Base and Quote Currency: + Since a foreign exchange quote is simply the ratio of one currency to another, a “complete” market maker quote must have two ISO designations (e.g., EUR/USD or USD/PY): — The first iSO currency quoted is called the base currency. — The second ISO currency quoted is called the quote currency. * For examples above: — EUR/USD: EUR is the base currency and USD is the quote currency. = _USD/JPY: USD is the base currency and JPY is the quote currency. + Recall that a market maker always provides the market with two prices, both a buy and sell quote (or price) for a currency. + For Example: EUR/USD: 1.3102/1.3126 — The first number quoted by the market maker is the market maker's buy price ($1.3102). + Itis called the market maker's bid quote (or buy price) — The second quoted number is the market maker's sell price ($1.3126). + Itis called the market maker's ask quote (or sell price) — Note: The bid quote is always lower than the ask quote. * Given the example: EUR/USD: 1.3102/1.3126, which currency is the market maker selling and which currency is the market maker buying? Answer: Market makers are always quoting prices at which they will buy or sell ONE UNIT of the base currency (against the quote currency) - Ss the above example: + The market maker will buy euros for $1.3102 — Thisis the bid price for euros. + The market maker will sell euros for $1.3126 — This is the ask price for euros. ‘+ Assume the following USD/JPY: 110.12/110.20 — Note: Now the base currency is the dollar and the quote currency in the yen, and recall that the market maker is quoting prices at which he/she will buy or sell ONE UNIT of the base currency = The market maker will buy dollars at ¥110.12 * This is the bid price for dollars. = The market maker will sell dollars at ¥110.20+ This is the ask price for dollars, Note Again: Regardless of the type of quote (American terms or European terms), the ask price is always higher than the bid. When viewing a foreign exchange quote, assign a value of 1 to the base currency (the base currency is the first in the ISO pair). The quotes you see refer to one unit of this base currency. — For example, if you see a market maker's ask price for the EUR/USD of 1.2811, that means that if you were to buy one Euro (the base currency) you are going to pay $1.2811. — If yousee a market maker's bid price for the USD/JPY of 120.10 that means if you were to sell one dollar (the base currency) you are going to get 120.10 for Also, whenever the bid and ask prices are moving up, that means that the base currency is getting stronger and the quote currency is getting weaker. Currencies are usually quoted to four decimal places, such as the Euro/US Dollar trading at 1.2400/1.2403, with the last decimal place referred to as a point or "pip". — Apip for most currencies is 0.0001 of an exchange rate; the one exception is the USD/JPY quote in which each pip is equal to 0.01 (the yen is only carried out two decimal places). Currency changes and currency spread (between bid and ask prices) are measured, and reported in “pips.” So for the EUR/USD quote, 1.2400/1.2403 this represents a spread of 3 ips and if the EUR bid goes from 1.2400 to 1.2410, this represents a change in the euro (strengthening) of 10 pips. ‘Assume you are a corporate client and you receive the following GBP/USD quote from a market maker bank: 1.8020/1.8050 ‘Assume you want to buy pounds from the market maker (or sell dollars to the market maker). — What would you pay (in dollars) for each pound? * The ask price is what the market maker will sell pounds for. = Thus, you would pay the ask price, or $1.8050 for each pound Assume you wanted to sell pounds to the market maker (or buy dollars from the market maker). — What would you get (in dollars) for each pound sold? * The bid price is what the market maker will buy pounds for. — You would get the bid price, or $1.8020 for each pound, ‘Assume you are a corporate client and you receive the following USD/JPY quote from a market maker bank: 112.50/112.75 — Recall: now the base currency is the dollar.* Assume you want to buy dollars from the market maker (or sell yen to the market maker). — What would you pay in yen for each dollar? — You would pay the ask price, or 112.75 for each dollar. * Assume you want to sell dollars to the market maker (or buy yen from the market maker). — What would you get in yen for each dollar sold? — You would get the bid price, or 112.50 for each dollar. + Remember: The market maker is always buying or selling the base currency (against the quote currency). * Recall, that all market makers provide both a bid (i.e., buy) and an ask (i.e, sell) quote for a currency. — The difference between the bid and ask price is the spread to the market maker. — This represents the market maker's “profit” from executing a “round” transaction (ie., an equal buy and sell for a currency), * Assume the following GBP/USD quote: 1.7921/1.7929 — What is the spread in pips? + Answer: 9-1=8 pips — What is the dollar spread to the market maker on a “round” transaction (assume 10 million pound transactions)? * Ask $1.7929 x £10,000,000 = $17,929,000 (price to sell pounds) * Bid $1.7921x £10,000,000 $17,921,000 (price to buy pounds) 1 + Spread (Commission) $ 8,000 (on round transaction) Observations About Bid/Ask Spreads * — Bid/ask spreads increase with exchange rate volatility. + Bid/ask spreads decrease with increases in market maker competition. + Bid/ask spreads larger in retail market than in wholesale (i.e. interbank) market. ~ Wholesale market: global bank to global bank — Retail market: bank to customer (client of bank) + Bid/ask spreads will differ slightly among markets. — As market makers attempt to adjust their positions. * Typical spreads for major currencies are 2 to 4 pips.