1. The Currency Market: Lecture 2
where money denominated in one currency is bought and sold with money denominated in another currency.

2. ORGANIZATION OF THE FOREIGN EXCHANGE MARKET
Participants at 2 Levels
1. Wholesale Level (95%)
- major banks
2. Retail Level
- business customers.

3. ORGANIZATION OF THE FOREIGN EXCHANGE MARKET
Two Types of Currency Markets
1. Spot Market:
- immediate transaction
- recorded by 2nd business day

4. ORGANIZATION OF THE FOREIGN EXCHANGE MARKET
2. Forward Market:
- transactions take place at a specified future date

5. ORGANIZATION OF THE FOREIGN EXCHANGE MARKET
Participants by Market
1. Spot Market
a. commercial banks
b. brokers
c. customers of commercial and central banks

6. ORGANIZATION OF THE FOREIGN EXCHANGE MARKET
2. Forward Market
a. arbitrageurs
b. traders
c. hedgers
d. speculators

7. PART III. THE SPOT MARKET
I. SPOT QUOTATIONS
A. Sources
1. All major newspapers
2. Major currencies have four different quotes:
a. spot price
b. 30-day
c. 90-day
d. 180-day

8. THE SPOT MARKET B. Method of Quotation 1. For interbank dollar trades:
a. American terms
example: $0.5838/€
b. European terms
example: €1.713/$

9. THE SPOT MARKET 2. For nonbank customers: Direct quote
gives the home currency price of one unit of foreign currency.
EXAMPLE: dm1.80/$

10. THE SPOT MARKET C. Transactions Costs 1. Bid-Ask Spread
used to calculate the fee
charged by the bank
Bid = the price at which the bank is willing to buy
Ask = the price it will sell the currency

11. THE SPOT MARKET
4. Percent Spread Formula (PS):

12. THE SPOT MARKET D. Cross Rates
1. The exchange rate between 2 non - US$ currencies.

13. THE SPOT MARKET 2. Calculating Cross Rates
When you want to know what the €/ cross rate is, and you know
€2/US$ and .55/US$
then €/ = €2/US$  .55/US$
= €3.636/ 

14. THE SPOT MARKET E. Currency Arbitrage 1. If cross rates differ from
one financial center to another, and profit opportunities exist.

15. THE SPOT MARKET 2. Buy cheap in one int’l market,
sell at a higher price in another
3. Role of Available Information

16. THE SPOT MARKET F. Settlement Date Value Date: 1. Date monies are due
2. 2nd Working day after date of original transaction.

17. PART III. THE FORWARD MARKET
I. INTRODUCTION
A. Definition of a Forward Contract
an agreement between a bank and a customer to deliver a specified amount of currency against another currency at a specified future date and at a fixed exchange rate.

18. THE FORWARD MARKET 2. Purpose of a Forward: Hedging
the act of reducing exchange
rate risk.

19. interbank market as a discount or premium.
THE FORWARD MARKET
B. Forward Rate Quotations
1. Two Methods:
a. Outright Rate: quoted to commercial customers.
b. Swap Rate: quoted in the
interbank market as a discount or premium.

20. 2. Longer-term Contracts
THE FORWARD MARKET
C. Forward Contract Maturities
1. Contract Terms
a. 30-day
b. 90-day
c. 180-day
d. 360-day
2. Longer-term Contracts