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Understanding Foreign Exchange Quotes

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Understanding Foreign Exchange Quotes Powered By Docstoc
					Lecture 5: The Foreign Exchange
                         Market
               Understanding Foreign
                   Exchange Quotes
Where is this Financial Center?
View from La Defense to Arc de
Triomphe (Paris)
What Else About Paris and the
Champs-Elysées?
The Role of Global Banks in the FX Market
n   Large global banks (e.g., Deutsche Bank) are involved
    in the interbank (i.e., wholesale) FX markets through:
    q (1) Their “external” clients” (Other large banks,
       exporters, importers, multinational firms, central
       banks, large non-bank financial institutions)
        n   Acting in a broker capacity at the request of these
            clients.
    q   (2) Their own banks (trading to generate profits).
        n   Acting in a “dealer” (i.e., trading) capacity (Taking
            positions (long and short) in currencies to make a profit).
    q   In dealing with external clients, these large banks are
        performing a “market maker” function:
        n   Quoting prices upon demand to other parties in the
            interbank market, and
        n   Buying and selling currencies at their quoted prices.
“Making the Market” in FX
n   The market maker function involves two primary
    foreign exchange activities:
n   (1) A willingness of the market maker to provide the
    market with “on-going” (i.e., continuous) two way
    quotes upon request:
    q   (1) Provide a price at which they will buy a currency
    q   (2) Provide a price at which they will sell a currency
        n This function provides the market with transparency

n   (2) A willingness of the market maker to actually buy
    and/or sell at the prices they quote:
    q   Thus the market maker offers “firm” prices into the market!
        n This function provides the market with liquidity.
Base and Quote Currency
n   Recall that a foreign exchange quote is simply
    the ratio of one currency to another.
n   Thus, a “complete” market maker quote consist
    of two ISO designations (e.g., EUR/USD or
    USD/JPY):
    q   The first ISO currency quoted in the sequence is
        referred to as the base currency.
    q   The second ISO currency quoted is referred to as the
        quote currency.
    q   For examples above:
        n   EUR/USD: EUR is the base currency and USD is the
            quote currency.
        n   USD/JPY: USD is the base currency and JPY is the
            quote currency.
Bid and Ask Quotes
n   A market maker always provides the market with
    two prices, specifically a price at which they will
    buy a currency and a price at which they will sell
    a currency.
n   Example: EUR/USD: 1.2102/1.2106
    q   The first number quoted by the market maker is the
        market maker’s buy price for 1 unit of the base
        currency ($1.2102).
        n   This is the market maker’s bid quote (or buy price)
    q   The second quoted number is the market marker’s sell
        price for 1 unit of the base currency ($1.2106).
        n   This the market maker’s ask quote (or sell price)
Bid Ask Quote Example
n   Example: GBP/USD: 1.5535/1.5537.
n   Assume you’re dealing with the market maker;
n   Questions:
    q   (1) How much will you pay for 1 pound;
    q   (2) how much will get when you sell 1 pound;
    q   (3) how much will you pay for 1 U.S dollar;
    q   (4) how much will you get when you sell 1 U.S. dollar?
n   Answers:
Bid Ask Quote Example Answers
n   Example: GBP/USD: 1.5535/1.5537.
n   Assume you’re dealing with the market maker;
n   Questions:
    q   (1) How much will you pay for 1 pound;
        n   $1.5537
    q   (2) how much will get when you sell 1 pound;
        n   $1.5535
    q   (3) how much will you pay for 1 U.S dollar;
        n   1/1.5535 = .6437 (64.37 British cents)
    q   (4) how much will you get when you sell 1 U.S. dollar?
        n   1/1.5537 = .6430 (64.36 British cents)
Bid Ask European Terms Example
n   Assume the following USD/JPY: 76.35/76.45
    (Note: now the base currency is the dollar and
    the quote currency is the yen)
n   Assume you’re dealing with the market maker;
    q   Question: (1) How much will you pay for 1 dollar;
    q   (2) how much will get when you sell 1 dollar;
    q   (3) how much will you pay for 1 yen;
    q   (4) how much will you get when you sell 1 yen?
n   Answers:
Bid Ask European Terms Answers
n   Assume the following USD/JPY: 76.35/76.45
    (Note: now the base currency is the dollar and
    the quote currency is the yen)
n   Assume you’re dealing with the market maker;
    q   Question: (1) How much will you pay for 1 dollar;
        n   76.45 yen
    q   (2) how much will get when you sell 1 dollar;
        n   76.35 yen
    q   (3) how much will you pay for 1 yen;
        n   1/76.35 = 0.0130975 (U.S. cents)
    q   (4) how much will you get when you sell 1 yen?
        n   1/76.45 = 0.0130804 (U.S. cents)
Bid Ask Spreads
n   The Bid Ask spread is the “profit” that a market maker
    bank will make on a “round” transaction (i.e., buying
    and selling an equal amount at the stated price).
n   Regardless of the type of quote (American terms or
    European terms), the ask price is always higher than
    the bid.
    q   That is, what they will sell the base currency for is always
        higher than what they will buy the base currency at.
n   Assume the following GBP/USD quote: 1.7921/1.7929
    q   What is the dollar spread to the market maker on a “round”
        transaction (assume 10 million pound transactions)?
        n   Ask $1.7929 x £10,000,000 = $17,929,000 (price to sell pounds)
        n   Bid $1.7921 x £10,000,000 = $17,921,000 (price to buy pounds)
        n   Spread (Commission)    =       $ 8,000 (on round transaction)
Bid Ask Spread: European Terms
n   Assume the following USD/CAD quote:
    q   1.0200/1.0210
        n   Note the ask price is higher
n   What is the spread on a round transaction
    assuming a $1,000,000 USD transaction.
    q   Ask price 1.0210 x $1,000,000 = 1,021,000 CAD
    q   Bid price = 1.020 x $1,000,000 = 1,020,000 CAD
    q   Spread = 1,000 CAD
Foreign Exchange Pips (or Points)
n   Pips (sometimes called points) refer to the
    smallest unit by which the prices for the currency
    pair may vary.
    q   Pip stands for percentage in point.
n   In the example: GBP/USD: 1.5535/1.5537, the
    difference in the bid quote and ask quote lies in
    the fourth decimal place, or 2 pips.
    q   A Pip for a 4 decimal place quoted currency is actually
        0.0001 of an exchange rate
n   Most currencies are quoted out to 4 decimal
    places.
n   Today, some currencies are being quoted out to
    5 decimal places because of competition among
    electronic trading platforms (e.g., FXStreet).
Observations About Bid/Ask Spreads
n   Bid and ask spreads widen or narrow in response to a
    number of factors. For example:
    q Spreads increase with exchange rate volatility and
      uncertainty.
    q Spreads decrease with increases in market maker
      competition.
    q Spreads are smaller in wholesale (interbank) market than in
      retail market (and tourist market).
        n   Example: GPB/USD for September 26, 2011
        n   Wholesale: 1.55145/1.55158; pip spread = 1.3
        n   Retail: 1.5512/1.5516; pip spread = 4
        n   Tourist retail (Wells Fargo quote): 1.4489/1.6152; spread =
            0.1663 cents
    q   Spreads can differ slightly among market markets.
        n   As market makers attempt to adjust their positions and thus
            make dealing with them more or less attractive.
Which Way is the Currency Moving?
n   Remember when viewing a foreign exchange quote,
    assign a value of 1 to the base currency (the base
    currency is the first in the ISO pair). The quotes you see
    refer to one unit of this base currency.
n   Thus, whenever the bid and ask prices are moving up,
    that means that the base currency is getting stronger
    (relative to the quote currency) and the quote currency is
    getting weaker (relative to the base currency).
n   Conversely, whenever the bid and ask prices are moving
    down, that means that the base currency is getting
    weaker (relative to the quote currency) and the quote
    currency is getting stronger.
Example: Which way is the
Currency Moving? Weakening or
Strengthening?
Currency   October 4,   October 5,   Move of    Move of USD
           2012         2012         Foreign
                                     Currency
EUR/USD    1.3018       1.3036

GBP/USD    1.6193       1.6133

USD/JPY    78.50        78.67

USD/CHF    0.9306       0.9298
Example: Which way is the
Currency Moving? Weakening or
Strengthening?
Currency   October 4,   October 5,   Move of         Move of USD
           2012         2012         Foreign
                                     Currency
EUR/USD    1.3018       1.3036       EUR             USD
                                     strengthening   weakening
GBP/USD    1.6193       1.6133       GBP             USD
                                     weakening       strengthening
USD/JPY    78.50        78.67        JPY             USD
                                     weakening       strengthening
USD/CHF    0.9306       0.9298       CHF             USD
                                     strengthening   weakening
Let’s Look at Real Time Currency Quotes
n   Go to the following web-site: http://www.fxstreet.com/
n   At this site, link to:
        n   Rates and Charts
    q   Go to Retail Rates Live
        n   Select currency as USD
        n   Observe ISO quotes
        n   Observe bid and ask quotes.
        n   Understand what currency and at what price the market maker is
            buying or selling (base currency).
        n   Understand what price you (a non-market maker) would buy or sell
            the base currency to the market maker.
        n   Observe changes in bid and ask quotes.
            q If these are going up, the base currency is strengthening and the
               quote currency is weakening. Reverse is true if these are going
               down.
    q   Next, link to: Interbank FX Rates Live and observe
        majors and G7 (note quotes to 5 decimal places)
Let’s Look at Real Time Currency Charts
n   Again, go to the following web-site:
    http://www.fxstreet.com/
n   At this site, link to:
      n Rates and Charts

    q Go to Streaming Forex Charts

      n Observe different currency pairs: Make sure
         you know which currency in the pair is
         strengthening and which is weakening.
      n Observe different time scales from ticks out
         to monthly.
Candle Stick Charting of FX

Patterns         Examples
n Patterns       n Go to FXStreet.com

                 n At this site, link to:

                 n Rates and Charts

                 n Go to Streaming Forex
                   Charts
                 n Under chart type go to
                   Candle Stick

				
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posted:7/30/2013
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