IBFE

FOREX
PARLANCE
 Bid/Offer
DR GARGI SANATI  Base Currency and

Quoting Currency

 Market Maker and

Taker

 Direct Quote and

Indirect Quote

 Cross Rate

FOREX MARKET  Hierarchy of the

Quote
FRONT OFFICE DEALING ROOM  Purchase and Sale

OPERATION  NOSTRO and VOSTRO

 Long and Short

Foreign Currencies dealt by the Bank
Position
The Bank deals in the following currencies and maintains
 Deal date and
Exchange positions in USD, EURO, GBP, YEN, AUD, Swiss
Settlement Date
Franc, Canadian dollar, Singapore dollar, Danish kroner,
Swedish kroner and Hong Kong dollar, etc.  Forex timeline

7.1 Forex parlance

Interbank Dealing – transactions carried out between
banks constitute interbank dealing. It is a wholesale
market and the trading volume is very high.
Merchant Dealing – The dealing is between a bank and
a customer.
Deal in foreign exchange market is unique in nature because of
two way quotes. For example, USD/INR quote is 67.2500/5000.
This is due to the fact that while giving the quote market maker does not know if the market
taker is going to buy or sell.
Base currency – The currency which is priced. In USD/INR, USD is the base
currency. In EUR/USD the base currency is EUR.
Quoting Currency or Price Currency – The currency which is the price. In
USD/INR quoting currency is INR and in EUR/USD quoting currency is USD.
Bid rate – The rate at which market maker buys the base currency. If USD/INR is
quoted as 66.70/72 then bid rate is 66.70. It means market maker is willing to buy
USD at the rate of 66.70 INR.
Offer Rate – The rate at which market maker sells the base currency. If USD/INR
is quoted as 66.70/72 then offer rate is 66.72. It means market maker is willing to sell
USD at the rate of 66.72 INR.
Market Maker – The bank which quotes the rate to the taker. Some of the major
market makers presently are Deutsche bank, J P Morgan, Citi bank, Barclays, and
UBS etc
Marker Taker. The bank which asks for the quote and approaches interbank market
for the quote.

Example of an Interbank Deal

 Market Taker calls a Market Maker and requests for quote, say USD/INR
 MT: “Please quote me INR 1 mio”
 Market Maker gives a two-way quote
 MM: “USD/INR 67.2500/5000”
 Market Taker selects his choice
 MT: “Mine “
 Deal is concluded by market maker confirming
 “I sold $ 1 mio at 67.5000”

Example- If the interbank quote for USD/INR is 68.71/72 then we can say that there are
two parties to the trade: (1) price maker; and (2) price taker. There are two actions or market
sides in any transaction: (1) buy; and (2) sell. There are two currencies in FOREX
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transaction: (1) base currency; and (2) quoting currency. There are two sides to the two-way
quote: (1) bid; and (2) offer.
In other word, price maker buys the base currency that is USD at the bid rate, i.e. 68.71 and
sells the base currency or USD at the offer rate 68.72.
In FX market, the action (i.e. buy, sell) may be specified in either base currency or quoting
currency. But, it is the base currency which is convenient to use in terms of Quoting
Currency. To conclude, we can say that if the market maker is buying the foreign currency,
it will quote the bid rate to the customer and if market maker is selling the foreign currency
it will quote the ask rate to the customer.

For example, on GBP/USD currency pair, buying GBP is the same as selling USD for any
bank. When the action is stated in base currency, it is easy to follow because it is a price
quotation.
In the market it is market convention to quote only the last two digits for the last two digits.
The last two digits in Forex parlance is known as the “small figure” are quoted.
For example, EUR/USD quote 1.1112/ 1.1113 is abbreviated to 1.1112/13 or to simply 12/13
USD/CHF is abbreviated to .9091 /9.9092 is abbreviated to 0.9091/92
The omitted part in the offer side is called the "big figure.”
The rule to derive the full form of offer side is that the offer price will have as many decimal
places as the bid price.

Purchase and Sale – Any Commercial Bank Transaction is classified as Purchase

and Sale Transaction. From the AD category 1 banks’ point of view conversion of
foreign currency on behalf of an exporter into Indian Rupees would involve a purchase
and conversion of domestic currency into foreign currency on behalf of an importer
would be a sale.
Likewise, outward remittance would involve sale of foreign currency while inward
remittance would involve purchase of foreign currency.
The Maxim applied is buy low and sell high
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 Long and short Position – Banks can maintain either Overbought (Long) or
Oversold (Short) Exchange Positions in permitted currencies within prescribed
limits. A Long or Short exchange position denotes the extent of the open (uncovered)
quantity of the currency.

7.2 ISO Standard and the SWIFT massages

International organization for standardization (ISO) has given three-letter code for
every currency in their ISO 4217 standard.
The first two letters are the country code defined by ISO in their standard ISO 3166,
and the third letter is usually, but not always, the first letter of the currency name.
Table 4: Currency Code
Country Currency ISO code
United Kingdom Pound GBP
European Union Euro EUR
United States Dollar USD
Japan Yen JPY
India Rupee INR
Switzerland Franc CHF
China Renbinbi CNY

The ISO codes are adopted by the Society for worldwide Inter-bank Financial
Telecommunications (SWIFT), which is the Communication and messaging network
for banks in the world over. Only these standard ISO/SWIFT codes, and not the
special characters (e.g. $, €), must be used in any standard FOREX messaging.
The market practice for the notation of a currency pair is to write the BC code first,
followed by the QC code. For example, EUR/USD. ISO 4217 is the International
Standard for Currency Code.
Table 5: An overview of SWIFT MT Categories
Message Type Description
MT0xx System Messages
MT1xx Customer Payments and Cheques

MT2xx Financial Institution Transfers

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 MT3xx Treasury Markets
MT4xx Collection and Cash Letters
MT5xx Securities Markets
MT6xx Treasury Markets - Metals and Syndications
MT7xx Documentary Credits and Guarantees

MT8xx Travelers Cheques

MT9xx Cash Management and Customer Status

7.3 Hierarchy of the Quote

For most of the currency pair USD is quoted as base currency except EUR, GBP, AUD and
NZD. It means if AUD is quoted against NZD or USD or CHF or INR, AUD would be the
base currency. If GBP is quoted against AUD or NZD or USD or INR, GBP would be the
base currency.
The on-going prices of currencies are known in the dealing room through two sources a.
Information screens provided by vendors such as Reuters, Bloomberg etc b. Price- matching
systems provided by a number of institutions (e.g. Deutsche bank, Barclays, Citi, UBS, 360
t).

7.4 NOSTRO and VOSTRO Account

NOSTRO Account --An account maintained in a foreign currency with a bank usually
located in that country. Example – an Indian bank maintains a USD account with Citi bank,
New York and maintains a euro account with Deutsche bank, Frankfurt. These accounts
would be referred to as the Indian bank’s USD NOSTRO account and GBP NOSTRO account
respectively. NOSTRO accounts are required to be maintained for the purposes of putting
through inward and outward remittances in the respective currencies.

VOSTRO Account - An INR account maintained with a bank in India by a bank located
abroad is referred to as a Vostro Account. Eg: Citi bank, New York maintains a rupee
account with Bank of Maharashtra, Mumbai. This account will be referred to as Citi bank’s
VOSTRO account. VOSTRO accounts are generally to be used for rupee payments to be
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made in India. Funding of the VOSTRO account is done by the foreign bank, by selling
foreign currency and buying rupee. The VOSTRO account cannot be used for USD/INR
trading by the foreign banks.

7.5 Value Dates or Settlement Dates

In a forex transaction two dates are involved – the date of the deal and the date of settlement
of the deal. The date of settlement is also known as the value date of the transaction. For
any inward remittances or for export transaction the NOSTRO fund would be credited and
for any outward transaction or import transaction the NOSTRO fund gets debited on the
respective value dates.
Table 6: Example of Value Dates

Settlement Settlement/Value Date Definition

Cash December 12 Deal Date, T=0

Value “Tomorrow Next” December 13 One “Mutual Business Date
After Deal date”, T+1
Spot December 14 Two “Mutual Business Date
After Deal Date” T+2
Forward December 15 or Later Three Business Days or More
After Deal date; Always
Longer Than Spot

The classification of the value dates are as follows

Cash value date – Settlement is at T = 0. The deal date and settlement date both
are same.
Tom value date – Settlement is at T+ 1. It means the date of settlement falls due
on the next working day for the non-USD centre (between USD/INR non-USD centre
is INR centre). On the settlement date both the USD and Non-USD center should
remain open.
Spot Date – Settlement is at T+2. 'Value spot’ means the date of settlement falls due
on the second working day for the non-USD centre (between USD/INR non-USD
centre is INR centre) after the date of deal. On the settlement date both the USD and
Non-USD center should remain open.
Spot is the most common value date used in the FOREX Transaction
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 Algorithm of Spot Value Date
Case – I:
USD is one of the currencies in the currency pair
 Spot value date is the date that must be a second business day
at non-dollar center and a New York business day.
 It need not be a second business day at New York.
 If New York is closed on what is a second business day at the
other center, then we move to the next business day on which
both non-dollar center and New York are simultaneously open.
Case – II:
USD is not one of the currencies in the currency pair (i.e. cross rate)
 Spot value date is the date that must be second business day at each
settlement center and a New York business day.
 Though not involved in settlement, New York must be opened
because the cross rates are ultimately derived by crossing two USD-
based rates.
 Therefore, New York will be indirectly involved in settlement. If any
of the settlement centers or New York is closed on such date, we
move to the next business day on which all the three are open.
Source: Forex Market by Derivative Association of India

Forward Value Date – Any settlement date beyond spot would be categorized as ‘forward’.

The rate of forward cover is arrived at after taking into consideration the current spot rate
and the current forward points for the date of delivery.

Rules for Forward value dates

Case I: Suppose a forward contract is booked on 15th of July for two months. So, to decide on
the maturity of the forward contract we first have to decide about the spot date. In this case,
spot is 17th July (assuming that this is the second working day of the non-USD centre and the
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working day of the USD Centre. So, the maturity of two months forward would be 17th
September.

Case II: Suppose forward contract is booked on 28th June. So, spot is 30th June (assuming
that this is the second business day of the non-USD centre and working day for the USD
centre). Now 30th June is the last working day of the month. So the two months forward
contract would also fall on the last working of the two months; that 31st August.

As per FEDAI rule the Date of Delivery under forward contract is considered as follows:

a) If bills or documents are purchased/discounted/negotiated : date of negotiation / purchase

/ discount and payment of rupee to customer
b) Bills or documents under collection : date of payment of rupees to the customer on
realization
c) In case of retirement / crystallization of import bill / documents : the date of retirement
or crystallization of liability whichever is earlier. If an import bill received under a letter
of credit and if the customer does not pay within ten days, his liability will be crystalized,
i.e. converted into India Rupees, on the tenth day receipt of documentary by the bank.

The interbank bid rate or ask rate is quoted to the customer. Along with it, the Cash / Spot
(C/S ) or the Tom / Spot ( T/S ) are the two pre spot dates for settlement earlier to the spot
dates. Forward market in India is liquid upto one year; however there is no restriction in
booking forward contract beyond one year. In the Indian forex market, forward points are
always quoted in terms of paise.

CASH TOM Value SPOT Anything beyond

Value Date Date T+1 Value spot is Forward
T= 0 Date T+1 Value Date T+1

Forward booing can be categorized into two parts 1) Month end rate 2) Rate for broken
dates.
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Month end rate - Month end rates are applicable for forward options and FEDAI clearly
prescribes the rules for this, Forward options are the type of forward, if booked then it can
be executed at any day of the month. However, FEDAI rules prescribe that if the market is
in premium then the premium rate for the last month can be passed on to the export
customer. However, premium would be charged to the import customer. For example, if
USD/INR spot rate is 67.72/73 and the 1 month forward rate is 4/5 then the export customer
who wants to book one month forward would be quoted the rate for USD as 67.72 INR -
Margin. He would not be given the benefit of premium. So, customer would receive less INR
against USD. This is for the benefit of the bank. Similarly, if the customer is import
customer, then he would be charged the premium price for USD. He would be charged 67.73
+ 0.05 + Margin = 67.78 + Margin.

Broken Date - The FP are generally given for the month end dates in India. However
forward contracts could be sold for any dates that fall between any of the months. Such
contracts are called the broken dates contract. In case of exporter the bank has to give bid
rate while for the importer the bank has to give the ask rate as the bank here is the market
maker.

We would discuss each of the above cases in details in the later section

Herstatt risk or Settlement Risk

1974 failure of Bank Haus Herstatt concerns the complexity of assuring the settlement of
both ends of a cross border currency deal covering different time zones. Herstatt risk is the
chance that a bank will deliver currency on one side of a foreign exchange deal and finds
that its counterparty cannot reciprocate and this can happen because banks operate in
different time zones. For example, a bank selling Yen and buying sterling pays Yen to
another bank in Japan during the Japanese business day and then waits until London opens
to get sterling in return.
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