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InternationalFinancial and
Foreign ExchangeMarkets
Spot FX Markets
Bid/Ask Prices andQuoting Conventions
Reciprocal Rates,Cross Rates andBid/Ask Spread
Fwd FX Markets
Main Features andQuoting Conventions
Fwd Premium andDiscount
Major TradedInstruments
Terminology
To Put It intoPractice
Lesson II: A Deeper Insight into EverydayFX Market Practice
Monday 9th March, 2020
InternationalFinancial and
Foreign ExchangeMarkets
Spot FX Markets
Bid/Ask Prices andQuoting Conventions
Reciprocal Rates,Cross Rates andBid/Ask Spread
Fwd FX Markets
Main Features andQuoting Conventions
Fwd Premium andDiscount
Major TradedInstruments
Terminology
To Put It intoPractice
Table of Contents
Spot FX MarketsBid/Ask Prices and Quoting ConventionsReciprocal Rates, Cross Rates and Bid/Ask Spread
Fwd FX MarketsMain Features and Quoting ConventionsFwd Premium and DiscountMajor Traded Instruments
Terminology
To Put It into Practice
InternationalFinancial and
Foreign ExchangeMarkets
Spot FX Markets
Bid/Ask Prices andQuoting Conventions
Reciprocal Rates,Cross Rates andBid/Ask Spread
Fwd FX Markets
Main Features andQuoting Conventions
Fwd Premium andDiscount
Major TradedInstruments
Terminology
To Put It intoPractice
Getting Started
Some useful trading jargon:
I Bid: rate at which a certain market player is willing tobuy
I Ask: rate at which a certain market player is willing tosell
Watch out: Bid<Ask
InternationalFinancial and
Foreign ExchangeMarkets
Spot FX Markets
Bid/Ask Prices andQuoting Conventions
Reciprocal Rates,Cross Rates andBid/Ask Spread
Fwd FX Markets
Main Features andQuoting Conventions
Fwd Premium andDiscount
Major TradedInstruments
Terminology
To Put It intoPractice
The Bid/Ask Spread
Bid/Ask Spread=Ask-Bid
The bid-ask spread can be conceived as a transaction cost(step back to Lesson I)
InternationalFinancial and
Foreign ExchangeMarkets
Spot FX Markets
Bid/Ask Prices andQuoting Conventions
Reciprocal Rates,Cross Rates andBid/Ask Spread
Fwd FX Markets
Main Features andQuoting Conventions
Fwd Premium andDiscount
Major TradedInstruments
Terminology
To Put It intoPractice
The Bid/Ask Spread in Practice I
Apart from two notable exceptions (GBP and EUR), all theother major currencies are quoted in European terms, thatis foreign currency per USD (Lesson I).
S FUSD⇒ think of these exchange rates as the buying and
selling prices of USD
InternationalFinancial and
Foreign ExchangeMarkets
Spot FX Markets
Bid/Ask Prices andQuoting Conventions
Reciprocal Rates,Cross Rates andBid/Ask Spread
Fwd FX Markets
Main Features andQuoting Conventions
Fwd Premium andDiscount
Major TradedInstruments
Terminology
To Put It intoPractice
The Bid/Ask Spread in Practice II
For instance,
I S CHFbidUSD
⇒ rate at which a certain mkt player is willing to
buy USD against CHF
I S CHFaskUSD
⇒ rate at which the same mkt player
sells USD against CHF
I Watch out: S CHFbidUSD
< S CHFaskUSD
InternationalFinancial and
Foreign ExchangeMarkets
Spot FX Markets
Bid/Ask Prices andQuoting Conventions
Reciprocal Rates,Cross Rates andBid/Ask Spread
Fwd FX Markets
Main Features andQuoting Conventions
Fwd Premium andDiscount
Major TradedInstruments
Terminology
To Put It intoPractice
The Bid/Ask Spread in Practice III
Conversely, EUR and GBP are quoted in USD equivalent
SUSDF⇒ think of these exchange rates as the buying and
selling prices of EUR or GBP
InternationalFinancial and
Foreign ExchangeMarkets
Spot FX Markets
Bid/Ask Prices andQuoting Conventions
Reciprocal Rates,Cross Rates andBid/Ask Spread
Fwd FX Markets
Main Features andQuoting Conventions
Fwd Premium andDiscount
Major TradedInstruments
Terminology
To Put It intoPractice
The Bid/Ask Spread in Practice IV
For instance,
I S USDbidGBP
⇒ rate at which a certain mkt player is willing to
buy GBP against USD
I S USDaskGBP
⇒ rate at which the same mkt player
sells GBP against USD
I Watch out: S USDbidGBP
< S USDaskGBP
InternationalFinancial and
Foreign ExchangeMarkets
Spot FX Markets
Bid/Ask Prices andQuoting Conventions
Reciprocal Rates,Cross Rates andBid/Ask Spread
Fwd FX Markets
Main Features andQuoting Conventions
Fwd Premium andDiscount
Major TradedInstruments
Terminology
To Put It intoPractice
A Closer Focus on Everyday Mkt Practice I
I S USDbidEUR
= 1.0758⇒ the price provider is willing to
buy EUR at 1.0758 USD
I S USDaskEUR
= 1.0759⇒ the price provider is willing to
sell EUR at 1.0759 USD
InternationalFinancial and
Foreign ExchangeMarkets
Spot FX Markets
Bid/Ask Prices andQuoting Conventions
Reciprocal Rates,Cross Rates andBid/Ask Spread
Fwd FX Markets
Main Features andQuoting Conventions
Fwd Premium andDiscount
Major TradedInstruments
Terminology
To Put It intoPractice
A Closer Focus on Everyday Mkt Practice II
I S JPYbidUSD
= 113.05⇒ the price provider is willing to
buy USD at 113.05 JPY
I S JPYaskUSD
= 113.06⇒ the price provider is willing to
sell USD at 113.06 JPY
InternationalFinancial and
Foreign ExchangeMarkets
Spot FX Markets
Bid/Ask Prices andQuoting Conventions
Reciprocal Rates,Cross Rates andBid/Ask Spread
Fwd FX Markets
Main Features andQuoting Conventions
Fwd Premium andDiscount
Major TradedInstruments
Terminology
To Put It intoPractice
Equivalent Notations I
S USDbidGBP
= S askUSDbidGBP
Rate at which the price provider is willing to buy GBPagainst (selling) USD (i.e. the buying rate for GBP andthe selling rate for USD)
InternationalFinancial and
Foreign ExchangeMarkets
Spot FX Markets
Bid/Ask Prices andQuoting Conventions
Reciprocal Rates,Cross Rates andBid/Ask Spread
Fwd FX Markets
Main Features andQuoting Conventions
Fwd Premium andDiscount
Major TradedInstruments
Terminology
To Put It intoPractice
Equivalent Notations II
S USDaskGBP
= S bidUSDaskGBP
Rate at which the price provider is willing to sell GBPagainst (buying) USD (i.e. the buying rate for USD andthe selling rate for GBP)
InternationalFinancial and
Foreign ExchangeMarkets
Spot FX Markets
Bid/Ask Prices andQuoting Conventions
Reciprocal Rates,Cross Rates andBid/Ask Spread
Fwd FX Markets
Main Features andQuoting Conventions
Fwd Premium andDiscount
Major TradedInstruments
Terminology
To Put It intoPractice
Watch Out!
Given
S USDbidGBP
and S USDaskGBP
,
what if YOU were to sell/buy GBP?
I S USDbidGBP
⇒ number of USD YOU will receive from the
bank from the sale of GBP per USD
I S USDaskGBP
⇒ the price that YOU must pay to buy GBP
from USD
InternationalFinancial and
Foreign ExchangeMarkets
Spot FX Markets
Bid/Ask Prices andQuoting Conventions
Reciprocal Rates,Cross Rates andBid/Ask Spread
Fwd FX Markets
Main Features andQuoting Conventions
Fwd Premium andDiscount
Major TradedInstruments
Terminology
To Put It intoPractice
Evidence on the bid-ask spread
The bid ask spread tends to:I vary throughout the day ⇒ in particular, the spread is
higher:I at the start/end of the trading day;I on Fridays (at closing), on Mondays (at opening) as
well as on the last trading day of the month;I on market holidays (for big financial centres)
I increase with the volatility of the spot rate
I decrease when more dealers are in the market⇒ thelarger the number of dealers, the thinner the spread
InternationalFinancial and
Foreign ExchangeMarkets
Spot FX Markets
Bid/Ask Prices andQuoting Conventions
Reciprocal Rates,Cross Rates andBid/Ask Spread
Fwd FX Markets
Main Features andQuoting Conventions
Fwd Premium andDiscount
Major TradedInstruments
Terminology
To Put It intoPractice
Reciprocal Rates and Bid/Ask Spread
When bid-ask prices are taken into account:
S iaskj
= 1S j
bidi
and
S ibidj
= 1S j
aski
InternationalFinancial and
Foreign ExchangeMarkets
Spot FX Markets
Bid/Ask Prices andQuoting Conventions
Reciprocal Rates,Cross Rates andBid/Ask Spread
Fwd FX Markets
Main Features andQuoting Conventions
Fwd Premium andDiscount
Major TradedInstruments
Terminology
To Put It intoPractice
Cross Rates and Triangular Arbitrages I
Suppose you were to buy GBP from EUR and assume that:
Bid AskSUSD
EUR1.102 1.105
SUSDGBP
1.5775 1.581
SGBPEUR
0.696 0.6965
In principle, you could either choose a direct transaction(you sell EUR to buy GBP) or an indirect transaction viaUSD (you first sell EUR to buy USD and then you sell USDto buy GBP)...
InternationalFinancial and
Foreign ExchangeMarkets
Spot FX Markets
Bid/Ask Prices andQuoting Conventions
Reciprocal Rates,Cross Rates andBid/Ask Spread
Fwd FX Markets
Main Features andQuoting Conventions
Fwd Premium andDiscount
Major TradedInstruments
Terminology
To Put It intoPractice
Indirect Transaction (via USD)
Bid AskSUSD
EUR1.102 1.105
SUSDGBP
1.5775 1.581
I Step 1:sell EUR to buy USD⇒ S USDbidEUR
I Step 2:sell USD to buy GBP⇒ S USDaskGBP
The indirect FX rate S GBPbidEUR
is thusS USD
bidEURS USD
askGBP
= 1.10201.581 =0.6970
InternationalFinancial and
Foreign ExchangeMarkets
Spot FX Markets
Bid/Ask Prices andQuoting Conventions
Reciprocal Rates,Cross Rates andBid/Ask Spread
Fwd FX Markets
Main Features andQuoting Conventions
Fwd Premium andDiscount
Major TradedInstruments
Terminology
To Put It intoPractice
Direct Transaction
Bid AskSGBP
EUR0.696 0.6965
In this case, you only have to sell EUR to buy GBP⇒S GBP
bidEUR= 0.696
InternationalFinancial and
Foreign ExchangeMarkets
Spot FX Markets
Bid/Ask Prices andQuoting Conventions
Reciprocal Rates,Cross Rates andBid/Ask Spread
Fwd FX Markets
Main Features andQuoting Conventions
Fwd Premium andDiscount
Major TradedInstruments
Terminology
To Put It intoPractice
Some Profit to Cash In...
Notice that, if you choose the indirect transaction, youwould get 0.6970 GBP. If you conversely go for the directtransaction, you would only get 0.696: are there profitopportunities? If so, how would you exploit them?
InternationalFinancial and
Foreign ExchangeMarkets
Spot FX Markets
Bid/Ask Prices andQuoting Conventions
Reciprocal Rates,Cross Rates andBid/Ask Spread
Fwd FX Markets
Main Features andQuoting Conventions
Fwd Premium andDiscount
Major TradedInstruments
Terminology
To Put It intoPractice
In More General Terms...
I As long as S GBPbidEUR
≥S USD
bidEURS USD
askGBP
, you are better off choosing
the direct transaction
I Conversely, if S GBPbidEUR
≤S USD
bidEURS USD
askGBP
, the indirect transaction
will offer you a better return
InternationalFinancial and
Foreign ExchangeMarkets
Spot FX Markets
Bid/Ask Prices andQuoting Conventions
Reciprocal Rates,Cross Rates andBid/Ask Spread
Fwd FX Markets
Main Features andQuoting Conventions
Fwd Premium andDiscount
Major TradedInstruments
Terminology
To Put It intoPractice
The Empirical EvidenceIn practice, however, triangular arbitrage opportunitiesare very unlikely to materialize.An increasing number of people will try to profit fromthe price differential and will consequently sell EUR ⇒ buyUSD ⇒ sell USD ⇒ buy GBP, thus driving EUR down andGBP up, until equilibrium is finally restored (No free lunchprinciple)
S GBPbidEUR
=S USD
bidEURS USD
askGBP
InternationalFinancial and
Foreign ExchangeMarkets
Spot FX Markets
Bid/Ask Prices andQuoting Conventions
Reciprocal Rates,Cross Rates andBid/Ask Spread
Fwd FX Markets
Main Features andQuoting Conventions
Fwd Premium andDiscount
Major TradedInstruments
Terminology
To Put It intoPractice
To Rust Off - Lesson I
I Spot exchange rate: FX rate that is contracted todayfor immediate delivery (generally, t+1 or t+2)
I Forward exchange rate: rate that is contracted todayfor the exchange of currencies on a specific date in thefuture (1m, 3m, 6m).
InternationalFinancial and
Foreign ExchangeMarkets
Spot FX Markets
Bid/Ask Prices andQuoting Conventions
Reciprocal Rates,Cross Rates andBid/Ask Spread
Fwd FX Markets
Main Features andQuoting Conventions
Fwd Premium andDiscount
Major TradedInstruments
Terminology
To Put It intoPractice
FX Fwd Markets: an Overview
Exactly like the spot market:
I No central location
I 24h trading
I Direct interbank market (decentralized, continuous,open-bid, double-auction) and indirect broker-basedmarket (quasi-centralized, continuous, limit-book,single-auction market) [Step back to Lesson I]
I Bid/Ask quotation
InternationalFinancial and
Foreign ExchangeMarkets
Spot FX Markets
Bid/Ask Prices andQuoting Conventions
Reciprocal Rates,Cross Rates andBid/Ask Spread
Fwd FX Markets
Main Features andQuoting Conventions
Fwd Premium andDiscount
Major TradedInstruments
Terminology
To Put It intoPractice
Adopted Notation
Forward exchange rate: rate that is contracted today forthe exchange of currencies on a specific date in the future.Fn( ij ) is the n-year forward exchange rate of currency i perunit of currency j
InternationalFinancial and
Foreign ExchangeMarkets
Spot FX Markets
Bid/Ask Prices andQuoting Conventions
Reciprocal Rates,Cross Rates andBid/Ask Spread
Fwd FX Markets
Main Features andQuoting Conventions
Fwd Premium andDiscount
Major TradedInstruments
Terminology
To Put It intoPractice
Quoting Conventions
Forward rates are generally quoted in terms of thecorresponding spot rate ± a suitable number of swappoints, depending on the forward maturity taken intoconsideration.Swap points will be added to (subtracted from) the spotbid-ask quotes whenever they are ascending (descending).
InternationalFinancial and
Foreign ExchangeMarkets
Spot FX Markets
Bid/Ask Prices andQuoting Conventions
Reciprocal Rates,Cross Rates andBid/Ask Spread
Fwd FX Markets
Main Features andQuoting Conventions
Fwd Premium andDiscount
Major TradedInstruments
Terminology
To Put It intoPractice
Quoting Conventions: an Example
Given the spot rates and the swap points below, how to findthe corresponding fwd bid-ask quotation?
Spot Bid/Ask Swap Points1.3965/1.3970 27/23
Descending swap points ⇒ to be subtractedFbid = 1.3965− .0027 = 1.3938andFask = 1.3970− .0023 = 1.3947
InternationalFinancial and
Foreign ExchangeMarkets
Spot FX Markets
Bid/Ask Prices andQuoting Conventions
Reciprocal Rates,Cross Rates andBid/Ask Spread
Fwd FX Markets
Main Features andQuoting Conventions
Fwd Premium andDiscount
Major TradedInstruments
Terminology
To Put It intoPractice
A Closer Mkt Insight
The bid-ask spread for forward quotations is wider astime to maturity increases: this is mostly due to market“thinness”
InternationalFinancial and
Foreign ExchangeMarkets
Spot FX Markets
Bid/Ask Prices andQuoting Conventions
Reciprocal Rates,Cross Rates andBid/Ask Spread
Fwd FX Markets
Main Features andQuoting Conventions
Fwd Premium andDiscount
Major TradedInstruments
Terminology
To Put It intoPractice
Fwd Premium and Discount
When it is necessary to pay more (less) for forward deliverythan for spot delivery of a currency, we say that the currencyis at a forward premium (discount).
N-year forward premium/discount=Fn
ij−S i
j
n·S ij
InternationalFinancial and
Foreign ExchangeMarkets
Spot FX Markets
Bid/Ask Prices andQuoting Conventions
Reciprocal Rates,Cross Rates andBid/Ask Spread
Fwd FX Markets
Main Features andQuoting Conventions
Fwd Premium andDiscount
Major TradedInstruments
Terminology
To Put It intoPractice
Fwd Premium and Discount:an Exmple
Given S JPYUSD
= 76.89 and F0.5 JPYUSD
= 76.65,
Fwd Premium/Discount=76.65−76.890.5·76.89 =0.00624
Fwd discount of the Dollar versus the Yen (or, equivalently,fwd premium of the Yen versus the Dollar)
InternationalFinancial and
Foreign ExchangeMarkets
Spot FX Markets
Bid/Ask Prices andQuoting Conventions
Reciprocal Rates,Cross Rates andBid/Ask Spread
Fwd FX Markets
Main Features andQuoting Conventions
Fwd Premium andDiscount
Major TradedInstruments
Terminology
To Put It intoPractice
Major Traded Instruments
I Outright fwd contract: agreement to exchangecurrencies at a pre-determined price on a future date
I FX Swap: agreement to buy and sell foreign exchangeat pre-specified exchange rates, where the buying andselling are separated in time (two major components: aspot transaction plus a forward transaction in thereverse direction). A swap-in (swap-out) EUR consistsof an agreement to buy (sell) EUR spot and to sell(buy) them forward
I Currency Swap: agreement involving two parties in theexchange of principal and interest payments on a loanin one currency for principal and interest payments inanother currency.
I Options: derivative contracts that give the buyer theopportunity to buy (call) or to sell (put) the underlyingasset at a given price sometime in the future
InternationalFinancial and
Foreign ExchangeMarkets
Spot FX Markets
Bid/Ask Prices andQuoting Conventions
Reciprocal Rates,Cross Rates andBid/Ask Spread
Fwd FX Markets
Main Features andQuoting Conventions
Fwd Premium andDiscount
Major TradedInstruments
Terminology
To Put It intoPractice
Some Trading Jargon
InternationalFinancial and
Foreign ExchangeMarkets
Spot FX Markets
Bid/Ask Prices andQuoting Conventions
Reciprocal Rates,Cross Rates andBid/Ask Spread
Fwd FX Markets
Main Features andQuoting Conventions
Fwd Premium andDiscount
Major TradedInstruments
Terminology
To Put It intoPractice
The Trading Book
I Bid Section: buying proposals, ascending prices
I Ask Section: selling proposals, descending prices
I Ranking criteria: Price priority and Time priority
I Mkt Depth: Ability to sustain large mkt orderswithout impacting the price of a security ⇒ a verylarge order will not significantly move the price of asecurity
I Mkt Width: it refers to the cost of executing atrade of a given size
InternationalFinancial and
Foreign ExchangeMarkets
Spot FX Markets
Bid/Ask Prices andQuoting Conventions
Reciprocal Rates,Cross Rates andBid/Ask Spread
Fwd FX Markets
Main Features andQuoting Conventions
Fwd Premium andDiscount
Major TradedInstruments
Terminology
To Put It intoPractice
No Free Lunch Principle
Free Lunch: situation where a good or a service is receivedat NO cost. In strict financial terms, No Free Lunch meansthat an investor will not be able to make large and risklessprofits on a continuous, persistent basis.
InternationalFinancial and
Foreign ExchangeMarkets
Spot FX Markets
Bid/Ask Prices andQuoting Conventions
Reciprocal Rates,Cross Rates andBid/Ask Spread
Fwd FX Markets
Main Features andQuoting Conventions
Fwd Premium andDiscount
Major TradedInstruments
Terminology
To Put It intoPractice
To put it into practice I
2.1: Based on the table below, answer the followingquestions:
Bid AskS USD
Currency1
1.35135 1.35227
SCurrency2USD
83.365 83.3925
I How much would you lose if you converted USD 1000into Currency1 and then back into USD?
I What is the bid-ask spread for SCurrency2USD
?
I What is the bid-ask spread for SCurrency2Currency1
?
I How much would you lose if you converted USD 1000into Currency1, then into Currency2 and finally backinto USD?
InternationalFinancial and
Foreign ExchangeMarkets
Spot FX Markets
Bid/Ask Prices andQuoting Conventions
Reciprocal Rates,Cross Rates andBid/Ask Spread
Fwd FX Markets
Main Features andQuoting Conventions
Fwd Premium andDiscount
Major TradedInstruments
Terminology
To Put It intoPractice
To put it into practice II2.2: Fill in the table below and answer the followingquestions:
Bid AskS CZJ
GBP42.7512 42.7983
SDKKGBP
11.3065 11.3235
S EURGBP
1.2439 1.2501
SNOKGBP
12.3363 12.3479
SDKKEUR
S EURNOK
SGBPCZJ
I Find the bid-ask spread for the S EURCZJ
quote.
I How much would you lose if you converted 1500 DKKinto GBP, then into EUR, further into NOK and finallyback into DKK?