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
Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall
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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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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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Exhibit 2.1
The Structure of the Foreign Exchange Market
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2.1 The Organization of the Foreign
Exchange Market
• Size of the Market
• Largest financial market in the world
• Types of Contracts Traded
• Focus in this chapter is on a spot market
contract that is settled in 48 hours
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Exhibit 2.2
Foreign Exchange Trading Activity
Around the World
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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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2.1 The Organization of the Foreign
Exchange Market
• Computerized Trading Systems
• The Competitive Marketplace
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Exhibit 2.3
The Top 20 Dealers in the Foreign
Exchange Market
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2.2 Currency Quotes and Prices
Currency Quotes and Prices: Overview
• Exchange Rates
• Exchange Rate Quotes
• Vehicle Currencies and Currency Cross-Rates
• Triangular Arbitrage
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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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Exhibit 2.4
Currencies and Currency Symbols
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Exhibit 2.5
Currency Quotes in the Wall Street Journal
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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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Exhibit 2.6
Cross-rates Quotes in the
Wall Street Journal
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2.2 Currency Quotes and Prices
• Triangular Arbitrage
• An arbitrage process involving three
currencies
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Exhibit 2.7
Triangular Arbitrage Diagram
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Exhibit 2.8
Good and Bad Triangular Arbitrages
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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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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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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
• Bid-Ask Spreads
• The difference between the bid and the ask rates
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Exhibit 2.9
The Reciprocal Nature of Bid and Ask Exchange Rates
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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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Exhibit 2.10
Communication Systems in the Forex Market
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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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2.5 Describing Changes in Exchange Rates
• Introduction
• Appreciation
• Depreciation
• Devaluations
• Revaluations
• Rates of Appreciation and Depreciation
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Exhibit 2.11
Netting Arrangements
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Exhibit 2.11
Netting Arrangements
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