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CHAPTER 3
FOREIGN EXCHANGE MARKET
 PART I
FOREIGN EXCHANGE RATES & QUOTATION

International
Business

Currency Foreign
systems across exchange
countries rate

International
payment
 CURRENCY SYMBOLS

- The quotations are designated by traditional currency symbols – ISO code (ISO
4217:2008)
- The ISO code were developed for use in electronic communications
- Three-letter ISO codes
 EXCHANGE RATE

- Exchange: is the conversion of one national currency into another national

currency. This conversion must be based on a certain rate – exchange rate.

- Exchange rate:
- The rate comparative relationship between the value of the national
currency with the value of another national currency.
- The price of one unit of currency expressed by another currency.

Eg: USD/VND = 23,417 Exchange rate between USD & VND is 23,417
1 USD = 23,417 VND
 EXCHANGE RATE
- The exchange rate is the price of one country’s money in terms of another country’s
money.
- The spot exchange rate is the price for immediate exchange. (Immediate usually
means within two working days.) This amounts to about 33% of all trading.
- The forward exchange rate is the price for exchange to take place at some specific
time in the future, often 30, 90, 180 days. This accounts for about 11% of all trading.
- A swap is a “package trade” that includes both a spot exchange of two currencies and
a contract to the reverse forward exchange a short time later. This is useful when the
parties to the swap have only a short-term need for the currency. This amounts to
about 56% of all trading.
 EXCHANGE RATE QUOTES

CUR1/CUR2

Base/Unit currency Price/Quote currency

 The number of units of the price currency (CUR2) required in exchange for
receiving one unit of the base currency (CUR1)
 Ex: EUR/USD = 0.9964 -> 1EUR = 0.9964 USD -> 0.9964 USD/EUR
 QUOTATIONS

European terms & American terms

 QUOTATIONS

Direct & Indirect quotations

- Direct quote: one unit of foreign currency in home currency terms

1 foreign currency = X home currency
- Ví dụ: At Paris, on 12/01/2001, 1 USD = 6.9020 FRF
1 JPY = 0.0584 FRF
- Indirect quote: one unit of home currency in foreign currency terms
1 home currency = X foreign currency
- Ví dụ: At London, on 12/01/2001, 1 GBP = 2.3945 CHF
1 GBP = 1.4795 USD
Loại tiền Quốc gia Mã tiền tệ Giá trị quy đổi sang VND

Dinar Kuwaiti Kuwaiti KWD 1KWD = 77,650.99 VND

Dinar Bahrain Bahrain BHD 1BHD = 61,201.85 VND

Rial Oman Oman OMR 1OMR = 59,925.19 VND

Jordan Dinar Jordan JOD 1JOD = 32,540.61 VND

Bảng Anh Anh GBP 1GBP = 31,584.61 VND

Euro Châu Âu EUR 1EUR = 27,461.99 VND

Đô la Cayman Cayman KYD 1KYD = 27,829.62 VND

Swiss Franc Thụy Sỹ CHF 1CHF = 24,961.95 VND

Đô la Mỹ Mỹ USD 1USD = 23,092.50 VND

Đô la Canada Canada CAD 1CAD = 18,307.99 VND

 BID RATES & ASK RATES

Base/Unit Currency

GBP/USD = 1.21035 – 1.21061

Quote/Price Currency
Bid rate
Ask rate

Bid-Ask Spread

Người Mỹ cần 10 000 bảng Anh để sang Anh du học -> mua bảng Anh (Ask)
15 000 đô Mỹ đổi sang tiền Bảng -> 15 000/ 1.21061 = 12.390
EXCHANGE RATE AT VIETCOMBANK 22/08/2023
 BID RATES & ASK RATES

- A Bid is the price in one currency at which a dealer will buy another currency

- An Ask is the price at which a dealer will sell the other currency

- Dealers bid (buy) at one price and ask (sell) at a slightly higher price, making their
profit from the spread between the prices.

- The bid-ask spread may be quite large for currencies that are traded infrequently, in
small volumes, or both.

- Bid/Ask Spread (Percentage) = [(ask rate - bid rate)/ask rate] x 100

BID RATES & ASK RATES
Assume the spot rate of some currencies as following:

USD/VND = 22.450-20; (Bid: 22,450 - Ask: 22.520)

USD/JPY =113,45-00;
GBP/USD =1,6568-00;
EUR/USD =1,2142-12;
AUD/USD =0,6794-24. (0.6794 - 0.6824)

a. What is the rate at which customers will sell USD for and buy AUD from the
bank? How much USD do customers have to sell in order to buy 10.000 AUD?
b. A firm XYZ wants to make payment for 10.000 USD contract. How much VND
would the firm sell for the bank?
a. The customers will sell USD and buy AUD at the rate of 0.06824.
The customers have to sell: 10 000 x 0.6824 = 6824 USD to buy 10 000 AUD
b. The customers will sell VND at the rate of 22.450
The customers have to sell: 10 000 x 22 450 = 224 500 000 VND
 BID RATES & ASK RATES

Example: At New York, the exchange rate is quoted as follow: ¥118.27/$ - ¥118.37/$

• ¥118.27/$: bid rates

• ¥118.37/$: ask rates

Note: These bid and ask quotes are given here as indirect quotes for the ¥ in terms of
the US$.
 BID RATES & ASK RATES

Spread:
• Bank will buy USD at ¥118.27/$ and sell USD at ¥118.37/$

=> Bid/Ask spread for USD = [(118.37 – 118.27)/118.37] x 100= 0.08%

• Bank will buy JPY at ¥118.37/$ and sell USD at ¥118.27/$

=> Bid/Ask spread for JYP = [(1/118.27)-(1/118.37)]/(1/118.27) x 100 = 0.08%

The percentage bid/ask spread is always the same for both currencies
 Spread = (Ask - Bid)/Ask x 100
Determine Bid rate, Ask rate and Spread (Bid/Ask)
Ask Bid
GBP/USD = 1.1741 – 22
Bid Ask
EUR/USD = 0.9962 – 66
USD/CHF = 0.9660 – 64
AUD/USD = 0.6890 – 92
USD/CAD = 1.3032 – 36
USD/HKD = 7.8466 – 72
USD/JPY = 137.52 – 55
 BID ASK SPREAD (%)

GBP/USD 1.6805 1.6807

EUR/USD 0.9962 0.9966
USD/CHF 0.966 0.9664
AUD/USD 0.689 0.6892
USD/CAD 1.3032 1.3036
USD/HKD 7.8466 7.8472
USD/JPY 137.52 137.55
1. If the direct quote of the US dollar is: USD1 = AUD0.9340, what is
its indirect quote?
1AUD = 1,0707USD

2. If the indirect quote of the Japanese yen is: AUD1 = JPY81.542,

what is its direct quote? 1JPY = 0.0123AUD

3. Convert the following indirect quotes to direct quotes, and direct quotes to
indirect quotes:
a. Euro: €1.22/$ (indirect quote) 1$ = 1.22Euro -> 1Euro/0.82$

b. Russia: RUB30/$ (indirect quote) 1$ = 30RUB -> 1$/0.033RUB

c. Canada: US$0.72/C$ (direct quote) -> 1C$/1.39US$

d. Denmark: $0.1644/DKr (direct quote) -> 1DKr/6/08$
 CROSS RATES

- Many currencies pairs are inactively traded, so their exchange rate is determined
through their relationship to a widely traded third currency
- Ex: A Vietnamese importer needs Japanese yen to pay for purchases in Tokyo.
The US dollar is quoted in both VND and Japanese yen (¥), i.e. we have direct
quotes for the US dollar in terms of VND and ¥ (or indirect quotes for both the VN
dong and the Japanese yen in terms of the US dollar)
Japanese Yen ¥118.79/$
Vietnam Dong VND22,870/$
 DETERMINE EXCHANGE RAGE BY CROSS-RATE
METHODS

Determine the cross rates including 3 types:

•The cross rate of two currencies in the base currency position
•The cross rate of two currencies in the quote currency position
•The cross rate of two currencies in both the base and quote currency positions.
 DETERMINE EXCHANGE RAGE BY CROSS-RATE
METHODS
The cross rate of two currencies in the base currency position
Example 1: Assume the spot rate of some currencies are as follow:
GBP/VND = 34,120 - 34,165
USD/VND = 21,210 – 21,240
a) An American company wants to convert 100,000 GBP into USD. How much will the
company receive in USD? What is the bid rate of GBP/USD ?
b) A UK company wants to convert 10,000 USD into GBP. How much will the company
receive in GBP? What is the ask rate of GBP/USD ?
Solution 1
a) An American company wants to convert 100,000 GBP into USD. How much will
the company receive in USD:
- The company must sell GBP to exchange for VND:
•The bank's buying rate for GBP is GBP/VND = 34,120
=> The company receives: 100,000 x 34,120 = 3,412 million (VND)
•Then, the company sells the received VND to exchange for USD:
•The bank's selling rate for USD is USD/VND = 21,240
=> The company receives: 3,412 million / 21,240 = 160,640 (USD)
The buying rate (GBP/USD) = 160,640 / 100,000 = 1.6064
b) A British company currently has 10,000 USD and wants to
exchange it for GBP.
•The company must sell USD to exchange for VND:
•The bank's buying rate for USD is USD/VND = 21,210
=> The company receives: 10,000 x 21,210 = 212.1 million (VND)
•Then, the company sells the received VND to exchange for GBP:
•The bank's selling rate for GBP is GBP/VND = 34,165
=> The company receives: 212.1 million / 34,165 = 6,208 (GBP)
The selling rate (GBP/USD) = 10,000 / 6,208 = 1.6108
Solution 2
a/ A U.S. company exports a shipment worth 100,000 GBP and needs to
convert it into USD.
•The company must sell GBP for VND at the GBP buy rate of 34,120, and then
sell the VND received to exchange for USD at the USD sell rate of 21,240.
GBP/VND = 34,120
=> GBP = 34,120 * VND = 34,120 * (USD / 21,240) = 1.6064 * USD
=> GBP/USD = 1.6064

b) A UK company has 10,000 USD and wants to convert it into GBP.

The company must sell USD for VND at the USD buy rate of 21,210, and then
sell the VND received to exchange for GBP at the GBP sell rate of 34,165.
USD/VND = 21,210
=> USD = 21,210 * VND = 21,210 * (GBP / 34,165)

=> GBP/USD = 34,165/21,210 = 1.6108

 CROSS RATE

Solution 3: Using formula

Cross rate of two currencies at the base currency position (both currencies are
quoted directly)

Bid A/C
Bid A/B =
Ask B/C
Ask A/C
Ask A/B =
Bid B/C
 CROSS RATE

The cross rate of two currencies in the quote currency position

Example 2: Assume the spot rate of some currencies are as follow:
GBP/AUD = 1.5150/87
GBP/USD = 1.6195/10
a. An American company wants to convert 100,000 AUD into USD, How much will
the company receive in USD? What is the bid rate of AUD/USD ?
b). An Australia company wants to convert 10,000 USD into AUD. How much will
the company receive in AUD? What is the bid rate of AUD/USD ?
Using solution 2

a/ A U.S. company wants to convert 100,000 AUD to USD.

•The company must sell AUD for GBP at the GBP sell rate of 1.5187, then sell
the GBP received to exchange for USD at the GBP buy rate of 1.6195.
GBP/AUD = 1.5187
=> AUD = GBP / 1.5187 = (1.6195 * USD) / 1.5187
=> AUD/USD = 1.6195/1.5187 = 1.0664

b) An Australian company has 10,000 USD and wants to convert it into AUD.
The company must sell USD for GBP at the GBP sell rate of 1.6210, then sell
the GBP received to exchange for AUD at the GBP buy rate of 1.5150.
GBP/USD = 1.6210
=> USD = GBP / 1.6210 = (1.5150 * AUD) / 1.6210

=> AUD/USD = 1.6210/1.5150 = 1.0700

 CROSS RATE
Using solution 3: Formular

• Cross rate of two currencies at the quote currency position (both

currencies are quoted indirectly)

Bid C/B
Bid A/B =
Ask C/A

Ask C/B
Ask A/B =
Bid C/A
 CROSS RATE

The cross rate of two currencies in both the base and quote currency positions.
Example 3: Assume the spot rate of some currencies are as follow:
GBP/USD = 1.5245 - 1.5275
USD/JPY = 91.65 - 92.95
a) A Japanese company wants to convert 100,000 GBP into JPY. What is the cross
rate between GBP and JPY (GBP/JPY)?
b) A UK company wants to convert 10.000 JPY into GBP. How much GBP the
company will receive?
Using solution 2
a/ A Japanese company wants to convert 100,000 GBP to JPY.
•The company must sell GBP for USD at the GBP buy rate of 1.5245, then sell
the USD received to exchange for JPY at the USD buy rate of 91.65.

GBP/JYP = GBP/USD * USD/JPY = 1.5245 * 91.65 = 139.72

b/ A UK company wants to convert 10,000 JPY to GBP.

The company must sell JPY for USD at the USD sell rate of 92.95, then sell the
USD received to exchange for GBP at the GBP sell rate of 1.5275.

GBP/JYP = GBP/USD * USD/JPY = 1.5275 * 92.95 = 141.98

 CROSS RATE
Using solution 3: Formular

Cross rate of two currencies at the base and quote currency positions

Bid A/B = Bid A/C x Bid C/B

Ask A/B = Ask A/C x Ask C/B

 CROSS RATE
Assume the spot rate of some currencies are as following:

1. USD/JPY = 90.76/90.80; USD/CAD = 1.22/1.23. What is the cross rate between CAD
and JPY (CAD/JPY)?

2. AUD/VND = 17.260-17.753; AUD/JPY = 84,23-96. What is the cross rate between

JPY and VND (JPY/VND)?

3. USD/VND = 22.670-22.750; EUR/USD = 1,2152-12. What is the cross rate between

EUR and VND (EUR/VND)?
 PART II
FOREIGN EXCHANGE MARKET
 FOREIGN EXCHANGE MARKET - FOREX
- The FOREX market provides the physical and institutional structure through which:
• The money of one country is exchanged for that of another country
• The rate of exchange between currencies is determined
• Foreign exchange transactions are physically completed
- Foreign exchange: money of a foreign country – foreign currency, bank balances,
banknotes, checks, drafts
-A foreign exchange transaction is an agreement between a buyer and a seller that a
fixed amount of one currency will be delivered for some other currency at a specified
exchange rate on a specified date.
 FOREIGN EXCHANGE MARKET - FOREX

There are six main characteristics of the FOREX markets which will be discussed:
 The geographic extent
 The three main functions
 The market’s participants
 Its daily transaction volume
 Types of transactions including spot, forward and swaps
 Methods of stating exchange rates, quotations and changes in exchange rates
 Functions of the Foreign exchange market

Transfer of Purchasing Power

-> transfer purchasing power between countries, which is necessary as international trade and
capital transactions involve parties living in countries with different national currencies

Provision of credit

-> obtain or provide credit for international trade transaction, related to negotiable
instruments such as bank’s acceptance, letter of credit

Minimizing Foreign exchange risks

-> Minimize exposure to exchange rate risk; the FOREX market provides “hedging” facilities for
transferring foreign exchange risk to someone else who is more willing to carry risk
 STRUCTURE OF FOREIGN EXCHANGE MARKET
Time of Day and Currency Trading

- The foreign exchange market is not a single place like the NY Stock Exchange
(NYSE).
- Geographically, the FOREX market spans the globe with prices moving and
currencies trading every hour of every business day
- It is a widely decentralized 24-hour-a-day market, made up of banks and traders
communicating electronically.
Source: Eiteman et al. (2016)
 MARKET PARTICIPANTS
- Foreign exchange dealers: banks & a non bank foreign exchange dealers; profit from buying
foreign exchange at a bid price and reselling it at a slightly higher ask price
- Participants in commercial and investment transactions: importers & exporters,
international portfolio investors, multinational firms, tourists & others use the FX
- Speculators & Arbitrageurs seek to profit from trading within the market itself. Speculators
seek all their profit from exchange rate changes; Arbitragers try to profit from simultaneous
differences in exchange rates in different markets.
- Central banks & treasuries use the market to acquire or spend their country’s foreign
exchange reserves as well as to influence the price at which their own currency is traded, a
practice known as foreign exchange intervention
- Foreign exchange brokers are agents who facilitate trading between dealers without
themselves becoming principals in the transaction and charge a small commission for this
service.
 TRANSACTIONS IN THE INTERBANK MARKET

FOREX

Primary Derivative
Market Market

Spot Forward Swap Future Option

transaction transaction transaction transaction transaction
 SPOT TRANSACTION

- A spot transaction in the interbank market is the purchase or sale of foreign

exchange at a specified rate, with immediate delivery and payment between
banks to take place (in practice, often not until the second business day following).
- The settlement date is often referred to as the value date.
 EXAMPLE - SPOT TRANSACTION

 Vietnamese importing firm buys a U.S. product from a U.S. firm, which
requires payment in U.S. dollars ($).
 The Vietnamese importing firm contacts its bank, gets a quote on the dollar-
VN dong exchange rate, and approves it.
 The Vietnamese importing firm instructs its bank to take VN dong from its
checking account, convert these to dollars, and transfer the amount to the
U.S. producer.
 The Vietnamese bank instructs its “correspondent” bank in New York to take
U.S. dollars from its account and pay the U.S. producer by transferring them
to the producer’s bank.
Illustration of business losses due to exchange rate fluctuations in
contracts

• A garment export company signed a contract worth 500,000 USD, and the
contract is payable 9 months after the signing date. At the time of signing, the
USD/VND exchange rate was 23,000. On the payment date, the exchange rate
changed to 21,000. As a result, the company effectively lost 100 million VND on
the entire contract.
• Company A signed an import contract at the beginning of the year when the
USD/VND exchange rate was 21,000. By the end of the year, when payment was
due, the exchange rate had risen to 23,000. If the contract was valued at 1 million
USD, the company had to cover an additional 2 billion VND.
 FORWARD TRANSACTION

- A forward transaction occurs where 2 parties agree to exchange currencies at a

future date at an agreed exchange rate.
• The exchange rate is specified and agreed upon at the time of the transaction, but
payment and delivery occur in the future.
• Forward rates are contracts quoted for settlement (value) dates of one, two, three,
six, nine and twelve months.
• Terminology typically used is buying (selling) forward.
• For example, a contract to deliver dollars for euros in six months is both buying euros
forward for dollars and selling dollars forward for euros.
 FORWARD TRANSACTION
• An import company in Vietnam needs to pay 500,000 USD to a foreign supplier after 6 months.
Currently, the exchange rate is 23,500 VND/USD, and the company is concerned that the rate will
increase in the next 6 months.
• To protect itself from the increase in the USD price, the company signs a regular Forward contract
with a bank to buy USD after 6 months at a fixed rate of 23,500 VND/USD.
• After 6 months: The spot exchange rate after 6 months has risen to 24,000 VND/USD (as the
company predicted).
• Result: Thanks to the Forward contract, the company is able to purchase 500,000 USD at the fixed
exchange rate of 23,500 VND/USD instead of the actual rate of 24,000 VND/USD.
• Comparison:
1. Without a Forward contract: The company would have to pay:
500,000 USD × 24,000 VND/USD = 12,000,000,000 VND (12 billion VND).
2. Thanks to the Forward contract: The company only has to pay:
500,000 USD × 23,500 VND/USD = 11,750,000,000 VND (11.75 billion VND).
• Savings: The company saves: 2,000,000,000 VND - 11,750,000,000 VND = 250,000,000 VND (250
million VND).
Non-deliverable forwards (NDFs)

• Non-deliverable forwards (NDFs) – NDFs possess the same characteristics as traditional

forward contracts except that they are settled only in US dollars and the foreign currency
being sold or bought forward is not delivered.
• Scenario:
• The company in Vietnam expects to receive 1 million USD in 3 months.
• Current exchange rate (spot rate): 23,000 VND/USD.
• The company fears the exchange rate might drop To hedge against this risk, they enter
into an NDF contract with a forward exchange rate of 23,000 VND/USD.
• After 3 months:
• The actual spot exchange rate is 22,000 VND/USD, as the company feared. Now let's
calculate the difference the bank will pay the company:
1.Forward rate (NDF contract rate): 23,000 VND/USD
2.Spot rate at settlement: 22,000 VND/USD
Non-deliverable forwards (NDFs)

• The difference per USD is 1,000 VND. Now, applying this to the total contract
amount (1 million USD)-> Total difference in VND: 1,000 VND/USD × 1,000,000
USD = 1,000,000,000 VND (1 billion VND)
• Settlement:
• Since NDFs settle in USD, the difference in VND will be converted back to USD at
the actual exchange rate (22,000 VND/USD).
• Difference in USD: 1,000,000,000 VND ÷ 22,000 VND/USD = 45,454.55 USD
• Thus, the bank will pay the company 45,454.55 USD to cover the difference
caused by the unfavorable change in the exchange rate. This ensures the
company effectively receives the value it expected when it hedged using the NDF
contract.
 Applications of Forward Contracts

• Hedging against exchange rate risk:

 Forward contracts are commonly used to hedge against exchange rate risks in international
business. If a company has receivables or payables in foreign currency, and the foreign currency is
expected to depreciate (typically assets denominated in foreign currency), the company will hedge
by selling forward that asset in the forward market. This way, regardless of how the foreign
exchange rate fluctuates in the spot market, the value of the asset remains constant in the
domestic currency.
 Conversely, if a company has liabilities or payments in foreign currency, the company can buy
foreign currency forward to balance the debt in the domestic currency, protecting itself against the
risk of foreign currency appreciation in the future.
 If exchange rates move as predicted, the company hedges the risk of losses in foreign currency. On
the other hand, if the exchange rate moves in the opposite direction, the company might forgo
potential profits, but the loss in the forward contract is considered as the cost of insurance.
 Applications of Forward Contracts

• Arbitrage: in the case of forward contracts, arbitrage could involve using different forward rates to
lock in a small, risk-free profit over time due to differences in rates between currencies or markets.

• Interest Rate Arbitrage with Exchange Rate Risk Hedging:

 This refers to the strategy of taking advantage of the interest rate differences between two
countries while using forward contracts to hedge against exchange rate risks.

 For example, if a company can borrow money at a lower interest rate in one country and invest it in
another country with a higher interest rate, it can make a profit from the interest rate difference.
However, to avoid the risk of exchange rate fluctuations affecting this profit, the company uses a
forward contract to lock in the exchange rate for converting currencies at a future date, ensuring
that exchange rate changes won’t erode their gains.
Disadvantages of Forward Transactions

• A forward foreign exchange transaction satisfies the customer's need to buy or sell foreign
currency, with the currency exchange taking place in the future. However, a forward transaction is
mandatory, so when the contract expires, both parties must execute the contract, even if the
conditions are unfavorable.
• Another disadvantage is that the forward contract may only meet the customer's future demand
to buy or sell foreign currency. Sometimes, customers might have immediate needs to both buy
and sell foreign currency at the same time, but the forward contract does not match the
simultaneous demand for buying and selling foreign currency.
• Forward transactions may become a tool for speculators seeking profit (in countries where
forward contract trading is developed). This means that speculators sign forward contracts
without needing the actual foreign currency, simply profiting from exchange rate differences
between the signing date and the delivery date. These markets can lead to speculative purchases,
driving the demand for foreign currency beyond real capital needs, increasing the risk of financial
instability (which is one of the contributing factors to financial crises).
 SWAP TRANSACTION
- A swap transaction is the simultaneous purchase and sale of a given amount of
foreign exchange for two different value dates.
- Both purchase and sale are conducted with the same counterpart.
- A common type of swap is a spot against forward:
• The dealer buys a currency in the spot market and simultaneously sells the
same amount back to the same bank in the forward market.
• Since this transaction occurs at the same time and with the same counterpart,
the dealer incurs no exchange rate exposure.
- Another type of swap is a forward-forward swap ( less common)
- Meet the need of current and future foreign exchange ; hedging against exchange
rate risks; seeking profits.
- Types of swaps: currency swaps, interest rate swaps…
 Illustration of a Foreign Exchange
Swap Transaction

• Company A is an export business based in Vietnam. Company A has

just received 1 million USD from a foreign partner and plans to use
this amount to settle another import contract in 3 months.

• However, at the moment, Company A needs VND to cover operating

costs.

• The company is concerned that the VND/USD exchange rate may

fluctuate in the future, leading to higher costs to buy back USD later.

• To manage exchange rate risk and meet the current demand for VND,
Company A decides to enter into a Spot-Forward Swap transaction
with Bank B.
 Illustration of a Foreign Exchange Swap Transaction

Transaction result:
Transaction details: •Immediately, Company A has 23.5 billion
Spot Leg: VND to use for current needs without
•Company A sells 1 million USD to Bank B at the spot rate worrying about exchange rate fluctuations.
of 23,500 VND/USD. •After 3 months, Company A will pay 23.6
Forward Leg: billion VND to buy back 1 million USD,
•At the same time, Company A and Bank B agree to ensuring it has the USD necessary to settle its
execute a forward transaction, in which Company A will import contract with the foreign partner.
buy back exactly 1 million USD after 3 months. Benefits of the transaction:
•The forward rate is agreed at 23,600 VND/USD. •Company A is protected from exchange rate
fluctuations over the next 3 months, ensuring
that it can buy back 1 million USD at a fixed
rate when needed, without being affected by
potential unfavorable movements in the
exchange rate.
•At the same time, the company can make use
of the 23.5 billion VND it immediately
receives for operating expenses.
 Illustration of a Foreign Exchange Swap Transaction

• Exercise 1:
• Assume a U.S. company has an immediate payment obligation in AUD (needs AUD immediately)
while temporarily holding 1 million GBP for 60 days.
The spot rate for GBP/AUD = 2.0345
The 2-month forward rate for GBP/AUD = 2.0189
The company decides to enter into a SWAP contract: sell 1 million GBP immediately for AUD and
buy back 1 million GBP with AUD at the end of 60 days.
Describe the result of the transaction.
• Exercise 2:
• Assume a Vietnamese company currently holds VND but needs 10,000 USD. However, it will only
receive the payment from its export contract (10,000 USD) after 60 days.
The company could consider buying 10,000 USD immediately at the spot rate and selling 10,000
USD forward after 60 days (once the receivables from the export contract have been collected).
Describe the result of the transaction.
Foreign exchange SWAP

• Foreign exchange SWAP transactions are a common activity in the foreign

exchange market.

• The volume of these transactions far exceeds spot or single forward transactions.

• Parties can use SWAPs as an effective hedging technique when the foreign
exchange market is volatile.

• When banks engage in this activity, they meet foreign exchange requirements for
business, both making a profit and hedging against risks.
Option transaction
In option transactions, there are two parties involved: the option buyer and the option seller.
•For the option buyer:
 A currency option grants the buyer the right, but not the obligation, to buy (call option) or sell
(put option) a certain amount of currency at a predetermined rate (known as the strike price or
exercise price) by a specific expiration date.
 The buyer can choose to exercise the option at the expiration date if it is advantageous or let it
expire, depending on the difference between the current spot rate and the strike price.
•The option buyer always pays a premium for the option, regardless of whether they exercise
the option or not. This premium is paid at the time of the contract.
•For the option seller:
 The option seller is obliged to honor the buyer’s choice, whether the buyer exercises the option
or not. In return, the seller receives a premium to compensate for the risk.
Nghiệp vụ quyền chọn ( Option)
• Content of Call or Put Options
• Types of options: American style or European style.
European style: can only be exercised on the expiration date.
American style: can be exercised at any time before the expiration date.
Example
According to the American style, a call option to buy 1 million EURO at a rate of 1 USD = 0.7
EURO from today until the expiration date of 20/05/20xx.
A European put option to sell 10 million EURO at a rate of 1 USD = 0.7 EURO exactly on
20/05/20xx.
• Quantity of foreign currency to be bought or sold.
• Strike price: the buying or selling price of foreign currency when the option buyer chooses
to exercise the option.
• Contract term (expiration date).
• Option premium (Option Price).
Illustration of an Option

• A Canadian company needs to pay for an import order worth 1 million USD within one month.
The company enters into a 1-month USD/CAD option contract with the following terms:
• Strike price: 1.2345 CAD
• Premium: 0.02 CAD
• Assume the spot rate after 1 month develops in the following scenarios:
1. USD/CAD = 1.2821
2. USD/CAD = 1.2345
3. USD/CAD = 1.1904
• Question: In which scenario should the company exercise the option, and in which scenario
should it let the option expire? Determine the amount of CAD the company must pay in each
case.
 Illustration of an Option
Solution:
The option premium is 1,000,000 USD * 0.02 = 20,000 CAD. If the company exercises the option,
the total CAD cost (including premium) will be:
1,000,000 * 1.2345 + 20,000 = 1,254,500 CAD.
•Scenario 1: USD/CAD = 1.2821, the spot rate. The total CAD payment without the option would be:
1,000,000 * 1.2821 + 20,000 = 1,302,100 CAD, which is higher than 1,254,500 CAD.
In this case, the company should exercise the option, and the total CAD payment will be
1,254,500 CAD.
•Scenario 2: USD/CAD = 1.2345, which matches the strike price. In this case, exercising the option
or not makes no difference, and the total CAD payment will be 1,254,500 CAD.
•Scenario 3: USD/CAD = 1.1904, so the total CAD payment without the option would be:
1,000,000 * 1.1904 + 20,000 = 1,210,400 CAD, which is lower than 1,254,500 CAD.
In this case, the company should not exercise the option, and the total CAD payment will be
1,210,400 CAD.
TRANSACTIONS IN THE INTERBANK MARKET