Download Foreign Exchange (FX) Market

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
Network of financial institutions and brokers
in which individuals, businesses, banks, and
governments buy and sell the currencies of
different countries
The liquidity of the market provides
businesses with access to international
markets for goods and services by providing
foreign currency necessary for transactions
worldwide


The bid price is the price at which the market
is willing to buy a particular currency
The ask price is the price at which the market
is willing to sell a particular currency
Convert From/To
Dollar
Pound
FFranc
DMark
Yen
Dollar
1
0.591
5.385
1.594
116.3
Pound
1.665
1
9.12
2.607
193.1
FFranc
0.1823
0.1095
1
0.2965
21.11
DMark
0.6149
0.3694
3.351
1
72.14
Yen
0.00847
0.005093
0.0465
0.01379
1
1.
Direct quote:
$.6149/DM
2.
Indirect quote (reciprocal rate):
DM1.6263/$ = 1/.6149
3.
Bid rate = $.6149/DM
(price bid by broker to purchase DM)
Ask rate = $.6273/DM =1/1.594
(price asked by broker to sell DM)
Spread = $.0124 = transaction cost

Objectives
◦
◦
◦
◦

Minimize cost of funds
Improve liquidity
Reduce risks
Improve return on investment
Cash inflows and outflows
Beginning cash balance
Collections
Disbursements
Ending cash balance
Investing surplus cash
Covering cash shortage
Ending cash required

Compare direct rates to cross rates to identify attractive
exchange opportunities:
◦ Direct rate to convert £ to DM = DM2.607/£
◦ Cross rate DM/£ using $:
Convert £ to $ ($1.665/£) and then
convert $ to DM (DM1.594/$):
($1.665/£) * (DM1.594/$ )= DM2.654/£
◦
This particular cross rate of £ to $ to DM is more attractive
than converting £ directly to DM.
Bilateral arbitrage opportunity:
Assume you can convert your $ into € 0.7431 with
a broker in New York and then convert each €
with a broker in Frankfurt for $1.346:
New York
Frankfurt
$1.3457 / €
€ 0.7429/$
€ 0.7431 /$
$1.346/ € _____
$1 € 0.7431 * $1.346/ € $1.0002
New York
€ 0.7431 /$
Frankfurt
CHF1.326/€
Zurich
$1.016/CHF
$1 € 0.7431 * CHF1.326/€
CHF.9854 * $1.016/CHF
$1.0011
Foreign exchange market efficiency –
Foreign exchange rates reflect all publicly available
information