Thus in the USD/CHF case, 0.0015 must be added to or subtracted from the
spot bid rate of 1.4265 & 0.0008 must be added to or subtracted from the spot
ask rate 1.4275
1. The bank must always make profit, i .e. the rate at which bank sells a
currency must exceed the rate at which it buys the same currency.
Hence outright forward ask rate must exceed the bid rate.
2. As a general rule, the bid-ask spread widens with time. It is narrowest
for spot, narrower for 1-month forward than for 3-month forward & so
forth. The reason as maturity increases, the volume of turnover declines
& counter party credit risk increases.
In the above example suppose the swap points are added: The following
emerges USD/CHF 1-month forward: 1.4280/1.4283. This violates the 2 nd
principle. Sometimes the mistake will be more obvious.
Taking another example, USD/CAD Spot: 1.2275 / 1.2282 3-month swap :
25/30 If we subtract, we get a 3-month forward of 1.2250 / 1.2252 which
violates the widening of spreads rule; If we add we get 1.2300/ 1.2312 which
satisfies both the requirements.
The difference between the two examples: In the USD/CHF case, the swap quotation was 15/8, a larger number followed by a smaller number; in the USD/CAD case it was 25/30, a smaller number followed by a larger number.
This rule is conditional upon our convention for quoting rates (B/A), viz. rates
are given as units of A per unit of B, bid followed by ask, bid is for the bank
buying currency B & ask is for bank selling currency B.
Suppose we have the following quote from a bank: USD/CAD Spot: 1.6560/70
2-month swap: 15/20. A customer will sell US $ spot & buy US $ 2 months
forward against Canadian dollars i. e. Bank buys spot & sells forward.
USD/CAD Spot: 1.2745/55 1 month swap: 5/10
What is the 1 month outright rate? Which currency is at premium?
A firm wants a swap in which it will buy USD spot & sell USD 1 month forward.
Short date transactions are those in which value date is before the spot value
date. For instance, it is possible to do a £/$ deal for a delivery same da y
because the 5-6 hour delay between New York & London allows instructions to
be transmitted to & processed in NY. A $/¥ deal for the same day would not be
possible because by the time NY opens for business, Tokyo is closed.
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