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Characteristics and Kinds of
Spot Transactions:
Currency Conversions and Currency Arbitrage
Menu of Main Points
1. Basics of Foreign Exchange Market
2. Spot Transactions
• Types of Spot Transactions
Basics of FOREX
1.
Exchange Market
• a place, where the supply of foreign currencies meets the
demand for them
2.
Market participants
• Banks
• Commercial companies
• Central banks
• Hedge funds as speculators
• Investment management firms
• Retail foreign exchange brokers
3.
Types of trades in the FOREX
• Forward trades
• Swap
• Spot trades
Spot Transaction
• a foreign exchange transaction in which each party
promises to pay a certain amount of currency to
the other on the same day or within one or two
days
• the spot rate
• a trade day
Pricing Spot Transactions
• 2 prices: 1. the buying price (bid)
2. the selling price (offer)
• the spread
Exchange Rates
•
is the price of one currency expressed in other
currency, it’s the relative price of two national
currencies
Quotation
•
•
–
–

Direct: x home currency units = 1 foreign currency unit
(e.g. in US – 1.25 USD = 1 EUR)
Indirect: x foreign currency units = 1 home currency unit
(e.g. in US - 0.80 EUR = 1 USD)
Term currency
Base currency
e.g. EURUSD exchange rate is 1.3 (1.3 USD per EUR)
term
base
Types of Spot Transactions
• Currency Arbitrage
• Two-currency arbitrage
• Three-currency arbitrage
• Arbitrage between prompt and term market
• Currency Conversions
Currency Arbitrage
• purchase of one currency in one financial EM and its selling
in other
• the aim - reach the profit from the price difference in two or
three financial exchange markets
• involves: - no negative cash-flow at any probabilistic or
temporal state
- a positive cash-flow in at least one state
Conditions for Arbitrage
• the law of one price
• 2 A with identical cash-flows do not trade at the same price
• A with a known price in the future does not today trade at its
future price discounted at the risk-free interest rate
Types of Arbitrage
• Two-currency
• Three-currency
• Arbitrage between prompt and term market
• two-currency arbitrage
• two different brokers offering different spreads
• at least one quote which differs between the brokers,
either the bid, the ask, or both
• A. between prompt & term market
• Influenced by: - the size of prompt & term rates
- the size of interest rates between
2 currencies
• three way forex arbitrage
• the exchange rates of three currencies don't match all
ratios, and there is a gap between expectation and reality
• the process of converting one currency to another,
converting it again to a third currency and, finally,
converting it back to the original currency within a short
time span.
Currency Conversions
• prompt spot transaction, in which is one
currency changed for another one and
vice versa
Thank you for your attention
Classification of ERs
1. Types of trade - prompt
- forward
- futures
- option
2. Time point of view - prompt
- term
3. Financial tools - foreign exchange
(devízové, valutové)