Introduction to FX Markets

The foreign exchange market

The foreign exchange market is the

"place" where currencies are traded

=> Currencies need to be exchanged in order to

conduct foreign trade and business
EXCHANGE RATES

The exchange rate is the rate between two currencies of

two countries. You can also call the exchange rate is the
price of a currency is calculated in a different currency.
Foreign Exchange Market (Forex): where banks,
businesses, governments, investors and traders come to
exchange and speculate on currencies and open 24 hours a
day, 5 days a week with the most important world trading
centers being located in London, New York, Tokyo, Zurich,
Frankfurt, Hong Kong, Singapore, Paris, and Sydney.

Who trades Forex?

Structure includes 3 latin characters: first 2 characters is
national name, the last character is named currency of
that country
For example:
 The name of the US currency (US dollar) is: USD
 The first two letters ‘US’  The United States
 Last character ‘D’  Dollar
GREAT BRITAIN
 The name of the British currency (pound) is: GBP
POUND
 The first two letters ‘GB’ 
 Last character ‘P’ 
JAPAN
 The name of the JapaneseYENcurrency (yen) is: JPY
 The first two letters ‘JP’ 
 Last character ‘Y’ 
 SYMBOLS
SYMBOL COUNTRY CURRENCY
USD UNITED STATES DOLLAR (Đô la Mỹ)
EUR EURO ZONE MEMBERS EURO (Đồng Euro)
(Liên minh châu Âu)
JPY JAPAN YEN
GBP GREAT BRITAIN POUND (Bảng Anh)
(Vương quốc Anh)
CHF SWITZERLAND FRANC (France Thuỵ Sĩ)
(Thuỵ Sĩ)
CAD CANADA DOLLAR (Dollar Canada)
AUD AUSTRALIA DOLLAR (Dollar Úc)
Kể từ sau năm 1848, Thụy sỹ có tên chính thức là
“Swiss Confederation” (tiếng Việt tạm dịch là Liên
minh Thụy sỹ), trong tiếng La Tinh có tên là
Confoederatio Helvetica (viết tắt là CH),
1 2

1000 yen, 2000 yen, 5000

yen and largest
1SGD=19.046 VND
denominations 10,000 Yen 50SGD=952.305 VND
1JPY=170 VND

4
3

1USD=25.060 VND 1CAD=18.323 VND

100USD=2.506.280 VND 5CAD=91.614 VND
5 6

1 THB=724 VND 1NZD=15.173 VND

100THB=72.363 VND 5NZD=75.865 VND

7 8

1AUD=16.716 VND 10.000 IDR=15.974 VND

5AUD=83.578 VND
Method of Quoting Foreign Exchange Rates
Direct Quote (Price Quotation) : a direct quote is a foreign
exchange rate quoted as the domestic currency . In other
words, it involves quoting in fixed units of foreign currency
against variable amount of the domestic currency.
In this method, the base currency is the foreign currency, the
quote currency is the local currency valuation.

Indirect Quote (Quantity Quotation) : a currency quotation in

the foreign exchange market that expresses the amount of
foreign currency required to buy or sell one unit of the
domestic currency.
This method is rarely used in some countries around the world.
Typical is the UK, New Zealand, Australia and other countries
using the euro.
For example, if the Japanese Yen is quoted at US$1 = JPY 100,
and US$1 = C$1.0600, what is the price of yen in Canadian
dollars (both direct and indirect quotations)?
The direct quotation would be:
JPY 1 = C$1.0600/100 = C$ 0.0106
In Canada, the indirect quotation would be:
C$1 = US$0.9434 x 100 (yen per USD) = 94.34 yen
3 systems of Exchange rate
FLOATING EXCHANGE RATES

A floating exchange rate is determined in foreign

exchange markets depending on demand and supply,
and it generally fluctuates constantly.

For example: one US dollar might buy one British

pound today, but it might only buy 0.95 British pound
tomorrow. The value “floats”.
A FIXED EXCHANGE RATES

A fixed exchange rates : is a country's exchange rate regime under

which the government or central bank ties the official exchange rate
to another country's currency (or the price of gold). The purpose of
a fixed exchange rate system is to maintain a country's currency
value within a very narrow band. Also known as pegged exchange
rate.
 MANAGED FLOATING – DIRTY FLOAT

A system of managed floating in which the

government or the country's central bank
occasionally intervenes to change the direction of
the value of the country's currency.
 Players in the Market

• Foreign exchange dealers-large banks,

• Other Financial Institutions-Asset Managers, Hedge
Funds, CTAs, Insurance Companies
• Brokers
• Firms
• Central Banks
• Individuals
The basic currencies are traded in the Forex market?

• USD
• EUR
• JPY
• GBP
• CHF
 Basic Terminology

Generic Definition:
Exchange Rate= units of local currency per foreign currency
Local Currency
Terms Currency
Foreign Currency
Base Currency
Bid price - ask/offer price - spread
 Terminology

• Base Currency-Denominator, usually 1 unit of

base currency is expressed in terms of units of
other currency! Another name used to refer to
base currency is “front” currency.
• Terms currency—#of units per base currency-
other currency in exchange. The other terms used
for terms currency are “back” or “counter”
currency.
 Reading The Exchange Rate Expressions
• In currency markets exchange rates are quoted in a
particular way. These expressions use three letter
ISO codes for each currency. For instance USD,
EUR and JPY are the codes associated with dollar,
euro and Japanese Yen.
• In market quotations, the base currency followed
by terms currency with a “/” and the units. Units
always are in terms currency.
• We will use these expressions in many exercises.
 Currency Quotations: American Terms

• Currencies can be quoted against the U.S. Dollar in

one of two ways:
• American Terms – Implies that the quotation is
expressed as the number units of U.S. Dollars per
unit of currency.
– Ex: 1.7500 U.S. Dollar = 1 GBP (base currency)
– 1.7500 Cents per GBP
– GBP/USD 1.7500
 Currency Quotations: European Terms

• European Terms ( direction) – Implies that the

quotation is expressed as the number units of
foreign currency per U.S. Dollar
– Ex: 1.1500 CAD = 1 U.S. Dollar (base currency)
– 1.1500 Canadian Dollars per U.S. Dollar
– USD/CAD 1.1500
 Terminology

– Bid—price at which traders( dealer) are willing to buy

foreign currency
– Offer/Ask—price at which traders (dealer) are willing
to sell foreign currency
– Spread—difference between bid and offer price
• Profit margin for the trader

• Bid-Offer Spread %=(Offer-Bid)/Offer

(Why?)
(Profit margin in base currency)
 Example: EUR/USD

• EUR/USD 1.3785/1.3790
• Base currency= Euro Terms Currency: USD
• Bid price= 1.3785; Ask (offer) price= 1.3790
• When Selling Euros, 1 Euro = USD$1.3785; when
buying Euros, USD$1.3790 = 1 Euro.
• Spread = | 1.3785 - 1.3790 | = 0.0005 or 5 pips
• Pip value= $0.0001
 Example: EUR/JPY

• EUR/JPY 117.95/118.00
• Base currency= EUR Terms Currency: JPY
• Bid price= 117.95; Ask price= 118.00
• When selling Euros, 1 Euro = JPY117.95; when
buying Euros, JPY118.00 = 1 Euro.
• Spread = | 117.95 - 118.00 | = 0.05 or 5 pips
• Pip value= JPY0.01
 GBP/USD

• GBP/USD 1.7400/10
• Base currency= GBP Terms Currency : USD
• Bid price= 1.7400; Ask price= 1.7410
• When selling Pound, 1 Pound = USD$1.7400; when
buying Pound, USD$1.7410 = 1 Pound.
• Spread = | 1.7400 - 1.7410 | = 0.001 or 10pips
• Pip value=$0.0001
 Direct-Indirect Quotes
• Direct quote—the number local currency per unit of foreign
currency.
In CR USD/CZK 21 (or CZK 21/$) is a direct
quote
In US EUR/USD 1.2996 ($1.2996/€) is a direct
quote
• Indirect quote—the number of units of foreign currency per
local currency
In US USD/JPY130 (or JPY130/$) is an indirect quote
In Europe EUR/JPY150 (JPY150/ €) is an indirect
quote
 Calculating Changes in Exchange Rates

• The Brazilian Real exchange rates moved from

USD/BRL3.2020 to USD/BRL3.1606 over two days.
• Calculate the change in the value of USD
– Since USD is the base/foreign currency, the change in the value of
base currency can be calculated as: S(1)-S(0)/S(0)
– S(0)=3.2020 S(1)=3.1606
– S(1)-S(0)/S(0)=3.1606-3.2020/3.2020=-0.01293 or -1.293%
– Dollar depreciated by 1.293%
 Changes in exchange rates…

• The Brazilian Real exchange rates moved from

USD/BRL3.2020 to USD/BRL3.1606 over two days.
• Calculate the change in the value of BRL
– Since BRL is the terms/local currency, the change in the value of
terms currency can be calculated as: S(0)-S(1)/S(1)
– S(0)=3.2020 S(1)=3.1606
– S(0)-S(1)/S(1)=3.2020-3.1606/3.166=0.01309 or 1.309%
– BRL appreciated by 1.309%
 Calculating Changes in Exchange Rates
July 1997 November 1997

Country Currency (per US$) (per US$

China USD/CYN 8.40 8.40

Hong Kong USD/HKD 7.75 7.73

Indonesia USD/INR 2,400 3,600

Korea USD/KOW 900 1,100

Malaysia USD/MYR 2.50 3.50

Philippines USD/PHP 27 34

Singapore USD/SGD 1.43 1.60

Taiwan USD/TWD 27.80 32.70

Thailand USD/TWB 25.0 40.0

Calculate change in HKD, MYR and TWD
Calculate change in USD against KOW and INR
 Textbook Expressions
• As you probably noticed so far, the textbook uses a different
convention to express exchange rates.
• For instance in our earlier description by using three letter
symbols we could express 1 unit of dollars in JPY term as
follows:
– USD/JPY 85

• In the textbook you will see an expression like the

following to mean the same thing:
– ¥85/$

• Note that in this case Yen symbol preceded the term of the
currency which was followed by a “/” and the dollar.
 Tips for avoiding confusion

• If you see three letter symbols following each other

you read the expression as a market quote
• If you see a symbol followed by a number and then
a “/” and another symbol you read the expression as
in the textbook!
 Dealer in the business of buying and selling Euro

Bid Ask (Offer)

USD 1.1885 USD 1.1888

Dealer Buys 1 Euro at this Dealer Sells 1 Euro at this

Price (Pays 1.1885 USD for Price (Receive/asks USD1.1888 for
each EURO) each EURO)
 Bid-Ask Spread

• Spread=Ask-Bid=1.1888-1.1885=$0.0003
• In FX jargon this a 3 pips (percentage in points)
spread
• Profit in a round trip transaction for the dealer!
• % Gain= 1.1888-1.1885/1.1888
• =0.0025% 1/1000th of 2.5%
 Spread

• Bid-Ask Spread%=(Ask Rate-Bid Rate)/Ask Rate

• May be as low as 1000th of 1% for active
currencies
• The bid/ask spread is normally greater for less
frequently traded currencies.
– 0.11% for Peso, 0.05% for Brazilian Real, 0.36% for
Rupiah,
– 0.13% for Baht (average 1995-00)
Bank Profits on Transactions
o banks quote two rates on transactions:
• bid rate – price bank is willing to pay for foreign
currency
• offer rate – price at which bank is willing to sell
foreign currency
o spread – difference between the bid and offer
o other profits:
o anticipating appreciation => bank raises bid &
offer to buy more of that currency => resells
later at high price making a profit
o anticipating depreciation => bank lowers bid &
offer to sell more of that currency => buys back
later at lower price creating profits
 THE SPOT MARKET

4. Percent Spread Formula (PS):

Ask  Bid
PS  x100
Ask
 Bid and Ask Rates
• Your company is an exporter of digital network equipment to Germany.
Due to competition, you accept to bill your customer in Euros. Your
customer wired Euro 10,000,000 into your London bank account. Your
shopping among 31 banks revealed the following Euro quotes:

Bank Bid Ask

Barclays: EUR/USD1.3310 EUR/USD1.3320
Citibank: EUR/USD1.3317 EUR/USD1.3319
JPM Chase EUR/USD1.3316 EUR/USD1.3321

• Which quote would yield the highest amount of US dollars for you?
 Example
• Suppose Siemens receives the following quotes for JPY and
TWD.
– EUR/JPY 132.30‐132.80
– EUR/TWD 40.50‐40.90

• How many EUR will Siemens receive from its sales of TWD
50,000,000?
• How many EUR will Siemens receive from the sale of JPY
10 billion?
• How many TWD Siemens will receive for EUR5, 000,000?
• How much JPY Siemens need to buy EUR 5,000,000?