2Copy of 13 Forex MktBB.docx

2Copy of 13 Forex MktBB.docx

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2Copyof13ForexMktBB

DepartmentofEconomics,NUICork

EC3202–InternationalMoneyandFinance

Lecturer:

StephanieSweeneyHandout2012/13No.3

TheForeignExchangeMarketTheforeignexchangemarketprovidesthephysicalandinstitutionalstructurethroughwhichthemoneyofonecountryisexchangedforthatofanothercountry,therateofexchangebetweencurrenciesisdeterminedandforeignexchangetransactionsarephysicallycompleted.Foreignexchangemeansthemoneyofaforeigncountrythatis,foreigncurrencybankbalances,banknotes,checksanddrafts.

Aforeignexchangetransactionisanagreementbetweenabuyerandsellerthatafixedamountofonecurrencywillbedeliveredforsomeothercurrencyataspecifiedrate.

TheSizeoftheMarket

Theforeignexchangemarketisuniquebecauseofitstradingvolume,theextremeliquidityofthemarket,thelargenumberoftradersandthegeographicaldispersion.AccordingtoaBISsurveyinApril2004theaveragedailyinternationalforeignexchangetradingvolumewas$1.9trillion.

FunctionsoftheForeignExchangeMarket

1）Transferpurchasingpowerbetweencountries

2）Obtainorprovidecreditforinternationaltradetransactions

3）Minimiseexposuretotheriskofexchangeratechanges

TheForeignExchangeMarketParticipants

1）ForeignExchangeDealers

2）Individualandfirmsconductingcommercialandinvestmenttransactions

3）SpeculatorsandArbitragers

4）CentralBankandTreasuries

5）ForeignExchangeBrokers

TransactionsintheForeignExchangeMarket

1）SpotTransactions现货交易:

Aspottransactionrequiresalmostimmediatedeliveryofforeignexchange.

2）OutrightForwardTransactions直接远期交易:

Aforwardtransactionrequiresdeliveryatafuturevaluedate,aspecifiedamountofonecurrencyforaspecifiedamountofanothercurrency.

3）SwapTransactions互换交易:

Aswaptransactioninvolvesthesimultaneouspurchaseandsaleofagivenamountofforeignexchangefortwodifferentvaluedates.

WhyareExchangeRatesImportant

1）Exchangeratesfeedinto:

a）Outlookfordomesticandglobaleconomy

b）Stockmarket

c）Industrialcompetitiveness（firm/industry.

2）Increasedglobalisation

a）Internationalisationofbusiness

b）Relativityofworldtradetodomesticdemand

c）Economicintegration（e.g.Europe）

d）Technologicaladvancesinmoneytransfer

BuyingvsSellingRatesAsinmanyothermarkets,mosttransactionsinvolveintermediaries,whoactastemporarybuyersforagentswishingtosellandastemporarysellersforagentswishingtobuySometimesintermediarieschargefeesMoreoften,theirprofitliesindifferencebetweenpriceatwhichtheybuycurrencyandpriceatwhichtheysellit.

BidrateforcurrencyAintermsofcurrencyBisrateatwhichdealersbuycurrencyA（sellcurrencyB）.Offerrate（oraskrate）israteatwhichdealersellscurrencyA（buyscurrencyB）.Bid/offerspreadisgapbetweenofferandbidrates.

Example:

Bid/offerspreadof€/£was0.03p,sodealerwouldmake£30,000ontransactionof£100m

Sincebuyingonecurrencyinvolvessellinganother,offerpriceforcurrencyA（intermsofcurrencyB）isreciprocalofbidpriceforcurrencyB（intermsofcurrencyA）.

Inabsenceoftransactioncosts:

–S（€per£）=1/S（£per€）

Doesn’tholdwhenyouallowforbid/offerspread

ExchangeRates

Anexchangerateisbasicallyaprice

BilateralvsTradeWeightedExchangeRates

Abilateralexchangerateisanexchangeratebetweentwocountries.ThebilateralexchangeratebetweentheUKandtheUSAisthepriceofdollarsintermsofpounds.Achangeintheexchangerateinfavourofthedollarcouldbeindicativeofeitheradeclineintheinternationalvalueofthepoundorariseinthedollarorboth.

Across-exchangerateisanexchangeratebetweentwocurrencies,AandB,neitherofwhichis€.ItcanbecalculatedastheratioofexchangerateofAtothe€,dividedbyexchangerateofBtothe€.

Ifwelookatcross-ratesandseethat€hasdepreciatedagainst$butappreciatedagainst£,istheneteffectariseorfallinthevalueof€?

NostraightforwardanswerIfpricesofsomegoodsarerisingwhilepricesofothersarefalling,theoverallchangeinpricesiscalculatedusingindex

Effectiveortrade-weightedexchangerateofcurrencyAisaweightedaverageofitsexchangeratesagainstcurrenciesB,C,D,E,etc.TheweightsusedareusuallytheproportionofcountryA’stradewhichinvolvesB,C,D,E,etc.respectively.

Effectiveexchangerateismultilateral,ratherthanbilateral

Absolutevalueofindexhasnomeaning-dependsonbaseyear（sameasCPI）.

E.g.ifeffectiveexchangerateof€is105today,itmeansthatitis5%aboveitsaveragelevelinbaseyear.

2.FOREXMarket–InstitutionsandOrganisation

164CurrenciesListedontheLondonInterbankMarket

QuotingConventions:

∙TheFXSymbolisdefinedinElectronicBankingSystemformatas"CCY1/CCY2".

oRatesareexpressedas"currency1incurrency2"（or"currency2percurrency1"）andarecalculatedasCCY2dividedbyCCY1,NOTCCY1dividedbyCCY2

∙CCY1/CCY2=X

WhereX=numberofunitsofCCY2thatoneunitofCCY1isworth.

Impliesthat:

oCCY1Amount*Rate（X）=CCY2Amount（whentradingCCY1）

oCCY2AmountRate（X）=CCY1Amount（whentradingCCY2）

∙MarketConventiondeterminesCCY1andCCY2foranycurrencypairbasedonthevalueofeachcurrencywithahierarchyofexceptions.ThelessvaluablecurrencyistypicallyCCY2（givingarate>1）,exceptforthe11currencieslistedbelowwhicharealwaysCCY1:

EUR;GBP;AUD;NZD;FJD;TOP;WST;PGK;BWP;SBD;USD.（Theorderofthislistisimportant!

）

Ifanyofthe12currenciesonour‘exceptions’listarequotedagainsteachother,thenthecurrencyhigherinthelistwillbeCCY1.

Examples:

∙AratebetweenSwissFranc（CHF）andJapaneseYen（JPY）willbequotedasCHF/JPYbecause1CHFisworthmorethan1JPYinthemarket.

（NB:

the‘/’signcanbeconfusing;itiseasytomistakeitforaratio–i.e.youmightbetemptedtoquotethenumberofSwissFrancstotheJapaneseYen.Rememberourrateis,infact,theopposite,quotingthenumberofYentotheSwissFranc.）

∙AratebetweenGBP（PoundSterling）andAUD（AussieDollar）willbequotedasGBP/AUDbecauseGBPappearsfirstintheabovelist.

∙Insomecaseswhereacurrency（notintheabovelist）withahighvalueisquotedagainstacurrencyinthelist,theratecanbelessthan1.Examplesare:

USD/BHD;USD/CYP;andUSD/KWD.

∙Incertainlocalmarkets,however,manycorporatesprefertheirowndomesticcurrencytoalwaysbeCCY1orCCY2.SwisscompaniesforexamplepreferCHFalwaystobeCCY2,sotheyasktheirbanktoquoteaJPY/CHFrateratherthanaCHF/JPYrate.Thisisnotinterbankmarketconventionbutlocalmarketpractice.

∙Untilrecently,GBPwasalwaysquotedCCY1becauseoneunitofGBPwasworthmorethanoneunitofanyothermajorcurrency.Likewise,forsomeothercurrencieswithstronghistoricalconnectionstoGBPsuchastheAUDandNZD.

Withtheadventoftheeuroonthein1998,theECBstipulatedthatEURshouldalwaysbeCCY1,evenagainstGBP.Therewassomeoppositiontothis,particularlyfromLondonBanks.WhentradinginEURbeganonJan4th,1999,automatedbrokerssuchasReuters3000Spotmatching,supportedbothEUR/GBPandGBP/EURsothatmarketcoulddecidewhichwouldemergeasmarketstandard.EUR/GBPwasveryquicklyestablishedasacceptedmarketconvention.

∙CCY1isalsoknownas‘basecurrency’andCCY2isknownas‘terms’currency.‘Basecurrency’,however,isoftenusedtodescribeabanksdomesticoraccountingcurrency.Becarefulwhenusingtheterm‘base’intrading.Forexample,ifaBritishBankwhoseaccounting/basecurrencyisGBP,istradingEUR/GBP,thebasecurrencyofthetrade（CCY1）isneverthelessEUR.

∙ThereisnoorganisationthatdecideswhatmarketconventionshouldbeforanyaspectofForextrading.Thisexplanationismerelystatingpracticesthatarefollowedbytheinterbankmarket.

SpotFXTrading

∙Foreignexchange（oftenabbreviatedtoFXorforex）meansthebuyingandsellingofcurrenciesagainstothercurrencies.Amassive1.5trillionUSDollarsistradedeverydayinthewholesaleforeignexchangemarket.Thatequatesto1billionUSDollarsperminute.

∙FXspotpricesareusuallyquotedtobetween4and6significantfigures.Forexample,EUR/USD,themostfrequentlytradedcurrencypair,hasseenratessuchas0.8225,1.0015or1.4628.Thenumberofdecimalsdoesnotvaryforaparticularcurrencypairaccordingtomovementsintherate,exceptinthecaseofdevaluations.

FXspotpriceshaveabidpriceandanofferprice,forexample:

Bid

Offer

EUR/USD

1.0345

1.0347

∙ThebidpriceiswherethebankiswillingtobuyCCY1andtheofferpriceiswherethebankiswillingtosellCCY1.Inthiscase,thebankiswillingtobuyEURagainstUSDat1.0345andiswillingtosellEURagainstUSDat1.0347.Thedifferencebetweenthebidandtheofferiscalledthespread.ItismarketconventionalwaystotalkaboutwhatyouaredoingwithCCY1.Forexample,ifsomeoneis"buyingUSD/JPY",theyarebuyingUSDandsellingJPY.

Marketparticipantsaregenerallyexpectedtoknowwhatthefirstpartoftheratewillbe（inthiscase1.03..）,andthispartisknownasthe"bigfigure".Becausethecurrentbigfiguredoesnotusuallyvaryfromoneminutetothenext,tradersnormallyquoteonlythelast2digitsoftherate（3digitsforsomecurrencypairs）,andthesedigitsareknownasthe"pips".Atraderwouldthereforequotethebidandofferinthisexampleas"4547".Whentradingoverthephone,itiscommontoquoteonlythepips,whereaselectronicsystemsgenerallydisplaytheentirerate（althoughthepipsmaybegivenmorep