12 Questions
What is the characteristic of the forex market that makes it unique?
It is an electronic network of banks, brokers, institutions, and individual traders
What is the primary function of the foreign exchange market?
To facilitate the exchange of one currency for another
What is the role of a market maker in the FX market?
To provide liquidity to the market
What is the term for the price at which a market maker is willing to sell a security?
Ask price
What is the term for the party that initiates a trade by accepting a market maker's prices?
Price taker
In what year did the FX market record a single largest market transaction of USD5.3 trillion?
2013
What is the main characteristic of a commodity currency in the forex market?
It is a currency from a country with large reserves of a specific valuable item
What is the term for a currency pair that involves the USD, but the USD is not the base currency?
Reciprocal currency
What is the bid price in a two-way quote?
The maximum price a buyer is willing to pay
What is the difference between the bid and ask prices in a two-way quote?
The spread of a security
What is the rule for determining the Forward Value Date when the Transaction Date is June 16?
Date-to-Date Rule
What is the Forward Value Date for a 1-month Forward transaction when the Transaction Date is June 28?
July 31
Study Notes
Elements of an FX Cash Flow
- Direction: Inflow or Outflow
- Currency Involved: Currency bought and currency sold
- Value Date: Spot or Forward
- Domicile: Locus of Settlement
Currencies in an FX Transaction
- Commodity Currency: A currency from a country with large reserves of a specific valuable item or commodity
- Terms Currency: The currency in which an exchange rate is quoted
- Reciprocal Currency: A currency pair involving the USD, but the USD is not the base currency (e.g., EUR/USD, GBP/USD, NZD/USD, AUD/USD)
- K.A.P.E. mnemonic for reciprocal currency:
- K – Kiwi – NZD/USD
- A – Aussie – AUD/USD
- P – Pound – GBP/USD
- E – Euro – EUR/USD
Understanding a Two-Way Quote
- A quote is the price at which an asset can be traded or the most recent price agreed upon
- A two-way quote indicates both the current bid price and the current ask price of a security
- Bid price: The maximum price a buyer is willing to pay for a security
- Ask price: The minimum price a seller is willing to take for the same security
- Spread: The difference between the bid and ask prices, indicating liquidity
Determining Forward Value Date
- Fix the Spot Date:
- Transaction Date: June 16
- Spot Value Date (T+2): June 18
- Rules in determining the Forward Value Date:
- Date-to-Date Rule: 1-month Forward July 18
- Month-end to month-end Rule:
- Transaction Date: June 28
- Spot Value Date (T+2): June 30
- 1-month Forward: July 31
Foreign Exchange
- Foreign Exchange (FX): The trading of one currency for another
- Forex market: The largest, most liquid market in the world, with trillions of dollars traded daily
- Major financial centers: Sydney, Singapore, Tokyo, Frankfurt, London, and New York
- No centralized location; rather, an electronic network of banks, brokers, institutions, and individual traders
Parties Involved in an FX Transaction
- Market makers (Quoting Party): Professional traders who offer to sell securities at a given price (ask price) and bid to purchase securities at a given price (bid price)
- Price takers (Calling Party): Parties who trade on existing orders, buying at a price maker's offer or selling at a price maker's bid
Test your knowledge of the foreign exchange market, also known as the forex market, where currencies are traded. Learn about the largest and most liquid market in the world, where trillions of dollars are exchanged daily. Take this quiz to understand the basics of forex trading.
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