The Foreign Exchange MarketI Conceptual Questions
The settlement of a transaction takes place by transfers of deposits between two parties. The day on which these transfers are effected is called theSettlement Date or the Value Date.
Spot Rate: When the exchange of currencies takes place on the second working dayafter the date of the deal, it is called spot rate.
Forward Transactions: If the exchange of currencies takes place after a certain periodfrom the date of the deal (more than 2 working days), it is called a forward rate. Atrader may quote a forward transaction for any future date. It is a binding contract between a customer and dealer for the purchase or sale of a specific quantity of astated foreign currency at the rate of exchange fixed at the time of making thecontract.
Swap Transaction: A swap transaction in the foreign exchange market is combinationof a spot and a forward in the opposite direction. Thus a bank will buy DEM spotagainst USD and simultaneously enter into a forward transaction with the samecounter party to sell DEM against USD against the mark coupled with a 60- dayforward sale of USD against the mark. As the term ‘swap’ implies, it is a temporaryexchange of one currency for another with an obligation to reverse it at a specificfuture date.
Bid Rate: The bid rate denotes the number of units of a currency a bank is willing to pay when it buys another currency.
Offer Rate: The offer rate denotes the number of units of a currency a bank will wantto be paid when it sells a currency.
Bid - Offer Rate: The bid offer Rate is the rate which states both, the price which isthe bank is willing to pay to buy other currencies and the price the bank expects whenit sells the same currency. Bid and Ask will always be from a bank’s point of view.Thus (A/B)bid will denote the number of units of A the bank will pay when it buysone unit of B and (A/B)ask will mean the number of units of A the bank will want to be paid in order to sell one unit of B.
European Quote: The quotes are given as number of units of a currency per USD.Thus DEM1.5675/USD is a European quote.
American Quotes: American quotes are given as number of dollars per unit of acurrency. Thus USD0.4575/DEM is an American quote.
Direct Quotes: in a country, direct quotes are those that give unit of the currency of that country per unit of a foreign currency. Thus INR 35.00/USD is a direct quote inIndia.1