SUMMARY

1. Thebidaskspreadonforeignbanknotesishighbecauseofinventorycostsofholding
currencyandthecostsandrisksofnotehandling.Banknotesareexchangedatbothretailand
wholesalelevels.
2. Thespotforeignexchangemarketisthemarketinwhichcurrenciesintheformofbank
depositsaretradedandexchanged.Inthismarket,currenciesaregenerallyreceivedoneor
twobusinessdaysafteranexchangeofcurrenciesisagreed.
3. TheinterbankforeignexchangemarketisthelargestmarketonEarth.Itconsistsofacomplex,
globalnetworkofinformallinkagesbetweenbanksandforeignexchangebrokers.When
banksaredealingwitheachother,theyquotebuy(bid)andsell(offerorask)exchangerates.
4. Theinterbankmarketcanbecharacterizedasadecentralized,continuous,openbiddouble
auctionmarket.
5. Whenbanksorcompaniesdealwithaforeignexchangebroker,theystatetheirintentions.The
brokerquotestheinsidespreadtoprospectivecounterparties.
6. Bankssettlebetweenthemselvesonthesamedaytheircustomersreceiveandpayforforeignexchange.
MessagesbetweenbanksaresentviaSWIFT.
7. BankscleartransactionsbetweenthemselvesatclearinghousessuchasCHIPSinNewYork,
whichclearsUSdollartransactions.Banksalsomaintaincorrespondentaccountswitheach
otherforsettlingcustomersaccountsinforeigncurrencies.Systemwideriskhashelpedspur
thegrowthofContinuousLinkedSettlement,CLS.Underthissystem,creditsanddebitsare
simultaneous.
8. ExchangeratesaregenerallyquotedinEuropeanterms;thatis,inunitsofforeigncurrencyper
USdollar.Newspapersgenerallyquotesellingormiddlerates.Whenexchangeratesare
quotedinEuropeanterms,itiseasiertothinkofratesasbidsandasksontheUSdollar.The
BritishpoundandtheeuroarequotedinUSdollarequivalent.Thedollarpoundanddollar
euroratesarebestthoughtofasbidsandasksonthepoundoreuro.Intheinterbankmarket,
bidratesaretypicallyquotedbeforeaskrates.
9. Transactioncostsintheformofbidaskspreadsonexchangeratesareimportantbecausethey
cangreatlyinfluencereturnsonshorttermforeigninvestments.Theyalsoprovidethe
potentialforlargerevenuesforbanksandrepresentacosttobusinesses.
10. AcrossrateisanexchangeratewhichdoesnotinvolvetheUSdollar
forexample,MalaysianringgitsperBritishpound.Intheabsenceoftransactioncosts,cross
exchangeratescanbeobtainedfromexchangeratesvisvistheUSdollar.
11. Intheabsenceoftransactioncosts,themanypossiblecrossexchangeratesbetweenn
differentcurrenciescanbeobtainedjustbyknowingthen1valuesofthecurrenciesagainst

theremainingnthcurrency.Inprinciple,anystandardwilldoformeasurement.
12. Inthepresenceoftransactioncosts,wecannotcomputecrossratespreciselyfromratesversus
theUSdollar.Instead,wecancomputeonlyarangewithinwhichcrossratesmustbequoted.

ANINTRODUCTIONTOEXCHANGERATES
REVIEWQUESTIONS
1. Whatisabankdraft?Areallbankdraftspaper?
2. Whatisanexchangeratespread?
3. Whatdoesabanknotewholesalerdo?
4. Whatisaspotexchangerate?

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INTERNATIONALFINANCIALMARKETSANDENVIRONMENT
5. Whatistheinterbankspotmarket?
6. WhatisSWIFTandwhatdoesitdo?
7. WhatisContinuousLinkedSettlement?
8. WhatisCHIPSandwhatdoesitdo?
9. Howdoestheinterbankspotmarketdifferfromthebrokeredmarket?
10. Whatdowemeanbythebidrateandaskrateonaforeigncurrency?
11. WhatisthedifferencebetweentheUSdollarequivalentandEuropeantermsinexchangerate
quotations?
12. Whatdowemeanbyapointinquotationofexchangerates?
13. Whatisroundtriptriangulararbitrage,andhowdoesitdifferfromonewayarbitrage?
14. Whatisacrossrate?
15. CanwedeterminetheprecisecrossratefromexchangeratesagainsttheUSdollar?