a long leg). An FX Swap is the combination of a spot deal with a simultaneous forward deal. A FOREX swap is the portfolio of long and short positions entered simultaneously at two different dates prevailing in the future. The simultaneous purchase and sale of a specified amount of one currency in exchange for two different value dates. A swap transaction is essentially a financing at a fully collateralized basis.

21. © 2006 ปริทรรศน์ เหลืองอุทัย, CFA, FRM 21 Foreign Exchange Swaps Sell/Buy (S/B) Near Leg : Sell fixed amount of Base Currency Far Leg :Buy fixed amount of Base Currency Buy/Sell (B/S) Near Leg : Buy fixed amount of Base Currency Far Leg :Sell fixed amount of Base Currency

22. © 2006 ปริทรรศน์ เหลืองอุทัย, CFA, FRM 22 Forward-Forwards When the short leg of the FX swap is more than two business days, then the swap is called a forward/forward swap. A forward-forward swap is a swap deal between two forward dates rather than from spot to a forward date. FX forward-forwards are referred to by the beginning and end dates of the forward period, compared with the spot value date. For example, to sell USD 1 month forward and buy them back 3 months forward. In this case, the swap is for the 2-month period between the 1-month date and the 3- month date : “1v3”