BWBB3033 Topic 8 Part 2

BWB3033 International Banking
TOPIC 8
BANKING ON THE
FOREIGN EXCHANGE MARKET
PART 2
© Abmalek F. Abubakar, 2005

EXCHANGE RATES
Reciprocal Rates
A rate quotation such that the Reference Currency
in a Volume Quotation is expressed as a unit in
terms of the Commodity Currency
If AUD 1.0 = USD 0.5670
Reciprocally this can be expressed as:

USD 1 = AUD???
Algebraically, USD 1 = 1/0.5670

= AUD 1.7636
CROSS RATES
A foreign exchange rate derived from two
other exchange rates.
Example : Given the following exchange rates,

it is possible to derive JPY 1.00 in terms of
MYR
USD 1 = MYR 3.80000

USD 1 = JPY 121.75

CROSS RATES
Algebraically,
US$ 1.0000 = JPY 121.75 = MYR 3.8000
or JPY 121.75 = MYR 3.8000
Therefore JPY 1.0000 = MYR 3.8000

JPY 121.75
= MYR 0.031211

BID AND OFFER RATES
A foreign exchange rate is normally

quoted in a 2-way price with the Buying
Price (BID RATE) followed by the Selling
Price (OFFER RATE).
Example : when Bank ABC quotes:
Spot US$ / MYR 3.7990 / 10

BID AND OFFER RATES
Spot US$ / MYR 3.7990 / 10
It means : Bank ABC is willing to

 buy (BID) the commodity currency, i.e. US$
1.0, at a price of MYR 3.7990
 sell (OFFER) the commodity currency at a

price of MYR 3.8000

BID AND OFFER RATES
In the quotation
US$ / MYR 3.8 0 90 / 10

BID AND OFFER RATES
In the quotation reference bid

currency rate
US$ / MYR 3.8 0 90 / 10
commodity big offer

currency figure rate

BID AND OFFER RATES
The difference
between
In the quotation bid & offer
reference bid
is called
currency rate
“spread”
the
difference
between
bid & offer US$ / MYR 3.8 0 90 / 10
is called
“spread”
commodity big offer pips

currency figure rate

PIPS & POINTS
PIPs are the numerical units behind the
decimal place of an exchange rate.
In the Quote, USD 1.0 = MYR 3.7995
5 Pips is MYR 0.0005
95 Pips is MYR0.0095
995 Pips is MYR 0.0995
10
PIPS & POINTS
PIPs are the numerical units behind the
decimal place of an exchange rate.
In the Quote, USD 1.0 = JPY 121.77
7 Pips is JPY 0.07
77 Pips is JPY 0.77

177 Pips is JPY 1.77
11
FX EXPOSURE
What is the impact of a movement of 1 pip
in exchange rates to your company ?
1 pip = RM0.0001
Suppose your company has a payable of
USD1,000,000 to be made to a foreign supplier. Your
breakeven rate is USD1 = RM3.8000.
A drop or an increase of RM0.0001 in the USD/RM

exchange rate would save or would cost your
company additional RM100.
Equivalent to RM10,000 for every 1 sen !!!

BID AND OFFER RATES
There are always TWO parties to a quote
● The Quoting Party:

The party that gives the price
● The Calling Party:
The party that asks for the price
The Calling Party performs the opposite of the

transaction to the Quoting Party and only at the
Quoting Party’s price.

BID AND OFFER RATES
In the quotation : Spot US$ / MYR

3.7990 / 10
Quoting Party at Calling Party
BUYS US$ at MYR SELLS US$ at MYR
3.7990 3.7990 3.7990
(Implicitly SELLS MYR) (Implicitly BUYS MYR)
SELLS US$ at MYR BUYS US$ at MYR

3.8000 3.8000 3.8000
(Implicitly BUYS MYR) (Implicitly SELLS MYR)

BID AND OFFER RATES
In the quotation : Spot US$ / MYR

3.7990 / 10
BID RATE Rate at which the Quoting Party is willing to BUY
the Commodity Currency (or rate at which the
Calling Party can SELL the Commodity Currency)
OFFER RATE Rate at which the Quoting Party is willing to SELL

the Commodity Currency (or the rate at which the
Calling can BUY the Commodity Currency)
SPREAD The difference between the BID and the OFFER

rates.

BID AND OFFER RATES
● Parties to the quotation
Quoting Bank – the party that quotes the price;
Calling Bank – the party that calls to ask the quoting
bank for a price
● The Price
Bid Price – the rate at which the quoting bank is
willing to buy the commodity currency;
Offer Price – the rate at which the quoting bank is
willing to sell the commodity currency
● The Currencies
Commodity currency – the currency being priced;
Reference currency – the currency that gives value
to the commodity currency
Banks and Foreign Exchange
http://www.maybank2u.com.my/en/personal/investment/forex-rates.page

INTERPRETATION OF BANK EXCHANGE RATES
Selling Buying Buying OD

TT/OD TT
1 US Dollar 3.8250 3.7750 3.7650

1 British Pound 7.0250 6.8860 6.8660
Question :
Why are there two buying rates ?? … and

Why is the Buying OD rate lower than Buying TT rate ??
Selling Buying Buying

TT/OD TT OD
1 US Dollar 3.8250 3.7750 3.7650

1 British Pound 7.0250 6.8860 6.8660
 Bank sells foreign exchange;

Customer pays Ringgit
 Flow of currencies is immediate on same day

TT/OD TT OD
1 US Dollar 3.8250 3.7750 3.7650

1 British Pound 7.0250 6.8860 6.8660
 Bank buys foreign exchange;

Customer gets Ringgit
 Flow of currencies is immediate on same day

TT/OD TT OD
1 US Dollar 3.8250 3.7750 3.7650

1 British Pound 7.0250 6.8860 6.8660
 Bank buys foreign exchange;

Customer gets Ringgit
 Flow of Ringgit is immediate on same day;
Flow of foreign currency at later date
Selling TT/OD Buying TT Buying OD
US
Dollar 3.8250 3.7750 3.7650
Bank sells for Bank buys from Bank buys from
customers to remit customers who have clients who receives
by telegraphic received TTs from checks or drafts from
overseas, or for overseas or
transfers
exporters who exporters who
receive documentary receive documentary
credits allowing credits calling for
reimbursement by reimbursements at
TTs sight or travelers
presenting travelers’
checks.
(applicable for (or people
importers or receiving money (applicable for
people sending from overseas exporters, people
money outside applicable for receiving money
Malaysia) exporters ) from overseas, or
© Abmalek F. Abubakar, 2005 travelers)
Elements of a Foreign Exchange Transaction
In any foreign exchange transaction, there must

exist the following 6 elements:
● the commodity currency

● the reference currency
● the rate of exchange
● the value date
● the amount of money to be exchanged
● the parties to the exchange

FX Trading
Broadly there are 5 types of FX trading

activities:
1. Spot Foreign Exchange Dealing

2. Forward Foreign Exchange
3. FX Futures
4. FX Options
5. FX Swaps

TRADING METHODOLOGY
Foreign exchange trading can be done

through either of the following
methods:
1. direct with a counterparty over the telephone,

telex, or any computerized dealing system, or
2. through an intermediary such as the foreign

exchange brokers.

VALUE DATES
In a foreign exchange transaction, the
value date can be any specific date
(FIXED DATE) or period of dates
(OPTIONAL DATES)
● value today (FIXED DATE)
● value tomorrow (FIXED DATE)
● value spot (FIXED DATE)
● value 1 mth from spot (FIXED DATE)
● value spot to 1 month (OPTIONAL DATE)
● value 2 to 3 months (OPTIONAL DATE)

Spot FX Dealing
Definition
The buying and selling of foreign currency
(usually US Dollar) against another
currency with actual settlement of the
transaction taking place 2 business days
after date of deal.

Spot FX Dealing forms the bulk of the
transactions that takes place in the
Interbank Foreign Exchange Market.
SPOT FX DEALING
Major Participants
1. Banks
They form the major buyers and sellers.

In Malaysia, only commercial banks are
authorized to trade in foreign exchange.
2. Brokers
They act as middlemen and bring buyers

and sellers together.
SPOT FX DEALING
Commonly Traded Currencies
1. EUR/USD
2. USD/JPY
3. USD/CHF
4. GBP/USD
In Malaysia
1. USD/MYR
2. USD/SGD
Spot FX Trading
SPOT FX RISKS
There are several types of risk which must
be considered and managed for successful
FX trading. The main risks include:
1. Settlement and replacement risk
2. Market risk

SPOT FX RISKS
Pre-settlement Risk (or replacement cost

risk) is the risk that the non-defaulting
counterparty will incur a cost (a loss) in
replacing a treasury contract.
Settlement Risk (or principal risk) is the

risk that one party in a foreign exchange
trade pays out the currency it sold but does
not receive the currency it bought.

SPOT FX RISKS
Market Risk is the risk of loss resulting

from an adverse movement in market
rates on an open position. A profit can
rapidly become a loss and a loss can get
even bigger. A party who has a square
position is not subject to market risk.

Factors Affecting Exchange Rates
The exchange rates in the spot forex market

fluctuate according to supply and demand of
the currencies concerned.
It may fluctuate quite widely sometimes in

response to political and economic news,
rumours, etc.

THE DROP IN MALAYSIAN RINGGIT IN 2015
Three external factors:

1. The oil price plunge
2. China’s economic slowdown
3. Foreign capital outflow

34
The oil price plunge
Since June 2014, global crude oil prices
plunged by more than 50% due to
oversupply and weak demand.
Even though, Malaysia is a net oil importer,
oil-related industries account for a third of
its revenue.
Palm oil prices are likewise on the decline;
and Malaysia is the world’s number two
producer of palm oil.

35
The Oil Price Plunge
Both oil-gas related products and palm oil

constitute at least 28% of Malaysia’s total
exports, significant enough to narrow the
trade surplus as has been the case over the
last few months.
This leads net commodities-exporting
countries like Malaysia to contend with
currency weakening issues.

36
China’s Economic Slowdown
The rationale for China’s currency devaluation
is to boost exports by making them price-
competitive and thus stimulate growth.
China has been trying to shift its export-driven
growth to consumer spending, but evidently
this has not been smooth sailing.
Just two months prior to China’s currency
devaluation, its stock market plummeted 30%
and it took government intervention to halt the
sell-off. © Abmalek F. Abubakar, 2005
37
Foreign Capital Outflow
The third external factor is foreign capital
outflows sparked by an impending interest rate
hike in the US.
Investors appear to be moving away from
investing in risky economies to what is
perceived as stable economies like the United
States.
Malaysia has seen outflows in equities and
bonds, totaling nearly US $7.6 billion.
38
Drop in RM: Another notes
Malaysia is not the only country that has to
contend with these global economic challenges,
but it has been hit particularly hard.
The ringgit is the worst performing currency in
Asia, having lost more than 20% of its value
against the US dollar over the past year.

39
Drop in RM: Another notes
The speed of the ringgit’s decline, falling past
the psychological RM 3.8 peg, is reminiscent to
risk-averse investors of the Asian Financial
Crisis.
It has been suggested that the lack of
transparency over 1MDB has lowered investor
confidence contributing to the foreign capital
outflows, which in turn has impacted the
ringgit.
40

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BWB3033 International Banking

© Abmalek F. Abubakar, 2005

Reciprocally this can be expressed as:

Algebraically, USD 1 = 1/0.5670

Example : Given the following exchange rates,

USD 1 = MYR 3.80000

© Abmalek F. Abubakar, 2005

US$ 1.0000 = JPY 121.75 = MYR 3.8000

or JPY 121.75 = MYR 3.8000

Therefore JPY 1.0000 = MYR 3.8000

© Abmalek F. Abubakar, 2005

A foreign exchange rate is normally

Example : when Bank ABC quotes:

Spot US$ / MYR 3.7990 / 10

© Abmalek F. Abubakar, 2005

Spot US$ / MYR 3.7990 / 10

It means : Bank ABC is willing to

 sell (OFFER) the commodity currency at a

© Abmalek F. Abubakar, 2005

US$ / MYR 3.8 0 90 / 10

© Abmalek F. Abubakar, 2005

In the quotation reference bid

US$ / MYR 3.8 0 90 / 10

commodity big offer

© Abmalek F. Abubakar, 2005

commodity big offer pips

© Abmalek F. Abubakar, 2005

In the Quote, USD 1.0 = MYR 3.7995

5 Pips is MYR 0.0005

In the Quote, USD 1.0 = JPY 121.77

7 Pips is JPY 0.07

77 Pips is JPY 0.77

A drop or an increase of RM0.0001 in the USD/RM

Equivalent to RM10,000 for every 1 sen !!!

There are always TWO parties to a quote

● The Quoting Party:

The Calling Party performs the opposite of the

© Abmalek F. Abubakar, 2005

In the quotation : Spot US$ / MYR

SELLS US$ at MYR BUYS US$ at MYR

© Abmalek F. Abubakar, 2005

In the quotation : Spot US$ / MYR

OFFER RATE Rate at which the Quoting Party is willing to SELL

SPREAD The difference between the BID and the OFFER

© Abmalek F. Abubakar, 2005

© Abmalek F. Abubakar, 2005

Selling Buying Buying OD

1 US Dollar 3.8250 3.7750 3.7650

Why are there two buying rates ?? … and

Selling Buying Buying

1 US Dollar 3.8250 3.7750 3.7650

 Bank sells foreign exchange;

Selling Buying Buying

1 US Dollar 3.8250 3.7750 3.7650

 Bank buys foreign exchange;

Selling Buying Buying

1 US Dollar 3.8250 3.7750 3.7650

 Bank buys foreign exchange;

Elements of a Foreign Exchange Transaction

In any foreign exchange transaction, there must

● the commodity currency

© Abmalek F. Abubakar, 2005

Broadly there are 5 types of FX trading

1. Spot Foreign Exchange Dealing