Chapter 5
The Foreign Exchange Market
◼ Learning Objectives
1. Explore the multitude of functions of the foreign exchange market
2. Detail how the structure of the global foreign exchange market has evolved
3. Describe the financial and operational transactions conducted in the foreign exchange
market
4. Examine the forms of currency quotations used by currency dealers, financial institutions,
and agents of all kinds when conducting foreign exchange transactions
◼ Chapter Outline
I. Functions of the Foreign Exchange Market
II. Structure of the Foreign Exchange Market
A. The Global Trading Day
B. Market Participants—The Players
Bank and Nonbank Dealers
Commercial and Investment Transactors
Speculators and Arbitragers
Central Banks and Treasuries
Foreign Exchange Brokers
C. Evolution of the Market
D. The Evolution of FX Trading
1985
1990s
2010
E. The Three Components of FX Trades
F. FX Market Manipulation: Fixing the Fix
III. Transactions in the Foreign Exchange Market
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5. Foreign Exchange Transaction. Define each of the following types of foreign exchange
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6. Swap Transactions. Define and differentiate the different type of swap transactions in the
foreign exchange markets.
7. Nondeliverable Forward. What is a nondeliverable forward, and why does it exist?
Chapter 5 The Foreign Exchange Market 31
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(ISDA). Although originally envisioned to be a method of currency hedging, it is now
estimated that more than 70% of all NDF trading is for speculation purposes.
8. Foreign Exchange Market Characteristics. With reference to foreign exchange turnover in
9. Foreign Exchange Rate Quotations. Define and give an example of each of the following
quotes:
10. Reciprocals. Convert the following indirect quotes to direct quotes and direct quotes to
indirect quotes:
11. Geographical Extent of the Foreign Exchange Market. Answer the following:
12. American and European Terms. With reference to interbank quotations, what is the
difference between American terms and European terms?
13. Direct and Indirect Quotes. Define and give an example of the following:
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14. Base and Price Currency. Define base currency, unit currency, price currency, and quote
currency.
Foreign exchange quotations follow a number of principles, which at first may seem a bit
confusing or nonintuitive. Every currency exchange involves two currencies, currency 1
(CUR1) and currency 2 (CUR2):
15. Cross Rates and Intermarket Arbitrage. Why are cross currency rates of special interest