FOREIGN EXCHANGE MARKET MECHANISM

FOREIGN EXCHANGE
 Foreign exchange is the system or process of
converting one national currency in to
another, and of transferring money from one
country to another.
 NEED FOR FOREIGN EXCHANGE
 International Trade: To pay for imports and receive payments for
exports.
 Investment Opportunities: To facilitate investments in foreign
markets or receive foreign investments.
 Tourism and Travel: To allow individuals and businesses to
transact in foreign countries.
 Repayment of Debts: For servicing loans or debts in foreign
currencies.
 Income Transfers: To remit money across borders, including
profits, dividends, or remittances.
 Economic Stability: To stabilize a country’s currency value
 SIGNIFICANCE AS A MEANS OF SETTLING
INTERNATIONAL TRANSACTIONS
 Eliminating Barriers: It allows businesses and governments to
trade and invest across borders without being constrained by
currency differences.
 Facilitating Payment Systems: It provides mechanisms for
clearing and settling international payments efficiently.
 Exchange Rate Mechanism: Enables buyers and sellers to
agree on currency values, ensuring fair trade practices.
 Economic Growth: By facilitating trade and investment, it
contributes to global economic development and resource
allocation.
 Liquidity in Global Markets: Foreign exchange markets ensure
FOREIGN EXCHANGE MARKET
 The Foreign Exchange Market is a global decentralized
marketplace where currencies are bought and sold. It is
the largest and most liquid financial market in the
world, with trading volumes exceeding $6 trillion per
day. The forex market facilitates international trade
and investment by enabling businesses to convert one
currency into another.
FOREIGN EXCHANGE MARKET
 The forex market operates 24 hours a day, 5 days a week, with
trading taking place in major financial centers around the
world.
 The market is driven by various factors, including economic
data, geopolitical events, and central bank policies.
 The exchange rate, which is the value of one currency relative
to another, is determined by supply and demand forces in the
market.
KEY FEATURES

 Decentralized Nature: Transactions occur over-the-

counter (OTC) without a centralized exchange.
 Global Reach: Involves participants from all over the
world, including banks, corporations, governments, and
individual traders.
 High Liquidity: Due to its global nature, Forex markets
have high trading volumes and liquidity.
 Dynamic Pricing: Exchange rates fluctuate constantly
based on market supply and demand, economic factors,
geopolitical events, and speculation.
FUNCTIONS OF FOREIGN EXCHANGE MARKET

The foreign exchange market is a market in

which national currencies are bought and sold
against one another.

It performs three important functions :-

1. Transfer of Purchasing power

2. Provision of Credit

3. Provision of Hedging facilities

 Transfer of Purchasing power

It is the primary function of a

foreign exchange market =

“Transfer of purchasing power

from one country to another
and from one currency to
another”.
 Provision of Credit

The credit function performed by forex market is plays an

important role in the growth of foreign trade, for
international trade depends to a greater extent on credit
facilities.

Mr. A can get his bill discounted with a foreign exchange bank
in New York and this bank will transfer the bill to its
correspondent in India for collection of money from Mr. B
after the stipulated time.
 Provision of Hedging facilities

Hedging refers to covering of foreign trade risks, and provide a

mechanism to exporters and importers to guard themselves against
losses arising from fluctuations in exchange rates.

US importer, importing the goods for pound 62500 fears an

appreciation of pound he like to hedge the risk through option.
Option are available to him at two different rates.

a. USD 1.60 per pound with a premium of 10.03 per pound.

b. USD 1.70per pound with a premium of $0.03per pound.

PARTICIPANTS IN FOREX MARKET
 COMMERCIAL BANKS
 BROKERS & CUSTOMERS
 CENTRAL BANKS
 NON –BANK FOREX COMPANIES
 COMMERCIAL BANKS :

The inter bank market caters for both the

majority of commercial turnover and large
amounts of speculative trading every day.

 BROKERS :

Individuals constitute a growing segment

of this market, both in size and
importance, they participate indirectly
through Brokers.

They charge a commission in addition to

the price obtained in the market.
 CENTRAL BANKS :
National central banks are play
an important role in the forex
market.

They try to control the money

supply , inflation and interest
rates and often have official or
unofficial target rates for their
currencies.

They can use their often

substantial foreign exchange
 NON-BANK FOREX COMPANIES
:
Non-bank forex companies offer
currency exchange and
international payments to private
individuals and companies.

They are also known as forex

brokers, but are distinct in that
they do not offer speculative
trading but currency exchange with
payments , ie, there is usually a
TYPES OF TRANSACTIONS IN FOREX MARKET

 SPOT & FORWARD EXCHANGES

 FUTURES

 OPTIONS

 SWAP OPERATIONS

 ARBITRAGE
 SPOT & FORWARD EXCHANGES :

SPOT - The transactions are completed on the spot or

immediately.

This trade represents a “direct exchange”

between two currencies, has the shortest time

frame, involve the cash rather than a contract.

FORWARD – Market forward contracts are delivered at a

specified future date. In this, money does not

actually change hands until some agreed up on

future trade. A buyer and seller agree on an

exchange rate for any date in the future , and

transactions occurs on that date, regardless of

what the market rates are then.

 SPOT

 In the spot exchange market, the business is transacted throughout the

world on a continual basis. So it is possible to transaction in foreign

exchange markets 24 hours a day. The standard settlement period in

this market is 48 hours, i.e., 2 days after the execution of the

transaction. The spot foreign exchange market is similar to the OTC

market for securities. There is no centralized meeting place and no

fixed opening and closing time. Since most of the business in this

market is done by banks, hence, transaction usually do not involve a

physical transfer of currency, rather simply book keeping transfer entry

among banks. A spot transaction requires almost immediate delivery of

foreign exchange. In the inter bank market, a spot transaction involves

the purchase of foreign exchange with delivery and payment between

banks to take place, normally, on the second following business day.

The date of settlement is referred to as the “value date.”

 A forward transaction requires delivery at a future value date of a

specified amount of one currency for a specified amount of another

currency. The exchange rate to prevail at the value date is established at

the time of the agreement, but payment and delivery are not required

until maturity. Forward exchange rates are normally quoted for value

dates of one, two, three, six, and twelve months. Actual contracts can be

arranged for other lengths. Outright forward transactions only account

for about 9 % of all foreign exchange transactions. The basic objective of

a forward market in any underlying asset is to fix a price for a contract

to be carried through on the future agreed date and is intended to free

both the purchaser and the seller from any risk of loss which might incur

due to fluctuations in the price of underlying asset. A forward contract is

customized contract between two entities, where settlement takes place

on a specific date in the future at today’s pre-agreed price. The

exchange rate is fixed at the time the contract is entered into. This is

known as forward exchange rate or simply forward rate.

 FUTURES :

Foreign currency futures are

exchange traded forward
transactions with standard contract
size and maturity dates.

Futures are standardized and are

usually traded on an exchange
created for this purpose.

Futures transactions are usually

inclusive of any interest amounts.
 A currency futures contract provides a
simultaneous right and obligation to buy and
sell a particular currency at a specified future
date, a specified price and a standard quantity.
In another word, a future contract is an
agreement between two parties to buy or sell
an asset at a certain time in the future at a
certain price. Future contracts are special types
of forward contracts in the sense that they are
standardized exchange-traded contracts.
 OPTIONS : ( FX Option)

FX Option is a derivative where the

owner has the right but not the
obligation to exchange money
denominated in one currency in to
another currency at a pre-agreed
exchange rate on a specified date.

Fx option market is the deepest ,

largest and most liquid market for
option of any kind in the world.
 Currency option is a financial instrument that give the option

holder a right and not the obligation, to buy or sell a given

amount of foreign exchange at a fixed price per unit for a

specified time period ( until the expiration date ). In other

words, a foreign currency option is a contract for future delivery

of a specified currency in exchange for another in which buyer

of the option has to right to buy (call) or sell (put) a particular

currency at an agreed price for or within specified period. The

seller of the option gets the premium from the buyer of the

option for the obligation undertaken in the contract. Options

generally have lives of up to one year, the majority of options

traded on options exchanges having a maximum maturity of

nine months. Longer dated options are called warrants and are

generally traded OTC.

 SWAP :

The most common type of forward

transaction is the Fx Swap.

In an fx swap , two parties

exchange currencies for a certain
length of time and agree to reverse
the transaction at a later date.

These are not standardized

contracts and are not traded
through an exchange.
 A swap transaction involves the simultaneous purchase and sale of
a given amount of foreign exchange for two different value dates.
The most common type of swap is a spot against forward, where
the dealer buys a currency in the spot market and simultaneously
sells the same amount back to the same back in the forward
market. Since this agreement is executed as a single transaction,
the dealer incurs no unexpected foreign exchange risk. Swap is
private agreements between two parties to exchange cash flows in
the future according to a prearranged formula. They can be
regarded as portfolio of forward contracts. The currency swap
entails swapping both principal and interest between the
parties, with the cash flows in one direction being in a different
currency than those in the opposite direction. There are a various
types of currency swaps like as fixed-to- fixed currency swap,
floating to floating swap, fixed to floating currency swap.
 ARBITRAGE :

Arbitrage is the simultaneous

buying and selling of foreign
currencies with the intention of
making profits from the differences
between the exchange rate
prevailing at the same time in
different markets.

In London: USD/GBP £0.645

In New York: USD/GBP £0.625.

HEDGER, SPECULATORS AND
ARBITRAGEURS
 Speculators: These are traders who essentially buy and sell
foreign currency to make profit from the expected futures
movement of the currency. These traders do not have any
genuine requirement for trading foreign currency. They do
not hold any cash position in the currency.
 Arbitrageurs: These buy and sell the same currency at two
different markets whenever there is price discrepancy. The
principle of “law of one price” governs the arbitrage
principle. Arbitrageurs ensure that market prices move to
rational or normal levels. With the proliferation on internet,
cross currency, cross currency arbitrage possibility has
increased significantly.
SPECULATORS AND ARBITRAGERS

 Speculators and arbitragers seek to profit from

trading in the market. They operate in their own
interest, without a need or obligation to serve clients
or to ensure a continuous market. Speculators seek
all of their profit from exchange rate changes.
Arbitragers try to profit from simultaneous exchange
rate differences in different markets. Arbitragers buy
and sell the same currency at two different markets
whenever there is price discrepancy. The principle
of “law of one price” governs the arbitrage principle.
 Foreign exchange rates represent the
price of one currency in terms of
another. They are essential in
determining the value of international
transactions, investments, and trade.
 Direct and Indirect Quotations

 Exchange rates can be quoted in two ways: direct quotation

and indirect quotation.

 Direct Quotation

 Definition: A direct quotation shows the value of one unit of a

foreign currency in terms of the domestic currency.

 Formula: Direct Quotation=Domestic Currency/Foreign Currency

 Example (from the perspective of the U.S.):

If USD 1 = INR 82, this is a direct quotation for an Indian resident,

as it shows how many Indian rupees are required to buy one U.S.

dollar.
 Under direct quotation the bank buys the foreign currency at

lower price and selling it to a customer at a higher price. For

instance a bank may buy US dollar at 46 and sell at 46.20

and thus book a profit. Therefore, under direct quotation the

maxim is buy low; Sell high. The quotation under Method I, in

which exchange rate is expressed as the price per unit of one

US dollar in terms of the home currency is known as home

currency quotation or ‘direct Quotation’. It may be noted

that under direct quotation the number of units of foreign

currency is kept constant and any change in the US dollar

quoted at under different values of rupees.

 2. Indirect Quotation

 Definition: An indirect quotation shows the value of one unit

of the domestic currency in terms of the foreign currency.

 Formula:

Indirect Quotation=Foreign Currency/Domestic Currency

 Direct Quote=1/Indirect Quote

 Example (from the perspective of the U.S.):

If USD 1 = 0.85 EUR, this is an indirect quotation for an

American resident, as it shows how many euros can be

obtained for one U.S. dollar.

 For example, if the exchange rate
between the US dollar and the Chinese
yuan is 0.56 yuan per US dollar, it is a
direct quote for China, as the domestic
currency for China is represented per
unit of the US dollar (foreign currency).
 Similarly, the exact currency quote above
is an indirect quote for the USA, as a
USD1.79 per yuan.
Exchang Currency Currenc Valid Exchang Translati
e rate (from) y (to) from e rate on ratio
type

USD USD EUR 1/1/1999 92.81993 100: 1

EURO EUR USD 1/1/1999 1.08238 1: 1

 1. If direct quote is Rs 45/US $, how can this
exchange rate be presented under indirect
quote?
 2. If indirect quote is US $ 0.025/Rs., how can
this exchange rate be shown under direct
quote?
 3. If direct quote is Rs 50/US$, how can this
exchange rate be presented under indirect
quote?
Q. 1

 Indirect Quote=1/Direct Quote

 Rs 45/US $,
 Indirect Quote=1/45US $ per Rs
Indirect Quote=0.0222 US $ per Rs
 Ans. 2 : Direct Quote=40Rs per US$
 Ans. 3 : Indirect Quote=0.02US$ per Rs
 Ans. 4 : Direct Quote=50Rs per US$
THE FOLLOWING QUOTES ARE AVAILABLE IN THE
MARKET USD / INR = 50 / 52, FIND OUT INDIRECT
QUOTE OF INR/ USD?
 Given: USD / INR = 50 / 52 INR / USD = ?
(INR/USD)bid = 1 /(USD / INR) ask
= 1/52 (INR/USD)ask
= 0.0192

(INR/USD)ask = 1/ (USD / INR) bid

= 1/50
= 0.0200

Therefore, Indirect Quote of INR / USD = 0.0192 /

0.0200
Q. 2

 The following quotes are available in the

market INR / GBP = 0.0121/ 0.0125, Find out
direct quote of GBP / INR?
 Given: INR / GBP = 0.0121 / 0.0125
 GBP / INR = ?

 (GBP / INR)bid = 1 / (INR / GBP) ask

= 1 /0.0125
= 80
 (GBP / INR)ask = 1 / (INR / GBP) bid
= 1 / 0.0121
= 82.645
 Therefore, direct Quote of GBP / INR =

80/82.645
 If the exchange rate for USD/INR is
74.50/55, what is the direct and indirect
quote for INR/USD
 Ans. 0.01342
 Q. The exchange rate for EUR/USD is
1.1820/25. Calculate the direct and indirect
quotes for USD/EUR. Ans. 0.8456/60
 Q. Given the direct quote for AUD/USD as
0.7500/05, what is the indirect quote for
USD/AUD? Ans. 1.333
 Q. The indirect quote for USD/JPY is
110.25/30. What is the direct quote for
JPY/USD Ans. 0.00907
CROSS RATE
 A cross rate is a foreign exchange market quote between two
currencies (not involving the U.S. dollar) that are then both
valued against a third currency. If used as a base currency,
the U.S. dollar is always seen to assume the value of one.
 Ex.: Two foreign exchange pairs being used are USD/EUR and
USD/JPY, and we want to calculate the cross rate of EUR/JPY.
 bid/offer for USD/EUR is about 1.2191-1.2193, while the
bid/offer for USD/JPY is about 109.744-109.756. This means
for every one USD, you can purchase 1.2191 EUR or 109.744
JPY. calculate EUR/JPY
 Q. Given the following quotes:
 USD/INR = 83.1750/60
 EUR/USD = 1.0320/26
Find the cross-rate for EUR/INR.
 Ans . EUR/INR = 85.8366/85.8875.
 Given the following exchange rates:
 USD/INR = 75.15/20 (direct quote)
 GBP/USD = 1.2850/55 (direct quote)
Calculate the GBP/INR cross-rate using direct and
indirect quotes.
 Ans. (GBP/INR) =75.15×1.2850
Bid = 96.567
(GBP/INR) Ask =75.20×1.2855 = 96.669
FOR PRACTICE
Q. USD/INR = 74.50/55 (direct quote)
 EUR/USD = 1.1000/10 (direct quote)

 Find: EUR/INR cross-rate (Bid/Ask).

Q. GBP/USD = 1.3050/60 (direct quote)

 EUR/GBP = 0.8650/60 (direct quote)

 Find: EUR/USD cross-rate (Bid/Ask).

Q. USD/INR = 82.10/20 (direct quote)

 AUD/USD = 0.7500/10 (direct quote)

 Find: AUD/INR cross-rate (Bid/Ask).

Q. USD/CHF = 0.9200/10 (direct quote)
 GBP/USD = 1.3100/05 (direct quote)

 Find: GBP/CHF cross-rate (Bid/Ask)

 Q. USD/CAD = 1.2400/10 (direct quote)

 EUR/USD = 1.1800/05 (direct quote)

 Find: EUR/CAD cross-rate (Bid/Ask).

 CALCULATE:

CHF/EUR
GBP/EUR
CHF/GBP

Spot Rate Expected Spot

rate

USD/EUR 1.3690 1.3457

CHF/USD 0.9164 0.9020

USD/ GBP 1.5160 1.5102

 Does EUR Appreciate / Depreciate
against CHF and by how much?
 The strongest currency over the next
year.
 Spot Rate CHF/ EUR = 1.2546

 Expected Spot rate CHF/ EUR = 1.2138

 Spot Rate GBP/EUR = 0.9030

 Expected Spot rate GBP/EUR = 0.8912

 Spot Rate CHF/GBP= 1.3893

 Expected Spot rate CHF/GBP = 1.3620

 Percentage depreciation in EUR relative to

CHF = (1.2138-1.2546/1.2546) = -3.251%

 The percentage change in the CHF/EUR

exchange rate is approximately -3.25%,

meaning the Swiss Franc (CHF) is

expected to appreciate by 3.25% against

the Euro (EUR).

 Hence, the strongest currency is CHF.

CONCEPT OF APPRECIATION AND
DEPRECIATION
 1 USD = 75 INR (Initial Rate)
 1 USD = 70 INR (New Rate)
 Analysis: {(70-75)/75 }*100= -6.6%
 Effect on USD: The US dollar has depreciated
against the Indian rupee. It now takes more dollars
to buy the same amount of rupees.
 Effect on INR: The Indian rupee has appreciated
against the US dollar. It now takes fewer rupees to
buy the same amount of dollars.
 1 USD = 75 INR (Initial Rate)
 1 USD = 80 INR (New Rate)
 Analysis: {(80-75)/75 }*100= +6.66%
 Effect on USD: The US dollar has appreciated
against the Indian rupee. It now takes fewer
dollars to buy the same amount of rupees.
 Effect on INR: The Indian rupee has depreciated
against the US dollar. It now takes more rupees to
buy the same amount of dollars.
 CALCULATE:

CHF/EUR
GBP/EUR
CHF/GBP

Spot Rate Expected Spot

rate

USD/EUR 1.3690/97 1.3457/67

CHF/USD 0.9164/75 0.9020/25

USD/ GBP 1.5160/69 1.5102/20

 1. The current spot rate for GBP/USD is 1.3100, and the
expected spot rate is 1.2800. Calculate the percentage
change.
• -2.29% GBP is expected to depreciate against USD.

 The percentage change is -2.29%. This means the GBP is

expected to depreciate against the USD by approximately
2.29%. In other words, the pound is expected to become
weaker relative to the dollar.
 2. The current spot rate for USD/JPY is 145.60, and the
expected rate is 148.20. Is the JPY appreciating or
depreciating? By what percentage?
• 1.79% percentage is positive, the JPY is depreciating, and the USD is
appreciating
 The current spot rate for USD/CHF is
0.8900, and the expected spot rate is
0.9200.Calculate the percentage change. Is
the USD appreciating or depreciating against
CHF?
• +3.37% USD is appreciating against the CHF,
meaning the Swiss Franc (CHF) is depreciating
relative to the US Dollar (USD).
 The current spot rate for EUR/USD is 1.1000, and the

expected spot rate is 1.1200. Calculate the percentage

change and determine whether the EUR is appreciating

or depreciating.
• +1.82% EUR is appreciating against the USD, meaning the USD

is depreciating relative to the Euro.

 The current spot rate for GBP/CHF is 1.1500, and the

expected spot rate is 1.1200. Calculate the percentage

change and determine which currency is strengthening.

• −2.61% GBP is depreciating, and the CHF is strengthening.
 The current spot rate for USD/JPY is 147.50, and the
expected spot rate is 150.00. Calculate the percentage
change and determine if the JPY is appreciating or
depreciating.
• 1.69% percentage change is positive, the JPY is depreciating
against the USD

 The current spot rate for EUR/GBP is 0.8600, and the

expected spot rate is 0.8450. Calculate the percentage
change and determine which currency is strengthening.
• −1.74% percentage change is negative, the EUR is depreciating
relative to the GBP, and the GBP is appreciating against the EUR.
ARBITRAGE OPPORTUNITY
STEPS
 Identify an exchange rate discrepancy
 Calculate the implied cross exchange rates
 Compare the implied rates to the actual exchange
rates
 If Actual Rate (bid) >Implied Rate (ask) then Buy
currency at Implied rate then sell at actual rate
 If Actual Rate(ask) < Implied Rate(bid) then Buy currency
at actual rate then sell at Implied rate

 Execute the arbitrage

 Calculate the profit
 Step 1: Identify the Exchange Rate Discrepancy
 Let's say the current market exchange rates are as
follows:
 USD/EUR = 0.85
 EUR/GBP = 0.70
 GBP/USD = 2.00
 These currency rates mean that 1 USD equals 0.85
EUR,
 1 EUR equals 0.70 GBP, and 1 GBP equals 1.428 USD.
 Step 2: Calculate the Implied Cross Exchange Rates
 To determine if there's an arbitrage opportunity, the
implied USD/GBP exchange rate needs to be calculated
and compared with the actual USD/GBP exchange rate.
The implied rate can be found by multiplying the
USD/EUR and EUR/GBP rates. This is done as follows:
 Implied USD/GBP = USD/EUR x EUR/GBP = 0.85 x 0.70 =
0.595
 The implied exchange rate indicates that 1 USD should be
exchangeable for 0.595 GBP.
 Step 3: Compare With the Actual
Exchange Rate
 The actual exchange rate for GBP/USD is
2.00, which is equal to:
 USD/GBP rate of 1/2.00 = 0.50
 This is lower than the implied rate of 0.595
Thus, there is the potential for triangular
arbitrage.
 Step 4: Execute the Arbitrage
 Let's say the trader has 100,000 USD. The trader
would buy EUR with 100,000 USD at the 0.85 rate:
 100,000 x 0.85 = 85,000 EUR
 The trader would then the 85,000 EUR proceeds to buy
GBP at the 0.70 rate:
 85,000 x 0.70 = 59,500 GBP
 With the 59,500 GBP, the trader would then purchase
USD at the 2.00 rate:
 59,500 x 2.0 = 119,000 USD
 Step 5: Calculate the Profit
 The trader began with 100,000 USD and
ended with 119,000 USD. Thus the profit is:
 119,000 - 100,000 = 19,000
 Thus, the trader received a triangular
arbitrage of 19,000 USD
 JPY/USD= 100
 USD/GBP= 1.60

 JPY/GBP= 140

Se
D
US

ll
JP
Y/

Y
JPY
JP

at
0
10

St
=

=
St

14
0
at

JP
D

Y/
US

GB
P
ll
Se

USD GBP

Sell GBP at St = 1.60 USD/GBP

 Take the first two quotes. Then, the implied (no-arbitrage)

JPY/GBP quote should be:

 JPY/GBP= JPY/USD x USD/GBP= 160

 JPY/GBP > JPY/GBP (160>140)

 (1) Borrow USD

 (2) Sell USD/Buy JPY at JPY/USD = 100 i,e, sell the USD for JPY

100.

 (3) Sell JPY/Buy GBP at JPY/GBP = 140 i.e., sell JPY 100 for GBP

0.7143

 (4) Sell GBP/Buy USD at USD/GBP = 1.60 i.e., sell the GPB 0.7143

for USD 1.1429

 (5) Profits: USD 0.1429 (14.29% per USD borrowed).

 USD/INR = 83.1750/60

 GBP/USD = 1.1290/96

 GBP/INR =102.4230/40

Verify if there is an arbitrage opportunity. If yes,

calculate the profit for 1,000 GBP.

ARBITRAGE OPPORTUNITY
 GBP/INR (implied)=GBP/USD × USD/INR
 Bid (GBP/INR):
 Bid (GBP/INR)=Bid (GBP/USD)×Bid (USD/INR)

=1.1290×83.1750

=93.9045
 Ask (GBP/INR):
 Ask (GBP/INR)=Ask (GBP/USD)×Ask (USD/INR)
=1.1296×83.1760

=93.9556

implied GBP/INR rate is 93.9045/93.9556.

STEP 2
 Compare the implied rate with the actual market rate for
GBP/INR.
 The actual GBP/INR rate is 102.4230/40.
 The implied rate (93.9045/93.9556) is lower than the actual
market rate (102.4230/40).
 This means arbitrage is possible by buying GBP using USD
and selling it for INR.
 Notice that the implied GBP/INR rate (93.9045) is lower than the
direct GBP/INR selling rate (102.4240). This means you can get
more INR by converting GBP to USD and then USD to INR than by
directly selling GBP for INR. This indicates an arbitrage opportunity.
 Step 3: Calculate arbitrage profit for 1,000 GBP.

• Step 3.1: Buy 1,000 GBP in the USD market.

Use the Ask (GBP/USD) rate to buy GBP:

• USD required=GBP Amount ×Ask (GBP/USD)=1,000×1.1296=1,129.60 USD

• Step 3.2: Sell USD for INR.

Use the Bid (USD/INR) rate to sell USD:

• INR received=USD Amount ×Bid (USD/INR)=1,129.60×83.1750=93,954.48

INR

• Step 3.3: Sell GBP for INR in the INR market.

Use the Bid (GBP/INR) rate to sell GBP:

• INR received=GBP Amount ×Bid (GBP/INR)=1,000×102.4230=102,423.00

INR.

• Step 3.4: Calculate arbitrage profit.

The arbitrage profit is the difference between selling GBP in the INR market

and the INR received from converting via USD:

 Danny Oglivy is a forex trader with NMI Inc, a leading
international bank. Rohit Kapoor, an intern at NMI, is
learning how to determine if there is a potential for
triangular arbitrage. Oglivy uses three currencies, INR,
PKR and USD to explain the concept to Kapoor. The
interbank spot rates for INR/USD and PKR/USD are
given below:
 USD/INR = 68.2210/68.2450
 USD/PKR = 104.7500/104.9500
 A dealer quotes a bid-offer rate of 0.6460/0.6490 in
INR/PKR.
 Step 1
 : Calculate the interbank implied cross rate for
INR/PKR.
 Bid ( INR/PKR )=
Bid( INR/USD ) x Bid( USD/PKR ) =
68.2210 *1/104.9500 = 0.6500.
 Ask( INR/PKR ) = Ask( INR/USD ) x Ask( USD/PKR
) = 68.2450 *1/104.7500 = 0.6515
 Step 2:
 Compare the dealer’s offer rate and the
interbank bid rate. Since the dealer’s offer rate
of 0.6490 is below the interbank bidrate of
0.6500, triangular arbitrage will involve
 buying PKR (base currency) from the dealer and
selling PKR in the interbank market
 Step 1: USD to PKR: Convert $10,000 USD to PKR using the
PKR/USD ask rate: $10,000 * 104.9500 PKR/USD = 1,049,500
PKR.
 Step 2: PKR to INR: Convert 1,049,500 PKR to INR using the
INR/PKR bid rate: 1,049,500 PKR * 0.6460 INR/PKR = 677,477
INR.
 Step 3: INR to USD: Convert 677,477 INR back to USD using the
INR/USD bid rate: 677,477 INR / 68.2210 INR/USD = $9,930.68
USD.
 In this scenario, the ending amount of USD $9,930.68, is less than
the starting amount of $10,000. Therefore, when following that
path, there is a loss.
 Step 1: USD to INR:
 Convert $10,000 USD to INR using the INR/USD ask rate: $10,000 *
68.2450 INR/USD = 682,450 INR.

 Step 2: INR to PKR:

 Convert 682,450 INR to PKR using the PKR/INR ask rate (1/INR/PKR
bid): 682,450 INR / 0.6460 INR/PKR = 1,056,424.15 PKR.

 Step 3: PKR to USD:

 Convert 1,056,424.15 PKR back to USD using the PKR/USD bid rate:
1,056,424.15 PKR / 104.7500 PKR/USD = $10,085.19 USD.

 In this reverse path scenario, starting with $10,000 USD, results

in $10,085.19 USD. Therefore there is a profit of $85.19 USD.
 Therefore, by taking the second set of steps, there is indeed a
triangular arbitrage opportunity, generating a profit of
approximately $85.19 on a $10,000 investment.
Q.

 Brendan Rosner manages a global equity fund

based in Hong Kong. He is evaluating stocks
from Japan and New Zealand to add to the
portfolio. As part of his evaluation, he is also
considering the impact of interest rates,
exchange rates and inflation in these countries.
He has gathered the following currency and
market rates:
Country Currency Spot Exchange
Rate**

Hong Kong HKD NA

Japan JPY/HKD 14.07/14.08

New Zealand NZD /HKD 0.1800/0.1900

**Number of foreign currency units per one HKD

If a dealer's bid-side quote for JPY/NZD is 80.00, then a

profit on a NZD 1 investment in the triangular arbitrage
opportunity is closest to:
 Calculate the Implied JPY/NZD Rate:
 JPY/HKD = 14.07/14.08
 NZD/HKD = 0.1800/0.1900

 Implied JPY/NZD =
 Compare with the Dealer's Rate:
 Sell 1 NZD to the dealer for 80 JPY.
 Convert 80 JPY back to NZD at the implied rate: 80 JPY /
78.22 JPY/NZD = 1.02275 NZD
 Profit: 1.02275 NZD - 1 NZD = 0.02275 NZD
Country Currency Spot Exchange
Rate

Hong Kong HKD NA

Japan JPY/HKD 14.07/14.08

New Zealand NZD 0.1800/0.1900

Canada CAD 0.174/0.175

**Number of foreign currency units per one HKD

If a dealer's bid-side quote for JPY/NZD is 78.45, then a

HKD 100,000,000 investment in the triangular arbitrage

opportunity would most likely result in a profit of how

 Convert HKD to NZD. (Use the NZD/HKD ask
rate)
 Convert NZD to JPY using the dealer's rate.
(Use the dealer's JPY/NZD bid rate)
 Convert JPY back to HKD. (Use the JPY/HKD
bid rate)
 Question 1:Given the following exchange
rates:
 USD/INR = 82.5000/82.5500
 EUR/USD = 1.1020/1.1030
 EUR/INR = 91.0250/91.0450

 Determine if there is an arbitrage

opportunity. If yes, calculate the profit for
1,000 EUR.
 Question. 2 Given the exchange rates:
 USD/JPY = 147.2500/147.3000
 EUR/USD = 1.0850/1.0855
 EUR/JPY = 159.7750/159.8000

 Check if an arbitrage opportunity exists and

calculate the possible profit for 1,000 EUR.
`

Question 3: You are given the following rates:

 GBP/USD = 1.2540/1.2550
 EUR/USD = 1.0935/1.0945
 GBP/EUR = 1.1450/1.1460

 Verify if an arbitrage opportunity exists. If so,

calculate the risk-free profit for 1,000 GBP.
Question 4: You are given the following
exchange rates:
 AUD/USD = 0.6570/0.6580
 USD/INR = 83.2000/83.2500
 AUD/INR = 54.6100/54.6300

 Is there an arbitrage opportunity? If yes,

calculate the profit for 1,000 AUD.
 You have the following bid/ask quotes:
 EUR/USD = 1.1510/1.1515
 GBP/EUR = 0.8840/0.8845
 GBP/USD = 1.0180/1.0185
 Remember that you buy at the ask price and sell
at the bid price.
 Is there an arbitrage opportunity? If so, how
would you exploit it, and what would your profit
be if you started with $2,000,000?
DETERMINE IF THERE IS A TRIANGULAR ARBITRAGE
OPPORTUNITY. IF YES, CALCULATE THE PROFIT FOR STARTING
WITH ₹1,000,000.

 Step 1: Calculate the Implied EUR/INR Rate Using USD.

 To check for arbitrage, calculate the implied EUR/INR rate by
going through USD.
 Implied EUR/INR Bid=Bid (EUR/USD)×Bid (USD/INR)
 Implied EUR/INR Ask=Ask (EUR/USD)×Ask (USD/INR)
 Implied Bid (EUR/INR):
 Implied Bid=1.0320×83.1750=85.8414
 Implied Ask (EUR/INR):
 Implied Ask=1.0326×83.1760=85.8484
 Implied EUR/INR rate is 85.8414/85.8484.
 Step 2: Compare with the Actual
EUR/INR Rate.
 The actual EUR/INR rate is 90.4550/60.
 The implied rate (85.8414/85.8484) is
lower than the actual rate (90.4550/60).
 This indicates arbitrage is possible by
buying EUR through USD and selling EUR for
INR.
 Arbitrage Calculation (Starting with ₹1,000,000).
 Convert INR to USD.
Use the Bid (USD/INR) rate to sell INR and buy USD:
 USD Bought=INR Amount/Bid (USD/INR)
 USD Bought=1,000,000/83.1750=12,023.47 USD.
 Convert USD to EUR.
Use the Bid (EUR/USD) rate to sell USD and buy EUR:
 EUR Bought=USD Amount ×Bid (EUR/USD)
 EUR Bought=12,023.47×1.0320=12,404.25
 Convert EUR to INR.
Use the Bid (EUR/INR) rate to sell EUR and buy INR:
 INR Received=EUR Amount ×Bid (EUR/INR)
 INR Received=12,404.25×90.4550=1,122,273.89 INR
 Calculate Arbitrage Profit.
The arbitrage profit is the difference between the INR received
and the INR invested:
 Profit=INR Received−Initial INR
 Profit=1,122,273.89−1,000,000=122,273.89 INR.
 The arbitrage profit for starting with ₹1,000,000 is ₹122,273.89.
 USD/CAD = 1.3250/1.3255
 CAD/EUR = 0.7580/0.7585
 EUR/JPY = 135.20/135.30
 JPY/USD = 0.007400/0.007410
 Your trading platform allows you to execute
trades simultaneously. You have $10,000,000
to trade with.
 Identify the Opportunity

 Calculate the implied USD/JPY rate using the other quotes:

 USD/CAD (bid) * CAD/EUR (bid) * EUR/JPY (bid) = Implied USD/JPY (bid)

 1.3250 * 0.7580 * 135.20 = 135.6672

 Compare the implied USD/JPY rate to the actual market

USD/JPY rate:
 Implied USD/JPY (bid) = 135.6672

 Actual USD/JPY (ask) = 1/0.007410 = 135.0067 (approximately)

 Is there an arbitrage opportunity?

 Yes. The implied USD/JPY bid price (135.6672) is higher than the actual

USD/JPY ask price (135.0067). This means we can buy USD/JPY cheaply in

the market and create synthetic USD/JPY to sell at a higher price.

 2. Execute the Trades

 Since we have $10,000,000 to start, let's determine the optimal trade size. We'll use

the actual USD/JPY ask quote to determine how many JPY we can buy initially.

 JPY to buy: $10,000,000 / 0.007410 = JPY 1,350,067,476 (approximately)

 Now, let's execute the trades in a loop to take advantage of the arbitrage:

 Buy JPY/USD: Spend $10,000,000 to buy JPY 1,350,067,476.

 Convert JPY to EUR: Sell JPY 1,350,067,476 for EUR at the bid price:
 JPY 1,350,067,476 / 135.20 = EUR 9,985,705.44 (approximately)

 Convert EUR to CAD: Sell EUR 9,985,705.44 for CAD at the bid price:
 EUR 9,985,705.44 / 0.7580 = CAD 13,173,754.14 (approximately)

 Convert CAD to USD: Sell CAD 13,173,754.14 for USD at the bid price:
 CAD 13,173,754.14 * 1.3250 = $17,458,582.72 (approximately)

 3. Calculate the Profit

 Ending USD: $17,458,582.72 (approximately)

 Starting USD: $10,000,000

 Therefore, the arbitrage opportunity allows for an approximate profit of

 REVERSE CALCULATION
PROBLEM:
A TRADER WANTS TO BUY €15,000 AND ONLY HAS INR. HOW MUCH INR WILL
BE REQUIRED, CONSIDERING THE EUR/INR = 90.4550/60 QUOTATION?

 Understanding the Quote:

To buy EUR, the trader needs to use the Ask
(EUR/INR) rate, which is 90.4560.
 Formula for INR Required:
 INR Required=EUR Amount ×Ask (EUR/INR)
 INR Required=15,000×90.4560
 INR Required=1,356,840
 Ans. The trader will need ₹1,356,840 to buy
€15,000.
 Question 1:
 A company needs to pay a supplier in USD
200,000. Their treasury department has EUR
available. The EUR/USD quote is 1.1015/20.
How much EUR will the company need to
exchange to make the payment?
• EUR 181,579.71 (USD 200,000 / 1.1015)
 Question 2:
 An investor wants to convert GBP 5,000,000
into JPY. The JPY/GBP quote is 150.20/30. How
much GBP will the investor receive?
• GBP 33,288.30 (JPY 5,000,000 / 150.20)
 Question 3:
 A tourist is traveling from the US to Thailand.
They want to exchange USD 1,000 into Thai
Baht (THB). The USD/THB quote is 32.50/60.
How much THB will the tourist receive?
• THB 32,600 (USD 1,000 * 32.60)
 Question 4:
 A trader sees the following quote: GBP/CHF
1.2540/50. They decide to sell GBP 50,000.
How much CHF will they receive?

• CHF 62,700 (GBP 50,000 * 1.2540)

 You have €10,000 and want to convert it to
CAD. The EUR/CAD quote is 1.4550/55. How
much CAD will you receive?
• CAD 14,550 (€10,000 * 1.4550)
 Question 5:
 You are an importer based in the Euro zone
and need to pay a supplier in Australia AUD
75,000. The EUR/AUD quote is 1.5580/90.
Calculate the amount of EUR required to
settle the invoice.
• EUR 48,148.15 (AUD 75,000 / 1.5580)
 Spread trading – also known as relative value trading – is a

method of trading that involves an investor simultaneously

buying one security and selling a related security. The

securities being bought and sold, often referred to as “legs,”

are typically executed with futures contracts or options,

though there are other securities that can be used.

 The primary goal for investors is to use the spread itself as a

way to generate profit when the spread widens or narrows.

 There are a variety of types of spreads and spreads with

names; the most common types of spreads are option

spreads and inter-commodity spreads.

 Inter-commodity spread
 The inter-commodity spread is created when an investor buys
and sells commodities that are decidedly different, but also
related. An economic relationship exists between the
commodities. For example:
 A crush spread is the relationship between soybeans and their
byproducts, which reflects the importance of processing
soybeans into oil or meal.
 A spark spread is a relationship between electricity and natural
gas; there are many power stations that require gas for fuel.
 Option spread
 Another common spread is option spread.
Options spreads are created with different
option contracts as legs. Both contracts must
pertain to the same security or commodity.
 spread refers to the difference between the
buying (ask) and selling (bid) prices of a
currency pair. It represents the cost of
executing a trade and serves as
compensation to the broker. This difference is
measured in pips and is a crucial factor
influencing trading costs and potential
profits.
 The spread percentage is calculated using the formula:
 Spread Percentage={(Ask Price−Bid Price)/Ask Price}*100

 USD/INR:
 Bid (USD/INR) = 83.1750
 Ask (USD/INR) = 83.1760

Spread Percentage= (83.1760−83.1750​)/ 83.1760 ×100

Spread Percentage= (0.0010/83.1760)×100= 0.0012%
Fixed Spread Variable Spread

Could face requotes No risk of requotes

Can get a tighter spread than

Predictable transaction costs
fixed

Smaller capital requirements Can reveal market liquidity

More appropriate for novice More appropriate for

traders experienced traders

A volatile market won’t affect Spread can widen rapidly if

the spread there is high volatility

Likely to be exposed to
Can be exposed to slippage
slippage
 The spread is usually an income source for
the broker. Every broker has a “liquidity
provider” who directs the trades to the
market and helps both the broker and the
trader make payouts.
Those liquidity providers have their spread as
well, so if the broker wants to have at least
some income, they either have to charge
commissions to the traders, or mark the
 Q. CAD/USD - Spread and Spread
Percentage
 The CAD/USD quote is 1.3520/25.
 Calculate:
 The spread
 The spread percentage
 NZD/USD - Spread and Spread
Percentage
 The NZD/USD quote is 0.6230/35.
 Calculate:
 The spread
 The spread percentage