Foreign Exchange Market Overview
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Questions and Answers

What is the first step in the triangular arbitrage example presented?

  • Convert JPY to EUR
  • Calculate the final result
  • Convert EUR to USD (correct)
  • Convert USD to JPY

    • What is the final result of the arbitrage operation starting with 1000 EUR?

  • -0.005%
  • 0.1%
  • 1.2068%
  • 0.005% (correct)

    • Which currency is converted to JPY in the described arbitrage operation?

  • GBP
  • CAD
  • AUD
  • EUR (correct)

    • What is the exchange rate used to convert USD to JPY in the example?

    <p>107.43</p> Signup and view all the answers

    What is the purpose of performing triangular arbitrage?

    <p>To exploit price differences between currencies for profit</p> Signup and view all the answers

    What is the size of a Standard Lot in the foreign exchange market?

    <p>100,000 units of the base currency</p> Signup and view all the answers

    What role do market makers play in the foreign exchange market?

    <p>Providing liquidity by buying and selling currencies</p> Signup and view all the answers

    What is the primary function of intermediaries or brokers in the foreign exchange market?

    <p>Mediation between buyers and sellers for a commission</p> Signup and view all the answers

    Which of the following does NOT describe the role of central banks in the foreign exchange market?

    <p>Providing speculative trading opportunities</p> Signup and view all the answers

    What characteristic of the foreign exchange market allows for arbitrage opportunities?

    <p>Homogeneity of exchange assets</p> Signup and view all the answers

    Which market actor typically does not own the currencies they trade?

    <p>Intermediaries or brokers</p> Signup and view all the answers

    What type of trading operation is commonly associated with individual market participants?

    <p>Engaging in tourism and small purchases in foreign currencies</p> Signup and view all the answers

    What is the smallest unit size for trades in the foreign exchange market?

    <p>1 unit of the base currency</p> Signup and view all the answers

    What is the differential (spread) for the USD/EUR currency pair?

    <p>0.0020</p> Signup and view all the answers

    Which currency pair has the highest spread percentage?

    <p>USD/GBP</p> Signup and view all the answers

    If a market operator is buying EUR/USD at 1.1259 USD, what is the selling rate?

    <p>1.1262 USD</p> Signup and view all the answers

    How would you express the quoting of EUR/USD based on the provided example?

    <p>1.1259/62</p> Signup and view all the answers

    What is the value at which the market operator is selling USD/JPY?

    <p>108.76 JPY</p> Signup and view all the answers

    What is the correct formula to calculate forward points swap?

    <p>Forward Spot * pip / Forward outright</p> Signup and view all the answers

    If the spot exchange rate is 1.1550 EUR/USD and the one-year forward rate is 1.1350 EUR/USD, what are the forward points trading at that moment?

    <p>200</p> Signup and view all the answers

    What does the bid price represent in the foreign exchange market?

    <p>The price at which the market buys the base currency</p> Signup and view all the answers

    What is the relationship between bid and ask exchange rates?

    <p>Bid is cheaper than ask</p> Signup and view all the answers

    What does a higher spread indicate about a currency?

    <p>The currency is less liquid</p> Signup and view all the answers

    How is the spread calculated in the foreign exchange market?

    <p>As the difference between the bid price and the ask price</p> Signup and view all the answers

    Which statement correctly identifies the forward rate based on the given spot price and forward points?

    <p>Forward rate is lower than spot rate when forward points are negative</p> Signup and view all the answers

    In terms of liquidity, what effect does a lower spread have on currency trading?

    <p>It indicates higher liquidity of the currency</p> Signup and view all the answers

    What is counterparty risk in the context of swap contracts?

    <p>The risk that the counterparty fails to meet its obligations.</p> Signup and view all the answers

    Which factor mitigates counterparty risk in swap transactions?

    <p>The use of an intermediary financial institution.</p> Signup and view all the answers

    What characterizes a fixed-variable interest rate swap (coupon swap)?

    <p>The fixed leg pays while the variable leg pays semiannually.</p> Signup and view all the answers

    What type of cash flows do interest rate swaps exchange?

    <p>Future cash flows based on interest rates.</p> Signup and view all the answers

    Which of the following is NOT a requirement for carrying out an interest rate swap (IRS)?

    <p>Each party being able to access a market under similar conditions.</p> Signup and view all the answers

    What is a 'notional' in the context of a swap contract?

    <p>The principal on which interest calculations are based.</p> Signup and view all the answers

    What is the role of a swap broker in interest rate swaps?

    <p>To act as an intermediary for buying and selling interests.</p> Signup and view all the answers

    What does it mean that cash flows in an interest rate swap are settled by differences?

    <p>The net interest payments are exchanged rather than the gross amounts.</p> Signup and view all the answers

    Study Notes

    Foreign Exchange Market

    • Foreign exchange is also known as FOREX
    • Foreign exchange market is decentralized
    • Transactions can be made in different sizes: standard lots, mini lots, micro lots, variable lots
    • Transactions in foreign exchange market are done with leverage
    • Foreign exchange market is global and the exchange rate is the same regardless of location
    • Arbitrage opportunities exist due to different market hours and prices
    • Arbitrage operations help prices converge

    Agents of the Foreign Exchange Market

    • Central banks manage their reserves and exchange rates
    • Intermediaries and brokers act as middlemen between buyers and sellers
    • Market makers provide liquidity to the market
    • Industrial and commercial companies engage in operations related to foreign trade, financing, and international investment
    • Individuals participate in the market for tourism, purchases, and financial operations

    Exchange Rates

    • Triangular arbitrage allows for profit-making by exploiting differences between exchange rates of three currencies
    • Formula for calculating triangular arbitrage: (EUR/USD * USD/JPY * JPY/EUR) = 1
    • Forward exchange rates account for the future value of currency
    • Forward points are the difference between the spot rate and the forward rate
    • Formula for Forward rate using Forward Points & Spot Rate: Forward Rate = Spot Rate + (Forward Points * Pip)
    • Bid and Ask exchange rates are the prices at which the market buys and sells a currency
    • Spread is the difference between Bid and Ask rates, representing the profit of market makers
    • Spread size reflects liquidity of the currency: more liquid = lower spread
    • Example of Bid and Ask rates: USD/EUR 0.8247 (Bid) / 0.8267 (Ask) with a spread of 0.24%

    Swap Contracts

    • Swap contracts are agreements to exchange cash flows in the future
    • Interest rate swaps (IRS) exchange future cash flows based on different interest rates
    • Swap contracts can be fixed-variable or variable-variable
    • IRS involves two parties with different interest rate expectations
    • IRS involves no exchange of principal
    • IRS can be used for hedging interest rate risk
    • Swap contracts carry counterparty risk: risk of one party failing to fulfill obligations
    • Intermediaries can mitigate counterparty risk
    • IRS is a form of hedging using swap contracts

    Interest Rate Swap

    • IRS requires two parties with opposite interest rate expectations
    • IRS involves exchanging cash flows calculated on different bases
    • IRS can be fixed-variable, where one party receives a fixed rate and the other receives a variable rate
    • Notional amount is the base for calculating interest payments
    • Swap Broker acts as an intermediary for buying and selling interest rate

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    Related Documents

    International Finance 4th Grade/GE PDF

    Description

    Explore the intricacies of the Foreign Exchange (FOREX) market, a decentralized marketplace where currency transactions occur. Understand the roles of various market agents, how exchange rates function, and the concept of arbitrage that influences currency pricing. Dive into the mechanisms that enable trading and the importance of liquidity in this global financial market.

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