Foreign Exchange and Precious Metals en

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Foreign exchange and precious metals

Marzia Pegorer and Thomas Hirt
Blended learning material co-developed by Compendio and Crealogix
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www.swissbanking.org
Foreign exchange and precious metals

Marzia Pegorer and Thomas Hirt
Technical revision: Hans Fritschi and Christian Lüdi
English version: cb service s.a. (Lausanne)
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Language: EN
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Module Foreign exchange and precious metals
Table of contents
Table of contents
Introduction 4
1 Currencies, notes and foreign exchange 6
1.1 What is a currency? 6
1.2 The exchange rate 8
1.3 Convertibility 12
1.4 The foreign currency account 14
Exercises 16
2 Foreign exchange trading 20

2.1 How is foreign exchange traded? 20
2.2 The role of banks in foreign exchange trading 25
2.3 How is foreign exchange trading used? 26
2.4 Types of transactions in foreign exchange trading 27
Exercises 39
3 Precious metals and coins 42

3.1 Gold and other precious metals 42
3.2 Gold trading 43
3.3 Gold investments 45
3.4 Opportunities and risks of gold 50
Exercises 52
Answers 55
Index 60
BankingToday 2.0 3
Introduction
Introduction
Foreign exchange in particular (and banknotes to a much lesser extent) is of central impor-
tance in international trade.
• People and companies in Switzerland regularly require foreign currency. Individuals need
to make payments in euros, for example, if they travel to Spain on holiday, or in US dollars
if they buy products from America on the Internet. Companies that import goods from
abroad also need to pay for their orders using the appropriate foreign currency.
• Conversely, people from other countries require Swiss francs if they visit Switzerland as
tourists. Without Swiss francs (for them a “foreign” currency), they would not be able to
enjoy Switzerland’s popular fondue or buy its world-famous chocolate. Foreign compa-
nies require Swiss currency if they purchase goods from Switzerland and are presented
with invoices in Swiss francs.
Whether we are dealing with foreign exchange or notes, in both cases we talk of foreign cur-
rencies. But how and where are these traded? How is the price at which you can obtain a for-
eign currency decided?
In addition to foreign currencies, this module will also examine precious metals. These are
popular (especially gold) and expensive. How and where are these precious metals traded?
What is understood by numismatics? What is a Vreneli coin?
At this point, have a look at the e-lesson entitled “Introduction”.
This e-lesson provides insight into the difficult conditions that apply to gold mining and dis-
cusses trends in gold prices in connection with economic and political events.
The second part deals with foreign currency trading, which nowadays is carried out on a huge
scale. You will be given a brief overview of the historical development of this market in this e-
lesson.
Length: approx. 20 minutes
4 BankingToday 2.0
Introduction
What you will learn in this module
This module is structured as follows:

• Chapter 1 “Currencies, notes and foreign exchange” defines the terms currency,
notes and foreign exchange and explains how these are quoted. It also outlines how ex-
change rates are determined and what factors have an influence. In addition, the chapter
deals with foreign currency accounts and how interest is paid on these.
• Chapter 2 “Foreign exchange trading” is devoted to foreign exchange trading and
what transactions are involved.
• Chapter 3 “Precious metals and coins” explains how precious metals are traded and
what opportunities are available with regard to investment and safekeeping. It also iden-
tifies the opportunities and risks associated with investing in gold.
Useful study material
To complement this lesson, the following e-media material is also available:
Introduction
This e-lesson provides insight into the difficult conditions that apply to gold mining and dis-
cusses trends in gold prices in connection with economic and political events. The second part
deals with foreign currency trading, which nowadays is carried out on a huge scale. You will be
given a brief overview of the historical development of this market in this e-lesson.
E-lesson: Foreign currency transactions
Modern foreign exchange trading is essential to the functioning of the international economy.
Discover factors that determine rates; how foreign currency transactions are carried out; and the
various types of transactions involved in professional trading.
Simulation: FOREX trading
Put yourself in the shoes of a foreign exchange trader: assess the factors and events that influ-
ence exchange rates and choose the optimum type of transaction.
E-lesson: Precious metals and coins
Discover which precious metals are most widely traded, and locate areas where they are mined
on an interactive map of the world. Learn about gold trading and the various types of invest-
ments in this metal. This e-lesson concludes with a foray into the world of numismatics.
Self Check
At this point, test your knowledge by doing the Self Check. Have you learned everything you
need to know?
BankingToday 2.0 5
1 Currencies, notes and foreign exchange
Learning goals: After studying this chapter, you will be able to:
• explain the terms currency, foreign exchange and notes.
• describe how currencies are quoted.
• name the main factors that influence exchange rates and use examples to describe how
changes in these factors affect the exchange rate.
• explain what a foreign currency account is, on what foreign currency accounts interest is paid
and what is understood by premium and discount.
Key concepts: ask rate, base currency, bid rate, bureau de change service, coin and note-issuing
privilege, convertibility, currency, direct quotation, discount, economic conditions, EMU, exchange
rate, foreign currency account, foreign exchange, indirect quotation, interest rate level, monetary
policy, notes, political conditions, premium, speculation
1.1 What is a currency?
If you want to pay for goods or services abroad, you need the money of the country in ques-
tion. Every country has a currency, which serves as the official means of payment. In Switzer-
land this is the Swiss franc (CHF), in the USA the US dollar (USD), in the United Kingdom the
British pound (GBP) and in many European countries the euro (EUR). Currencies are subdi-
vided into smaller units. The Swiss franc, for example, is divided into 100 centimes. The gov-
ernment decides how the currency is denominated. It has a coin and note-issuing privi-
lege. The Swiss National Bank (SNB), a joint-stock company under state mandate, is respon-
sible for issuing of banknotes. It controls the amount of notes in circulation and the amount
of deposit money.
In the case of the euro, it is not an individual state that takes these decisions but the European
Monetary Union (EMU). In 1999 eleven states formed the EMU. The euro was initially intro-
duced as deposit money and as of 1 January 2002 has replaced the currencies of the individ-
ual states as a cash currency. It is now the official national currency in 21 countries. New
states are joining the EMU on a more or less annual basis.
To enable global trade to function, uniform and standardised currency designations are
needed. The ISO code is used for this purpose. ISO stands for “International Organization for
Standardization”.
6 BankingToday 2.0
Figure 1 Important currencies with their symbol and ISO abbreviation
Country Symbol ISO code Currency
Switzerland SFr. CHF 1 franc = 100 centimes
Eurozone € EUR 1 euro = 100 cents
United Kingdom £ GBP 1 pound = 100 pence
Sweden SEK SEK 1 krona = 100 öre
Japan ¥ JPY 1 yen = 100 sen
USA US$ USD 1 dollar = 100 cents
Canada kan$ CAD 1 dollar = 100 cents
Australia austr$ AUD 1 dollar = 100 cents
1.1.1 What are notes and foreign exchange?

In the case of foreign currencies we talk about notes and foreign exchange. The exchange of
money from one’s own currency into a foreign currency, or vice versa, is referred to as ban-
knote and foreign exchange trading.
• Notes are .cash (banknotes and coins).
• Foreign exchange refers to claims on payments in foreign currencies. Claims on pay-
ments are funds that do not physically exist. The amounts owed are recorded on paper or
electronically (e.g. cheques, credit card payments, account entries, etc.). The term de-
posit money is also used.
Figure 2 Currency
Foreign currencies
Notes Foreign exchange

(cash: banknotes and coins) (claims on payments)
Comment Banknote trading. For the purposes of international travel banks offer travellers a bureau de
change currency exchange service. As a rule, banks only trade in banknotes and do not accept for-
eign coins. Currencies that are uncommon need to be ordered in advance, provided that they are
freely tradable (see section 1.3, p. 12).
Example Peter’s father has returned from a business trip to Japan with a few 5,000-yen banknotes as a souvenir
for his son. Peter is delighted, especially when his father tells him that they are worth roughly 50 Swiss
francs. Peter has been saving up for some time to buy a new hi-fi system and this money is just what
he needed. The next day he heads straight to the bureau de change counter at a bank. The bank buys
the Japanese notes from Peter and pays him the equivalent value in Swiss francs.
BankingToday 2.0 7
1.2 The exchange rate
Banks exchange currencies at the exchange rate. This expresses the price of one currency
in another currency. The rate tells us how much of a certain currency we will have to pay to
receive a certain unit of the other currency, or how much we will receive of a currency if we
sell a certain unit of the other. For example: how many CHF will we have to pay to receive a
certain unit of USD, or how many CHF will we receive if we sell a certain unit of USD?
Example
The exchange rate
USD/CHF 1.1725 means: USD 1 has a value of CHF 1.1725
1.2.1 Exchange rate quotation
Bid rate and ask rate
The exchange rates used for trading on the foreign exchange and banknote markets are pub-
lished daily in exchange rate lists. The rates are presented from the bank’s perspective, with
a distinction being made between the bid and ask rate.
• The bid rate is the purchase price at which the bank buys the foreign currency.
• The ask rate (or offered rate) is the selling price at which the bank sells the foreign
currency.
Example Figure 3 Foreign exchange and banknote rates (in the financial press, 25th Nov 2008)
Foreign exchange Banknotes The USD/CHF

banknote rate is
Bid Ask Bid Ask stated at a bid rate
of 1.1725 and an
1 EUR 1.5173 1.5565 1 EUR 1.5100 1.5700 ask rate of 1.2625.
This means that
1 GBP 1.8136 1.8535 1 GBP 1.7400 1.9000 the bank...
1 USD 1.2020 1.2330 1 USD 1.1725 1.2625 • buys USD for
CHF 1.1725
100 JPY 1.2315 1.2650 100 JPY 1.2250 1.3250 (bid)
• sells USD for
100 DKR 20.3497 20.8770 100 DKR 19.80 21.55 CHF 1.2625
(ask)
100 SEK 14.4491 14.8569 100 SEK 13.85 15.50
Spread
The ask rate is always higher than the bid rate. The difference between the ask and bid rate is
what the bank earns. It uses this to cover its expenses. This difference is referred to as the
spread.
8 BankingToday 2.0
Example In our previous example, the bank is prepared to:

• buy US dollars for CHF at a bid rate of 1.1725.
• sell US dollars for CHF at an ask rate of 1.2625.
• In doing so, it earns a spread of CHF 0.0900 per USD
Ask – Bid = CHF 1.2625 – CHF 1.1725
The spread is greater for banknotes than for foreign exchange. If someone wants to convert
banknotes into foreign currency or vice versa, the bank incurs costs.
• The bank has to keep a number of foreign currencies available for its bureau de change
service. These funds are unexploited; the bank is unable to use them, which leads to a
loss of interest.
• The bank needs to ensure that its supply of foreign currencies is not too low or too high.
Furthermore, security measures have to be taken when sending the notes, which results
in additional transport and insurance costs.
• What’s more, in the case of notes there is the risk of counterfeit money.
Thanks to electronic resources, foreign exchange can take the form of deposit money. This
means that many costs can be avoided.
Figure 4 Ask rate, bid rate and spread
Notes Foreign exchange

Spread Ask
0.0900 (offered rate)
Bank’s
earnings Spread Ask
Bank’s 0.0310 (offered rate)
earnings
Bid Bid
The bank buys
at 1.1725 The bank sells The bank buys The bank sells
at 1.2625 at 1.2020 at 1.2330
Direct and indirect quotation
A currency purchase is an exchange of two currencies. In most cases people want to

exchange their own currency for a foreign currency. In Switzerland, for example, CHF into
SEK (Swedish kronor), GBP (British pounds), JPY (Japanese yen).
There are rules relating to how exchange rates are quoted:

• The first currency stated is the base currency.
• The second currency stated is the currency being used to buy the base currency.
• The (exchange) rate indicates how much you have to pay to receive a unit of the base
currency.
BankingToday 2.0 9
Figure 5 Exchange rate quotation and base currency
Exchange rate 1st position 2nd position 3rd position JPY 100
quotation Base currency Currency being Rate = price for correspond to
used to buy base a unit of the CHF 1.3250
currency base currency
CHF 1
JPY / CHF 1.3250 JPY CHF 1.3250 corresponds
CHF / JPY 75.47 CHF JPY 75.47 to JPY 75.47
As shown in figure 5, there are always two possible ways to quote the exchange rate for a
currency pair. Depending on the base currency, we talk of direct or indirect quotation. Both
are commonly used in practice.
• Direct quotation: base currency is the foreign currency
• Indirect quotation: base currency is the local currency
Figure 6 Direct and indirect quotation
Direct quotation Indirect quotation

Foreign currency is base currency Local currency is base currency
Foreign currency / local currency Local currency / foreign currency
Direct quotation indicates how much of the Indirect quotation indicates how much of the
local currency you will have to pay for a unit foreign currency you will have to pay for a
of the foreign currency. unit of the local currency.
Common in, for example: Common in, for example:

• USA • Countries with EUR as their currency
• Switzerland • United Kingdom
• Sweden • Australia
• Japan • New Zealand
Please note that the quotation depends on how you look at it. A direct quotation in Switzer-
land is seen as an indirect quotation from the country of the foreign currency.
Example In Switzerland
• Direct quotation: Markus is travelling to the USA and needs US dollars. He goes to the bank and
asks for the USD/CHF rate. The client advisor gives Markus the rate 1.2625. In accordance with
common practice in Switzerland, this is a direct quotation. This means that for USD 1 Markus
has to pay CHF 1.2625.
• Indirect quotation: Markus would like to know how many US dollars he will receive for a Swiss
franc. The advisor converts the rate to an indirect quotation and gives him the rate 0.7920. This
means that for CHF 1 Markus receives USD 0.7920. This rate is an indirect quotation.
In the USA
• Markus has been in the USA for a few days and would like to exchange Swiss banknotes for USD.
He goes to the bank. In accordance with common practice in the USA, the client advisor gives
him the rate as a direct quotation. This is 0.7920. This means that for CHF 1 Markus receives
USD 0.7920. This rate is a direct quotation in the USA.
• Markus would like to know how many CHF he will need to pay to receive a certain amount of
USD. The converted rate is 1.2625. To receive USD 1, Markus must pay CHF 1.2625. This rate
is an indirect quotation in the USA.
Comment In international foreign exchange trading the USD is always the base currency. This means that all cur-
rencies are related to USD 1 (exceptions are: GBP, EUR, AUD and NZD; see chapter 2, p. 20).
10 BankingToday 2.0
1.2.2 How are exchange rates influenced?

Intensive foreign exchange trading creates a risk of exchange rate fluctuations. This currency
risk can result in gains or losses.
Example Ms Kälin has ordered books from an American online shop. She settles the invoice for USD 280.70
using her credit card. On the day she placed the order the USD/CHF rate was 1.1510. The USD invoice
therefore corresponded to a value of CHF 323.10. Later, when Ms Kälin receives her credit card state-
ment, she notices that the rate on the day the amount was debited was higher than on the day she
placed the order. The bank has debited her account with CHF 337.40, which corresponds to a rate of
approximately 1.2020.
Comment In the example a small amount is involved. However, if companies are working with large sums on a
daily basis, they are exposed to much greater risk. To eliminate this risk and simplify trade in Europe,
the euro was introduced.
Why is it that exchange rates vary so greatly? Just like all other prices, the rate of a currency
depends on supply and demand. If a currency is very much in demand, its value increases.
Conversely, the price of a currency falls if there is an excess supply of it. The following rules
therefore apply:
• If there is an excess supply of a currency, rates (prices) go down.
• If there is excess demand for a currency, rates (prices) go up.
Whether supply and demand are at a high or low level depends on numerous factors. The
main ones are shown in the figure below:
Figure 7 Factors that determine rates
Exchange rate
Political conditions
Interest rate level
Economic conditions
Speculation
Monetary-policy measures
Political conditions
Changes in political conditions can have a positive or negative influence on the confidence a
country inspires. This can lead to changes in the flows of funds between countries which
influence the exchange rate.
Example • A country’s government changes. During the election campaign the party that has now been
elected was calling for redistribution measures to help less well-off members of society. Now,
however, many affluent citizens and investors are taking a rather negative view of these develop-
ments. They try to invest their assets abroad, as they are afraid, for example, that higher taxes will
be introduced. This results in an excess supply of the local currency – supply increases and the
price of this currency falls.
• Conditions in a country have been stable for some time. The government is pursuing a policy that
is attractive to foreign investors. More money is being invested in the country. This means that
the local currency has to be bought. Demand increases along with the price.
BankingToday 2.0 11
Economic conditions
National economies are interlinked in many ways. International business relations therefore
have a substantial influence on the value of a currency.
Example • A country imports many more goods than it exports and therefore has an imbalance in its balance
of payments. Due to this import surplus, the number of foreign invoices the country has to pay is
greater than the number it can issue itself. To pay these invoices it has to exchange a great deal
of local currency for foreign currency. Demand for foreign currencies increases, and therefore
prices rise. There is an excess supply of the local currency, so its value falls.
• A country has a very high rate of inflation. The value of domestic currency is falling constantly.
For the same amount of money citizens are able to purchase fewer and fewer goods. For this rea-
son they invest their money in “strong” foreign currencies. This increases the demand for foreign
currencies and the local currency loses value.
Monetary-policy measures
A country’s central bank can influence the value of its currency.
Example The central bank uses the national currency to buy foreign currencies. As a result of this intervention,
demand for foreign currencies increases and their price rises. The value of the local currency, on the
other hand, goes down and domestic products can be purchased more cheaply abroad. The country
becomes attractive to tourists, as with their “strong” currency they can afford more in the country
concerned.
Interest rate level
Higher interest rates abroad can encourage many savers to invest their money in foreign
countries. This increases demand for foreign currencies and their prices rise. On the other
hand, there is an excess supply of the local currency and its price drops. The same also applies
to the reverse situation, of course, where domestic interest rates are higher than those
abroad.
Speculation
Traders can play an important role in the development of currencies. They buy and sell foreign
currencies on the basis of their market expectations. In this way they try to make large gains
quickly, and their transactions influence supply and demand.
1.3 Convertibility
If a currency can be exchanged for another currency without restriction, it is fully convert-
ible. Nowadays, most of the currencies of industrial nations are fully convertible, i.e. freely
tradable.
In certain countries, on the other hand, restrictions apply to the possession, use and/or the
import and export of foreign exchange and notes. The purpose of these legal controls is gen-
erally to protect the economy of a country with an unstable currency against strong foreign
currencies.
12 BankingToday 2.0
Example A country has an unstable and weak currency. To ensure that the currency does not become even
weaker, the state imposes restrictions on the import and export of the local currency. This means that
travellers can only take a limited amount of cash with them and that business people and investors
can only use the local currency to a limited extent for foreign transactions. Further weakening could
arise if people were to invest their assets in stable currencies. For this reason, the state instructs the
central bank to control all foreign currency transactions.
Foreign exchange transactions are controlled to varying degrees. These controls are divided
into three groups, referred to as the three levels of convertibility.
Figure 8 Convertibility
1st level There are no restrictions. The currency can be freely exchanged in all
The currencies are cases.
fully convertible Examples: CHF, EUR, USD
2nd level Typical restrictions are:

The currencies are • cash may only be imported or exported up to a certain amount, or
convertible to a • only foreigners may trade foreign exchange freely, or
limited extent • a different exchange rate applies to commercial transactions than to
speculative financial transactions
Examples: Indonesian rupiah, Thai baht
rd
3 level All foreign exchange and note transactions with foreign countries are
The currencies are controlled.
not convertible Examples: Cuban peso and currencies of several developing countries.
Example • Full convertibility in the eurozone: Mr Notter spends a great deal of time in France, both pri-
vately and on business. His transactions with France run to millions of euros. He can cover these
amounts at any time by exchanging Swiss francs for euros without restriction. If Mr Notter travels
to France on holiday, it is up to him how many euros he wants to take with him and how many
euros he wants to bring back to Switzerland. However, he is obliged to declare amounts of EUR
10,000 or more at customs (declare means pay duty on).
• Limited convertibility of the Thai baht: Ms Albers is planning a trip to Thailand. She finds out
at her bank about the conditions that apply to importing foreign currency. Tourists are permitted
to take a maximum of 2,000 baht into the country and take out a maximum of 50,000 baht. Fo-
reign currencies can be imported without restriction, but amounts valuing USD 10,000 or more
have to be declared. When you leave the country, the amount of foreign currencies you take with
you may not exceed the amount declared.
• Non-convertibility of the Cuban peso: Mr Zehnder has to travel to Cuba on business. Impor-
ting and exporting the Cuban peso is prohibited. This means that the Cuban peso cannot be ob-
tained at all abroad. In Cuba, tourists are not allowed to pay with USD, but must buy the conver-
tible peso, which is on par with the US dollar. The convertible peso is intended for tourists and
the Cuban peso is used by the local population. When he arrives in the country, Mr Zehnder must
declare any foreign currencies worth USD 5,000 or more at customs. When he leaves, he may
only export the amount he imported, less the amounts he has exchanged. Mr Zehnder may only
exchange the convertible peso back in Cuba. To do this must present the receipts for his ex-
change transactions.
BankingToday 2.0 13
1.4 The foreign currency account
So that business people do not have to keep their foreign currency assets abroad, in a safe or
under the mattress, banks offer their clients current accounts in foreign currencies (e.g.
an EUR account, a USD account).
Clients can make deposits into/withdrawals from their foreign currency account and can
use it to make payments. However, interest is not generally paid on these accounts. Euro
accounts are an exception – these usually do pay interest.
Deposits and withdrawals of banknotes into/from foreign currency accounts lead to costs for
the bank.
For transactions in the currency of the foreign currency account the bank a discount or pre-
mium to cover its costs. Premiums and discounts are indicated in percent.
• If the bank accepts notes from a client for payment into a foreign currency account with
the same currency, it charges a discount.
• If a client asks for cash to be paid out of a foreign currency account in the same currency,
the bank charges a premium.
Example Discount: Ms Huber has GBP 3,000 that she does not wish to change into CHF. She will soon be
travelling to England again and, what’s more, she expects the GBP/CHF rate to go down. She opens
a GBP account at her bank and pays her pounds into it. In accordance with applicable conditions, the
bank charges a discount of 1 % and credits the amount of GBP 2,970.
Premium: Mr Walser would like to withdraw EUR 25,000 from his euro account. The bank charges a
premium of 1 %. Mr Walser withdraws EUR 25,000, but EUR 25,250 is debited from his account.
If, on the other hand, notes in a currency that differs from that of the foreign currency
account are accepted or issued, the bank does not charge any premiums or discounts. It cov-
ers its costs from the banknote rate spread.
Currency
A currency is a country’s official means of payment.
• Notes are cash (banknotes and coins).

• Foreign exchange refers to claims on payments in foreign currencies that are payable
abroad.
Exchange rate quotation
• Exchange rates are always quoted from the bank’s perspective:

Bid = buy / ask = sell
• The difference between the bid and ask rate is known as the spread. This is what the
bank earns.
• From the client’s perspective, bid and ask rates for notes are generally worse than those
for foreign exchange. This is due to the costs of transport and insurance, the risk of coun-
terfeit money, etc.
14 BankingToday 2.0
Direct and indirect quotation
• Direct quotation indicates the price of a unit of the foreign currency in the local curren-
cy: the base currency is the foreign currency (example of Switzerland: USD/CHF). Di-
rect quotation is used in Switzerland, Sweden and Japan, for example.
• Indirect quotation indicates the price of a unit of the local currency in the foreign cur-
rency: the base currency is the local currency (example of the United Kingdom:
GBP/CHF). This indirect quotation is used in the United Kingdom, the euro countries, Aus-
tralia and New Zealand.
Exchange rate
Variations in exchange rates occur because of factors such as: political conditions, eco-
nomic conditions, monetary-policy measures, interest rate level, speculation.
Convertibility
There are three different levels of convertibility:
• Fully convertible currencies: No restrictions apply. Examples: CHF, EUR, USD.

• Currencies with limited convertibility: Upwards of a certain amount, notes and for-
eign exchange can only be traded subject to controls. Examples: Indonesian rupiah, Thai
baht.
• Non-convertible currencies: All foreign exchange and note transactions with other
countries are controlled. Examples: Cuban peso and currencies of several developing
countries.
Foreign currency accounts
• Interest is not generally paid on foreign currency accounts (except for euro accounts).
• Banks charge a premium when funds are withdrawn from an account in the same cur-
rency.
• Banks charge a discount when funds are deposited in an account in the same currency.
BankingToday 2.0 15
Exercises
Task 1 A] Ms Sommer would like to visit her daughter in Denmark. Besides travellers’ cheques and her
credit card she also wishes to take some cash with her on her trip. She goes to the bank to
exchange 300 Swiss francs at the exchange rate found in the table below. Calculate how many
Danish kroner Ms Sommer will receive for this.
Note down the exchange rate used and the calculation. Round off to the nearest tenth of a
krone. Do not take into account any commission charged by the bank.
Foreign exchange and banknote rates as at 25.11.2008
Foreign exchange Banknotes
Bid Ask Bid Ask
1 EUR 1.5173 1.5565 1 EUR 1.5100 1.5700
1 GBP 1.8136 1.8535 1 GBP 1.7400 1.9000
1 USD 1.2020 1.2330 1 USD 1.1725 1.2625
100 JPY 1.2315 1.2650 100 JPY 1.2250 1.3250
100 DKR 20.3497 20.8770 100 DKR 19.80 21.55
100 SEK 14.4491 14.8569 100 SEK 13.85 15.50
B] It is Paul’s birthday and his uncle has come to visit from England. As Paul has been saving
up for a moped for some time, his uncle gives him 100 British pounds in cash. Paul is over the
moon and the next day goes straight to the bank. He would like to exchange the money for
Swiss francs and deposit it into his savings account.
Calculate the amount in Swiss francs that Paul receives for his 100 British pounds. The
exchange rate can be found in the table above. You do not need to take any commission
charged by the bank into account.
Note down the exchange rate used and the calculation.
16 BankingToday 2.0
Task 2 A] Explain the meaning of the following terms using key concepts.
Currency:
Notes:
Foreign exchange:
B] Exchange rates can be quoted in different ways.

• Please show how banknote rates can be quoted, using an example in each case.
• State the official term for this form of quotation.
• Explain the terms bid rate and ask rate.
Example 1 – Switzerland
Form of quotation:
Example 2 – United Kingdom
Form of quotation:
Bid rate:
Ask rate:
C] Exchange rates change as a result of supply and demand. Supply and demand are in turn
influenced by a number of factors. Write the number of the corresponding factor next to each
example and explain its impact on the currency of the country concerned.
1 2 3 4 5
Political Economic Monetary-policy Interest rate level Speculation

conditions conditions measures
Example Factor Effect

number
The central bank buys large amounts of the local currency

and sells foreign currencies.
Exports are very high in a country and consequently the

local currency is in high demand abroad.
Parliamentary elections are imminent in a country. Citizens

have lost confidence in the government and its policy and
are transferring their assets abroad.
Swiss foreign exchange traders are buying British pounds in

large quantities with Swiss francs. They expect the rate to
rise.
Clara has invested her assets abroad. Like many of her fel-
low citizens, she is taking advantage of the better condi-
tions on offer abroad.
BankingToday 2.0 17
Task 3 If a currency can be exchanged for another, it is convertible. There are three levels of convert-
ibility.
• List the official term for each level and explain what it means in your own words.
• For each expression provide an example of a currency to which it applies.
1.
Explanation:
Example of currency:
2.
Explanation:
3.
Explanation:
Task 4 A] Ms Graf regularly trades with the USA. She has had a foreign currency account in US dollars
with her bank for some time. She occasionally also uses this account to make cash deposits or
cash withdrawals. Today, for example, she wishes to deposit USD 5,000 in cash.
Please indicate whether the bank will charge a discount (1 %) or a premium (1 %) for this
transaction and how many USD will be credited to the foreign currency account.
B] Mr Cremer has a foreign currency account in euros. He would like to withdraw EUR 10,000
in cash for a cash purchase.
Please indicate whether the bank will charge a discount (1 %) or a premium (1 %) for this
transaction. Calculate how many euros will be debited from the account and how many euros
will be paid out in cash to Mr Cremer.
18 BankingToday 2.0
Task 5 Mr Ganz visits your bank and would like to open a foreign currency account in euros. He asks
you about the conditions that apply to this account. Explain how you would advise Mr Ganz,
using short sentences.
BankingToday 2.0 19
2 Foreign exchange trading
• explain how foreign exchange trading takes place.
• explain how cross rates are calculated.
• describe various types of foreign exchange transactions.
Key concepts: arbitrage, call, cross rate, currency carry trade, derivatives, direct quotation, dis-
count, forward, forward outright, hedge, intraday transaction, limit order, long, over-the-counter
(OTC), overnight, premium, put, self-contracting party, short, spot, strike price, swap, tom/next
Unlike day-to-day banknote trading, foreign exchange trading transactions involve amounts
running into millions. When you are dealing with sums as large as this, the slightest fluctua-
tions in the exchange rate can mean the difference between substantial gains or significant
losses.
Large sums are traded on the foreign exchange markets. Here, various investors, such as
trading companies, individuals, banks and brokers interact. On these markets, they can
exchange their foreign exchange quickly and easily, manage their assets using various forms
of investment and also conclude speculative transactions.
At this point, take a look at the e-lesson entitled: currency transactions
Modern currency trading is essential to the functioning of the international economy. Discover
factors that determine rates, how foreign currency transactions are carried out, and the various
types of transactions involved in professional trading.
2.1 How is foreign exchange traded?
Professional foreign exchange trading by banks is predominantly carried out by telephone or

using an electronic trading system such as Reuters or Bloomberg.
In this context we also talk about “over-the-counter” (OTC) trading. OTC transactions are not
standardised, but negotiated individually. The OTC foreign exchange market is not tied to par-
ticular trading times. Trading takes place worldwide around the clock.
What does a foreign exchange trader do?
Foreign exchange trading is extremely hectic. Exchange rates change in a matter of seconds.
In order to make gains or avoid losses, traders must always have access to the latest interna-
tional information from the fields of economics and politics and at the same time act with a
great deal of speed and accuracy.
20 BankingToday 2.0
In the following example, we will look at how two traders execute a foreign exchange trans-
action:
Situation: Nick works as a foreign exchange trader for XX Bank, and Daniel for ZZ Bank. They
have the following telephone conversation.
Conversation Explanation Trading practice
Daniel calls: Daniel asks Nick for the USD/CHF rate. He does not yet say • There is no official unit of
“Hello Nick! This is whether he wants to buy or sell USD. If he did, Nick would trading.
Daniel from ZZ Bank. be able to state a price that would be advantageous for him- • The precise amount to be trad-
I’d like to know the self. ed is only mentioned once the
USD/CHF rate In principle, the amount to be traded is not mentioned either; rate has been set.
at most an idea is given of the volume involved. The higher • The volume is stated for small
this is, the better the price should be. (< 1 million) or large
(> 5 million) amounts.
Nick answers: Nick looks at his screen and sees that the rate is around • The trader who has been
Hello Daniel!.. 1.2020. He then looks at his USD position and decides called sets a bid/ask rate at
USD/CHF is 18 (to) whether he would prefer to buy or sell USD. which he is prepared to trade.
23.” • If he wants to buy, he sets the bid/ask rate slightly high- • He only mentions the pips.
er than the current market rate. The big figures are only stated
• If he wants to sell, he sets the bid/ask rate slightly lower. in special situations.
Nick’s decision: USD/CHF 1.2018/1.2023
• During the conversation he mentions only the last two
digits, the so-called pips, i.e. 18/23.
• He assumes that the so-called big figures (1.20.) are al-
ready known. The big figures are only mentioned in the
event of substantial and rapid fluctuations.
BankingToday 2.0 21
Conversation Explanation Trading practice
Daniel’s response: Daniel agrees to Nick’s price and sells USD 2 million at a rate • Once a rate has been set it is
“I’ll sell USD 2 million of 1.2018. binding, but it must be ac-
for CHF at 1.2018.” The rate set is binding. Both parties must adhere to this cepted immediately or it will
price. However, this only applies to this particular conver- lose its binding force.
sation. If Daniel hesitates, Nick may withdraw the rate and • Non-binding rate enquiries
set a new one. If the conversation ends without a deal being must be clearly signalled as
reached, a new rate must be requested when the next call is such (e.g. “for information on-
made. ly”, “I estimate”).
Nick’s response: Nick confirms the transaction and specifies where he wishes • The recipient of the currency
“I’ll buy USD 2 million to receive the USD. concerned determines where
for CHF at 1.2018. he or she would like the for-
Please transfer the USD eign exchange to be delivered.
to XX Bank in New
York.”
Daniel’s response: Daniel specifies where he wishes to receive the CHF. • The party delivering each cur-
“Please transfer the Settlement: rency is responsible for ensur-
CHF to the SNB in ing the transfer is made punc-
• With a value date of 2 bank working days.
favour of ZZ Bank.” tually and bears all the associ-
• Both banks are responsible for ensuring the transfer is
ated charges.
made punctually.
2.1.1 How is foreign exchange quoted?

Foreign exchange is traded around the clock, irrespective of national borders and national cur-
rencies. To standardise trading worldwide, trading practices (commercial customs) have been
agreed on. These include the rules of trading mentioned above and the same forms of quota-
tion.
Worldwide quotation in relation to the US dollar
In professional foreign exchange trading the USD is the base currency. This means that world-
wide, the value of any currency is related to the USD.
You therefore need to know how much of a certain currency you will have to pay to receive
a unit of USD.
Exceptions
As in the case of banknote trading, different rules also apply to the British pound, the Austral-
ian and New Zealand dollars and the euro in professional foreign exchange trading.
If the USD is traded against the GBP, for example, the USD is not the base currency, but in
this case is the price. You therefore want to know how many USD you will have to pay to
receive a unit of GBP.
22 BankingToday 2.0
Figure 9 Overview of worldwide quotation
In principle: direct quotation Exceptions: indirect quotation
USD/CHF 1.2020 1 USD = 1.2020 CHF GBP/USD 1.5170 1 GBP = 1.5170 USD
USD/JPY 97.065 1 USD = 97.065 JPY AUD/USD 0.6529 1 AUD = 0.6529 USD
USD/SEK 7.9477 1 USD = 7.9477 SEK NZD/USD 0.5476 1 NZD = 0.5476 USD
EUR/USD 1.2925 1 EUR = 1.2925 USD
Example Nick would like to sell GBP for USD. He calls a broker in London and, at the same time, uses the Reu-
ters electronic trading system to contact a bank in New York. Both parties give him the price in the
form GBP/USD (GBP 1 = USD x), irrespective of which currency is the foreign currency in their partic-
ular case. Nick will accept the best price and sell his GBP.
2.1.2 What are cross rates?

In foreign exchange trading, transactions are often executed in which currencies are
exchanged directly without first converting them into USD. In this case the currencies are
related directly to each other and we talk of cross rates.
Comment In the case of the bureau de change service at a bank the situation is different. Cross rates are not
used here. If a client in Switzerland wishes to buy British pounds with euros, the bank employee has
to make the following bookings: first of all she buys the euros and sells Swiss francs in return. She
then buys these Swiss francs back and sells British pounds to the client.
On the following pages you will find out how foreign exchange traders calculate cross rates.
To make the calculation easier to understand, we will leave bid and ask rates out of the equa-
tion in this section. The following statements and calculations always refer to the average rate.
The table below contains a number of cross rates. Each of these can be presented in two dif-
ferent ways. Here it is important to identify which currency is the base currency. Let’s look at
the example of the GBP/CHF rate more closely. The base currency is the one in the left-hand
column in each case.
1. If CHF is the base currency (CHF/GBP), the rate is 0.5484.

This means that CHF 1 = GBP 0.5484.
2. If GBP is the base currency (GBP/CHF), the rate is 1.8234.
This means that GBP 1 = CHF 1.8234.
Figure 10 Cross rates
Overview of cross rates (average rates)
Base currency USD EUR CHF GBP

CHF 1
USD 0 0.7737 1.2020 0.6592 corresponds to
GBP 0.5484
EUR 1.2925 0 1.5536 0.8520
CHF 0.8319 0.6437 0 0.5484 GBP 1

corresponds to
GBP 1.5170 1.1737 1.8234 0 CHF 1.8234
BankingToday 2.0 23
The calculation of cross rates in more detail
In Fig. 10 the cross rates had already been calculated. But how are these rates determined?
The calculation is performed as follows:
• You need to know the USD rates for the individual currencies.
• You need to know whether direct or indirect quotation applies and what this means.
From this information it is possible to derive the applicable mathematical formulae. The fol-
lowing examples show how cross rates are calculated in foreign exchange trading.
Example Cross rates in the case of direct quotation. A person wishes to exchange Canadian dollars (CAD) for
CHF. The following rates apply: USD/CHF 1.2020 and USD/CAD 1.2295. How are the cross rates cal-
culated?
Figure 11 Calculation of cross rates in the case of direct quotation
CHF/CAD = USD/CAD : USD/CHF = 1.2295 : 1.2020 = 1.0229

or
CAD/CHF = USD/CHF : USD/CAD = 1.2020 : 1.2295 = 0.9776
Example Cross rates in the case of indirect quotation. A person wishes to use euros to buy British pounds.
The following rates apply: EUR/USD 1.2925 and GBP/USD 1.5170. How are the cross rates calcu-
lated?
Figure 12 Calculation of cross rates in the case of indirect quotation
EUR/GBP = EUR/USD : GBP/USD = 1.2925 : 1.5170= 0.8520

or
GBP/EUR = GBP/USD : EUR/USD = 1.5170 : 1.2925 = 1.1737
Example Cross rates in the case of a mix of indirect and direct quotation. A person wishes to use Swiss
francs to buy British pounds. The following rates apply: USD/CHF 1.2020 and GBP/USD 1.5170. How
are the cross rates calculated?
Figure 13 Calculation of cross rates in the case of mixed quotation
GBP/CHF = USD/CHF · GBP/USD = 1.2020 · 1.5170= 1.8234

CHF/GBP = 1 : GBP/CHF = 1 : 1.8234 = 0.5484
24 BankingToday 2.0
2.2 The role of banks in foreign exchange trading
With a little luck and skill it is possible to make substantial gains in foreign exchange trading.
For this reason, foreign exchange trading is not only used for commercial purposes. Many
speculators invest millions on the foreign exchange market every day. Banks too not only
trade on the basis of the orders they receive from their clients. In order to manage their own
foreign currency holdings, banks need to participate in the market for their own account.
2.2.1 Trading for clients

The foreign exchange department of a bank manages the exchange of one currency for
another for its corporate and retail clients. The client pays neither charges nor commission as
the built-in margin covers the bank’s expenses and allows a certain profit to be made. The
bank takes advantage of supply and demand trends to achieve the highest possible exchange
gains.
Example Mr Müller has received the sum of GBP 2 million from a business partner. As his company will not
need these GBP in the near future, he would like to exchange them for CHF at his bank. The GBP/CHF
rate is currently 1.8234. Mr Müller calls his foreign exchange trader and asks for a binding price for
GBP/CHF. Naturally, he does not mention that he wants to sell the GBP. The trader gives him the fol-
lowing bid/ask rates: 32/39. Mr Müller agrees and says: “I’ll sell GBP 2 million.” or “GBP 2 million to
you”. This means that the deal has been concluded in a legally valid manner. The trader confirms the
transaction by repeating the details from his perspective: “I’ll buy GBP 2 million from you and sell CHF
to you at a rate of 1.8232.” The deal is recorded in writing on a foreign exchange settlement note.
Figure 14 Foreign exchange settlement note
XYZ Bank Account holder:

8000 Zurich
Josef H. Müller, Zurich
Confirmation
Spot exchange deal
As per deal date of 25 Nov. 2008
We will buy We will sell
GBP 2,000,000 1.8232 CHF 3,646,400
Value date 27 Nov. 2008 Rate Value date 27 Nov. 2008
Account to be debited: Account to be credited:
XYZ Bank, Zurich XYZ Bank, Zurich

Current account 123-4567 Current account 126-4988
BankingToday 2.0 25
2.2.2 Trading for the bank’s own account

When banks trade for their own account they act as “self-contracting parties”. That is why
foreign exchange settlement notes regularly contain the phrases “We will sell…” or “We will
buy…”. As the bank is acting as a self-contracting party, the foreign exchange transaction
also counts as one of the bank’s own-account deals. Banks usually maintain their own for-
eign exchange holdings and, together with the holdings at foreign correspondent banks, this
means that they have sufficient funds to be able to execute payment orders in foreign curren-
cies.
Having its own foreign exchange positions gives the bank opportunities to make gains, but
also exposes it to corresponding risks of losses. During times of uncertainty, banks try to close
out (liquidate) their own foreign exchange positions on a daily basis by means of purchases
or sales. If a bank does not want to run any risk with regard to foreign exchange, it will only
trade with clients while simultaneously closing out the position. This means that the trader
executes a simultaneous offsetting transaction with another bank so that the bank avoids
building up its own positions.
Example A trader receives a call from a client who asks for a USD/CHF rate. The trader does not want an addi-
tional USD position on his books. Before he offers a rate to the client, he contacts another bank and
asks for the USD/CHF rate. This bank gives him the price of 1.2021/26 USD/CHF. While the other bank
holds the line, he proposes the adjusted price of 20/27 to the client. The client wishes to sell the USD
and as soon as he enters into the transaction the trader will sell on the sum that his bank has pur-
chased. All this takes place in the space of a few seconds. The trader has therefore bought USD 2
million at 1.2020 and sold them on simultaneously at 1.2021. This means he has made a gain of CHF
0.0001 per USD.
2.2.3 Central banks in foreign exchange transactions

In section 1.2.2 we mentioned that central banks can intervene in the development of
exchange rates. Central banks use professional foreign exchange trading to implement their
monetary policy. An example can be found in section 2.4.3, p. 33.
2.3 How is foreign exchange trading used?
Foreign exchange trading is by no means only used for commercial trading. Foreign exchange
investments are also used for arbitrage transactions, hedging and speculation.
The volume that is traded daily has increased markedly in recent years. Own-account deals
by banks make up the lion’s share of foreign exchange transactions.
Arbitrage
In the past, the exchange rates in all countries were presented using indirect quotation (as is
now the case for the British pound). This resulted in significant price differentials at all the
important financial centres. In its original sense, “arbitrage” meant taking advantage of
these price differentials as quickly as possible. Nowadays, however, all currencies are quoted
against the US dollar. Modern, fast communication technology has also made the original
form of arbitrage virtually impossible. Today, arbitrage is understood to mean professional
26 BankingToday 2.0
trading between banks. These kinds of arbitrage transaction are usually closed again within
the same day of trading. Transactions that are closed out on the same day are referred to as
intraday transactions.
Example The trader buys USD 2 million from Mr Müller at 1.2020 and decides to keep this position on his books
for a while. Together with other USD purchases he builds up a position of USD 6 million. If the rate
now rises to 1.2050, he can sell the USD at a more expensive rate and realise a gain for the bank.
Hedging
The term hedging is used to describe the covering or limiting of risk. Foreign exchange trans-
actions involve currency risks, although these can be calculated and kept to a minimum with
the help of other foreign exchange transactions. In the following section we will see which
types of transactions lend themselves to hedging.
Speculation
Foreign exchange transactions are very popular speculative transactions. Speculators take
advantage of the fact that exchange rates change so quickly to realise quick gains. Thanks to
foreign exchange trading, they are able to invest their assets for a short period of time. In spite
of the major risks involved, they pursue the sole objective of using this capital to achieve sub-
stantial gains quickly.
2.4 Types of transactions in foreign exchange trading
Foreign exchange trading is extremely varied and new types of transactions are constantly
being introduced. The most important forms of transactions in foreign exchange trading are:
Figure 15 Overview of types of transactions in foreign exchange trading
Types of transaction in foreign exchange trading
Forward outright
Spot transactions Swaps Currency options
transactions
2.4.1 The spot transaction
Spot transactions are conventional foreign exchange deals.
Spot transactions are concluded with a value date of + 2 bank working days. The trans-
action must therefore be settled 2 bank working days following the deal date. Both parties
have to deliver their foreign exchange on the value date of “the day after tomorrow”. If the
value date does not fall on a bank working day, the next bank working day is regarded as the
value date.
BankingToday 2.0 27
Please note the rules relating to public holidays:

• If the deal date is a Thursday, the second day would fall on a Saturday. The second work-
ing day, however, is a Monday, so the transaction is settled with a value date of Monday.
If the Monday is a public holiday, though, e.g. Whit Monday, the value date falls on the
Tuesday.
• If the deal date is a Friday, the entire weekend has to be taken into account. The second
working day is Tuesday, so the transaction is settled with a value date of Tuesday.
Example Mr Müller calls his bank on 1 March (Wednesday) to sell his USD for CHF. He concludes the deal with
a value date of 2 working days. Consequently, Mr Müller has to make the USD available to his bank
with a value date of 3 March (Friday). On the other hand, the bank will also credit the CHF with a value
date of 3 March.
Figure 16 Spot transaction: value date of + 2 bank working days
SPOT SPOT
deal date settlement
date
01 March 02 March 03 March 04 March … 31 March

Time
today tomorrow day after
Limit and market orders

• Limit orders. Clients are unable to monitor the rate 24 hours a day in the hope that it will
reach their desired price so that they can then call their bank. Instead they can grant limit
orders. In this case clients instruct their bank, for example, to sell USD for CHF at a rate
that they have specified or, if possible, at a better one. The bank will monitor market de-
velopments and, as soon as the rate reaches the desired limit, will execute the order. As
traders too are unable to work 24 hours a day, limit orders are sent around the world. At
the end of a day, a Swiss trader will send a limit order to his colleagues at the New York
branch, who will monitor the market and, if necessary, execute the order. If the order has
still not been settled at the end of the day in New York, it will be passed on to the branch
in Japan. This process continues until the order has been settled, the order has expired or
the client withdraws it. However, there are also banks which carry out local trading 24
hours a day. In this case, traders work three 8-hour shifts.
• In the case of a market order, clients do not specify a price. They instruct their bank, for
example, to sell USD for CHF at the highest possible rate at the present time. The bank
will attempt to execute the order at the best possible price. With this form of transaction
the emphasis is on the immediate execution of the deal.
28 BankingToday 2.0
2.4.2 Forward outright transactions

With forward outright foreign exchange transactions the settlement date is different
from that of spot transactions.
The duration is (almost always) longer than in the case of spot transactions and can be chosen
freely by the client. Although virtually any duration is possible, those in excess of a year are
rather uncommon. In foreign exchange trading with a commercial background it is possible
to use forward outright transactions to hedge against rate fluctuations. Forward outright
transactions are obligations, so-called unconditional deals. This means that the deal is not
dependent on certain conditions; it must be settled, completely independently of how the
exchange rate may develop.
Example Mr Huber has ordered goods with a value of USD 200,000 from his business partner. He has to pay
the invoice in 30 days. At present, the USD/CHF rate is in his favour. The risk for Mr Huber is that the
USD rate will go up by the time the invoice is due. He would then have to pay more francs for the USD
200,000, meaning that the goods would cost him more. To rule out the risk of a rise in the rate, he
concludes a forward outright transaction. This involves fixing the following contractual elements now:
the amount, currency and counter currency, period and exchange rate. Mr Huber undertakes to buy
USD 200,000 for CHF in 30 days’ time at a fixed rate. If, as he fears, the USD rate rises, Mr Huber will
benefit from the forward rate fixed in the past. If, however, the rate is lower in 30 days, Mr Huber is
unable to profit from the more favourable rate. Nevertheless, he still has to settle his part of the for-
ward outright transaction.
The overnight transaction is a special case. This has a shorter duration than a spot transac-
tion – there is a value date of 1 day.
Example Overnight transaction: It is Monday morning. Ms Notter finds out that USD 180,000 will be paid into
her business account on Tuesday. She wants to exchange this money for CHF so that she can invest
it in another deal on the same day (Tuesday). She calls her bank and concludes an overnight transac-
tion. She sells USD 180,000 and in return buys CHF, with a value date of 1 day.
Figure 17 Spot and forward outright transactions
Spot Spot
date
Forward
Forward outright
outright
settlement date is some time later than for spot
deal date
Overnight
deal date
settlement date

Time
today tomorrow day after
tomorrow
BankingToday 2.0 29
Currency futures
If forward outright transactions are traded on an exchange, they are referred to as futures. In
the case of futures, clients can no longer choose the durations themselves, as the details of
the deal have been laid down. Futures are therefore standard contracts that are traded on an
exchange. They can be used not only for foreign exchange, but also for shares, indices, pre-
cious metals, etc. In almost all cases an exchange of money takes place when the deal
matures rather than a physical delivery. This means that usually only the difference between
the agreed price and the current market price is exchanged.
Calculating forward rates
The price differential between the spot and forward rate depends on the interest differential
of the currencies concerned. If a USD/CHF forward outright transaction is concluded with a
duration of one month, the interest rates for borrowing and investing USD and CHF are taken
into account. The investment and borrowing are not actually carried out for each deal, but the
bank calculates the forward rate as if that were the case. The interest differential from borrow-
ing and investing for one month is added to or subtracted from the spot price. The difference
is expressed in points or pips. For this reason, the difference between the spot price and for-
ward price is referred to as the premium or discount.
The following rules apply:

• If the interest rate of the base currency is lower than the interest rate of the quote curren-
cy, this results in a premium.
• If the interest rate of the base currency is higher than the interest rate of the quote cur-
rency, this results in a discount.
Figure 18 Forward outright foreign exchange transaction
On deal date (today):

Money market and
foreign exchange
market
Bank A 2
3
1
Mr Huber
On settlement date (30 days from today):

Money market
and foreign
exchange
market
Bank A 4
7
5
Mr Huber
6
30 BankingToday 2.0
Step Explanation
Deal
1. Mr Huber and his bank conclude a forward Mr Huber undertakes to buy USD 200,000 at a
outright transaction. fixed rate in 30 days. To offer the forward rate
The two parties agree on the duration, amount to Mr Huber, the bank has taken the interest dif-
and forward rate ferentials of the two currencies into account.
2. Bank A concludes a USD/CHF spot transac- To eliminate its own exchange risk, Bank A
tion and takes out a CHF loan. buys USD for CHF in a spot transaction. To do
this, it takes out a CHF loan with a term of 30
days. Bank A has to pay interest on this CHF
loan (interest expense).
3. Bank A invests the USD for 30 days. The USD purchased from the spot transaction
are invested by the bank. It is credited with
interest on this USD investment (interest
income).
Settlement
4. The USD investment is paid back. Bank A gets back the USD 200,000, including
interest income.
5. The bank sells the USD to Mr Huber at the With the USD from the investment Bank A can
rate agreed on the deal date. fulfil its obligation to Mr Huber.
6. Mr Huber transfers the equivalent value in Mr Huber fulfils his part of the obligation.
CHF to Bank A.
7. The bank pays back the CHF loan. With the CHF received from Mr Huber the bank
is able to pay back the loan due, including inter-
est.
The bank concludes a 30-day forward outright transaction with Mr Huber and therefore has
to calculate the forward rate. First of all, the bank needs to determine the current interest rates
for investing and borrowing USD and CHF.
Consideration/explanation Calculation/mathematical formula
Calculation of inter- USD/CHF spot rate: 1.2020 USD 200 000 · CHF 1.2020= CHF 240 400
est expense and
interest income for Amount ⋅ Interest rate ⋅ Days
Interest rate for CHF loan: 2.3 % ----------------------------------------------------------------------------
30 days. 360 ⋅ 100
Interest on CHF 240,400 over 30 days:
CHF 240 400 ⋅ 2.3 ⋅ 30
----------------------------------------------------------- = CHF 460.77
The interest rate of 360 ⋅ 100
the base currency is
Interest rate for USD investment: Amount ⋅ Interest rate ⋅ Days
higher than that of ----------------------------------------------------------------------------
2.5 % 360 ⋅ 100
the local currency.
This means that a Interest on USD 200,000 over 30
days: USD 200 000 ⋅ 2.5 ⋅ 30
discount is calcu- ------------------------------------------------------------ = USD 416.65
lated 360 ⋅ 100
BankingToday 2.0 31
Consideration/explanation Calculation/mathematical formula
A) Calculation of CHF loan plus interest: CHF 240 860.77

forward rate USD investment plus interest: USD 200 416.65
CHF amount plus interest-

--------------------------------------------------------------------
Forward rate in 30 days:
USD amount plus interest
The discount is therefore: 240 860.77

------------------------------ = 1.2018 forward rate
200416.65
forward rate – spot rate = discount/premium
1.2018 – 1.2020 = –0.0002 = discount
B) Direct calculation BC = base currency (here USD) Spot rate ⋅ (Interest rate LC – (Interest rate BC) ⋅ days)
------------------------------------------------------------------------------------------------------------------------------------------------
of discount LC = local currency (here CHF) 36 000 ⋅ (Interest rate BC ⋅ days)
1.2020 ⋅ (2.3 – 2.5) ⋅ 30

------------------------------------------------------------- = –0.0002
36 000 + (2.5 ⋅ 30)
Digression: currency carry trades (CCTs) – an investment strategy
With currency carry trades an investor takes advantage of the interest differentials of
currencies.
• Let’s assume that country A has lower interest rates than country B.
• A client takes out a short-term loan in country A at a low rate of interest and exchanges
this amount for the currency of country B.
• He then invests this sum for the longer term in country B at a higher interest rate. Here
he attempts to realise the highest possible gain in terms of the interest differential.
• The short-term loan in country A is renewed until the investment in country B matures.
This transaction can lead to very substantial gains. The greatest risks, however, are exchange
rate fluctuations and changes in interest rates. If exchange and interest rates remain constant,
you can only win. If, however, the exchange rate changes to the disadvantage of the investor,
he or she must expect to suffer considerable losses. Hedging against exchange rate fluctua-
tions by means of a forward outright transaction would not help. As you have learned above,
forward rates are calculated on the basis of the interest differential. A forward outright trans-
action would therefore only swallow up the expected interest income.
Example Mr Peter takes out a loan in Switzerland for CHF 100,000. Interest rates are currently very low and he
has to pay 2.3 % on the loan. He sells the CHF for GBP at a rate of 1.8234 and invests the GBP
54,842.60 in the United Kingdom at an interest rate of 4.5 %. If the rate remains constant, he will earn
interest income. Let’s assume that the GBP/CHF rate falls to 1.8150. To be able to pay back his loan
of CHF 100,000, Mr Peter now has to obtain more GBP than he has invested, in this case 55,096.41
(interest left out of consideration). His interest income is therefore reduced by the difference in the
rate (GBP 253.81).
32 BankingToday 2.0
Figure 19 Currency carry trades
Switzerland Exchange at GBP/CHF 1.8234 United Kingdom

CHF 100,000 = GBP 54,842.60
Loan Investment
CHF 100,000 Exchange at GBP/CHF 1.8150 GBP 54,842.60
at 2.3 % CHF 100,000 = GBP 55,096.41 at 4.5 %
(without interest)
Difference (loss) GBP 253.81
2.4.3 Swap
A swap is made up of two transactions, each of which has a different value date. Various
swap combinations are possible, the two main ones being:
1. Spot / forward outright combination: Here an amount of one currency is bought with a
value date of 2 days and the same amount sold again simultaneously with another value
date (or vice versa).
2. Forward outright / forward outright combination: Here an amount of one currency is
bought with a certain value date and the same amount sold again simultaneously with an-
other value date (or vice versa).
This method allows traders to swap their foreign exchange for a limited period.
Example Obtaining foreign currency

Mr Meier has to pay foreign debts amounting to USD 50,000 for his company. Unfortunately, he does
not currently have access to such an amount in USD. He does, however, have sufficient CHF to pay
off the debts. And he also knows that USD payments will be received in 3 months’ time. By conclud-
ing a swap transaction, Mr Meier can obtain the USD he needs. He buys USD 50,000 with CHF as a
spot transaction and sells USD 50,000 for CHF with a maturity date in 3 months. He is now able to
pay the debts and, on the settlement date, pay back the USD sum with the USD income he is expect-
ing.
Swap
Swap Spot Forward
deal date outright
USD bought USD sold

CHF sold CHF bought
13 March 14 March 15 March 15 April 15 May 15 June

Time
today tomorrow day after 3 months
tomorrow
Example Extending forward outright transactions

Huber Ltd has been expecting an invoice in USD for a goods delivery for some time. This will need to
be paid on receipt. It has therefore made a forward purchase of USD 200,000. The forward outright
transaction matures in 2 days. Unfortunately, the goods delivery is being postponed by a month,
which means that Huber Ltd will not need to pay the USD for a month. The company now decides to
conclude a swap transaction in order to defer the forward purchase. It sells the USD 200,000 for CHF
as a spot transaction and at the same time buys them back with a maturity date in one month.
BankingToday 2.0 33
Please note the following in this example:

• The first part of the swap involves reversing the original transaction. The original transaction is
closed out (cancelled out) by means of the spot transaction.
• The first part of the swap therefore creates a currency risk, as the original transaction has to be
concluded again in 30 days’ time at the latest. The second part of the swap, the forward outright
transaction, covers this currency risk, as it corresponds exactly to the original transaction with a
new value date.
Figure 20 Swap
Huber Ltd. Bank
1. Original transaction matures

in 2 days
USD bought
CHF sold
Closing out of original
foreign exchange
transaction 2. Swap to close out
and extend
a) in 2 days
USD sold
CHF bought
b) in 30 days
USD bought Forward outright

transaction with new
CHF sold value date
Swap with value date of 1 day (tom / next)
A variant of the second combination is the swap with a value date of 1 day, the so-called
tom/next swap. With a tom/next swap the first part of the transaction is settled 1 day after
the deal (i.e. tomorrow) and the second part the following day (i.e. the day after tomorrow).
The tom/next swap is a type of “last-minute” transaction. It is used to extend foreign
exchange transactions which mature the next day. As traders usually trade speculatively, they
do not always want to actually execute a deal on the date it matures. A tom/next transaction
allows them to comply with their delivery obligation but nevertheless retain their position.
Example On 1 March a trader purchases USD with CHF with a spot value date (usually 2 days for a spot trans-
action, i.e. 3 March). On 2 March he wants to avoid having to accept the USD on 3 March. He con-
cludes a tom/next transaction and sells the USD he will receive from the spot transaction with a value
date of 1 day (tomorrow), buying them back with a value date of 2 days (the day after tomorrow).
34 BankingToday 2.0
Figure 21 Tom/next transaction
Spot Spot
date
USD bought
CHF sold
Tom/next Tom/next
deal date settlement dates
USD sold USD bought

CHF bought CHF sold

Time
yesterday today tomorrow day after
tomorrow
What are swaps used for?
Swaps can be used for a variety of purposes. They are very well suited to commercial use,
making it possible to accept or swap foreign currencies temporarily. Like forward outright
transactions, swaps are also used to hedge against exchange risks. Both transactions are
therefore also referred to as hedging transactions.
Undesired maturity dates of forward outright transactions can easily be extended or short-
ened using swaps.
The Swiss National Bank (SNB) uses swap transactions to control the money supply. If it
wants to stimulate the economy, it needs to increase the money supply. To do this, it sells
CHF to the commercial banks for USD as a spot transaction and buys these CHF back simul-
taneously as a forward outright transaction. This means that the SNB lends CHF and receives
USD in return, while the commercial banks lend USD and receive CHF. If the SNB needs to
dampen the economy, it will temporarily reduce the money supply by concluding the opposite
swap. Instruments of central banks will be studied in more detail in the “Banking 2” module.
Figure 22 The use of swaps
Swap transactions
can be used to
• extend or shorten existing forward outright transactions
• obtain foreign currencies for a limited period
• avoid exchange risks
• control the money supply
BankingToday 2.0 35
2.4.4 Currency options

Currency options are conditional forward outright transactions. They comprise the option of
buying or selling an underlying asset at an agreed time. As option transactions are described
in more detail in the “Investing 3” module, we will only provide a brief overview of them here.
Options are contracts between two parties and are traded as call or put options. Options
give you the right to buy or sell something.
Figure 23 Currency options
Call option Put option
comprises an Options comprises an
option to buy option to sell

something something
Currency options are options that have a currency as the underlying asset. They are very pop-
ular and are used to limit the currency risk (hedging) or to execute speculative transac-
tions.
Rights and obligations of a buyer
Buyers of a currency option purchase the right, but not the obligation, to buy or sell a certain
currency for another at a certain rate and at a certain time. Buyers are not forced to exercise
this right. They can simply allow their option to expire.
For the right conveyed by the option the buyer pays the seller a premium when the transac-
tion is concluded.
Rights and obligations of a seller (writer)
Sellers, also known as writers, receive a premium and in return for this enter into an obliga-
tion. If buyers wish to exercise their right, sellers are forced to fulfil their part of the deal. If
buyers relinquish their right, the sellers’ obligations lapse.
Types of currency option transaction
To make it easier to understand the text that follows, a number of industry-specific expres-
sions are explained in the table below.
Figure 24 Industry-specific expressions
Expression Meaning
Long Purchase of an option (purchase of a right)
Short Sale of an option (assumption of an obligation)
Strike or exercise price The fixed exchange rate at which the option can be exercised
(e.g. USD/CHF 1.2020).
36 BankingToday 2.0
Expression Meaning
Call Purchase a good (in the case of foreign exchange: a currency)
Put Sell a good (in the case of foreign exchange: a currency)
OTC (over-the-counter) Options with which the strike price and expiry date can be cho-
sen freely. (These options are not traded on an exchange.)
• Call option
• Long call = If a person buys a call option, he or she buys the right to purchase the
agreed currency.
• Short call = If a person sells a call option, he or she sells the right to purchase the
agreed currency. This person therefore assumes the obligation to sell the agreed cur-
rency.
• Put option
• Long put = If a person buys a put option, he or she buys the right to sell the agreed
currency.
• Short put = If a person sells a put option, he or she sells the right to sell the agreed
currency. This person therefore assumes the obligation to buy the agreed currency.
Figure 25 Option transaction
I buy a USD/CHF I sell a USD/CHF

call option at a strike call option
price of 1.2020 at a strike price of 1.2020
Buyer pays premium

Buyer Seller
Seller pays USD (obligation)
Long USD call Buyer pays CHF (right) Short USD call
Example Mr Peter expects the USD/CHF rate to go up over the next 3 months. He buys a USD/CHF call option
at a rate of 1.2020. This means that he buys the right to purchase USD and sell CHF at a rate of 1.2020.
When the deal is concluded he pays a premium to the seller. The only thing that Mr Peter can lose is
the value of the premium. If the rate in 3 months’ time is lower than 1.2020, he simply allows the
option to expire. He can, after all, obtain the USD at a more favourable price on the market. If, how-
ever, the rate is higher, as he expects, he will exercise his right and purchase the USD at 1.2020. He
can then sell on the USD profitably on the foreign exchange market.
Quoting of prices
The strike price can be chosen by the buyer/seller. For exchange-traded options the
buyer/seller can choose between the strike prices quoted on the list of option prices. In the
case of OTC options, i.e. ones that are not traded on an exchange, clients can determine the
strike price themselves. Here the buyer and seller must reach agreement on a certain strike
price.
The premium that the buyer has to pay is based on the strike price. The better the hedge
offered by the strike price, the higher the premium. The price of the premium is stated in
points of the exchange rate. In the case of a USD/CHF option, the points correspond to the
Swiss centimes in the exchange rate. A premium price of 1.80 therefore means that the buyer
has to pay CHF 0.0180, or 1.80 centimes, per USD.
BankingToday 2.0 37
Example Mr Glauser will require USD 250,000 in March. He does not want to buy the USD today, but he is also
afraid that the USD/CHF rate will rise. On the list of option prices presented below Mr Glauser sees
that he could buy a call option with expiry in March at a strike price of 1.2000. The premium for this
is 4.20 centimes per USD. If he wanted to secure a lower strike price, e.g. 1.1750, he would have to
pay a higher premium, namely 5.50 centimes
Mr Glauser decides in favour of the strike price of 1.2000. He pays the bank the premium of CHF
10,500 (250,000 · 0.0420). If in March the USD/CHF rate is above 1.2000, he can exercise the option
and therefore purchase USD more cheaply. If the rate is lower, he can allow the option to expire and
his maximum loss is limited to the premium.
Distinction from an unconditional forward outright transaction: In contrast to an unconditional
forward outright transaction, Mr Glauser has the right, but not the obligation, to buy the USD at a price
of CHF 1.2000. In the case of an unconditional forward outright transaction, Mr Glauser would be
forced to buy the USD at a price of 1.2000, even if the price were below this on the maturity date. The
option is a better hedge than the forward outright transaction and, in return for this benefit, the buyer
of the option has to pay a premium.
Figure 26 Option prices
USD/CHF spot rate: 1.2020
Strike price 1.1750 1.2000 1.2250
--- C A L L ---
Expiry Long / Short Long / Short Long / Short
15.12.xx 3.60 / 3.80 2.00 / 2.20 0.95 / 1.15
16.03.xx 5.30 / 5.50 4.00 / 4.20 2.90 / 3.10
15.06.xx 6.25 / 6.45 5.00 / 5.20 3.90 / 4.10
14.09.xx 6.85 / 7.05 5.65 / 5.85 4.60 / 4.80
--- P U T ---
Expiry
15.12.xx 0.95 / 1.15 1.85 / 2.05 3.30 / 3.50
16.03.xx 3.20 / 3.40 4.35 / 4.55 5.75 / 5.95
15.06.xx 4.60 / 4.80 5.80 / 6.00 7.15 / 7.35
14.09.xx 5.60 / 5.80 6.80 / 7.00 8.15 / 8.35
At this point, take a look at the simulation entitled “FOREX trading”.
Put yourself in the shoes of a foreign exchange trader: assess the factors and events that influ-
ence exchange rates and choose the optimum type of transaction.
Length: approximately 10 minutes
38 BankingToday 2.0
International trade and movements of money and capital form the basis for foreign exchange
trading. Banks work around the clock as brokers between the supply of and demand for for-
eign exchange, acting both for their clients and for their own account. No charges are made
to clients. The bank covers its expenses by means of the spread (difference between the bid
and ask rate).
Currencies are quoted worldwide against the US dollar. A few important exceptions are the
GBP, AUD, NZD and EUR. If the USD is left out of the equation and currencies are related
directly to each other, this is referred to as the cross rate.
Important forms of foreign exchange transactions:
• Spot transactions are concluded with a value date of 2 days.

• Unconditional forward outright transactions have any value date that lies after the
spot date.
• Overnight transactions are concluded with a value date of 1 day.
• Swaps are a combination of a spot/forward outright or a forward outright/forward out-
right transaction.
• Tom / next swaps are swaps with a value date of 1 day and a reverse transaction on the
following day.
• Currency options are options to buy or sell a currency at a price agreed in advance.
Exercises
Task 6 Calculation of cross rates
A] A client wants to sell CHF 20,000 as a spot transaction and buy Japanese yen. What
CHF/JPY rate will the bank offer him and how will the rate be calculated? The following average
rates are available to you:
USD/CHF 1.2020
USD/JPY 97.0650
B] The client would like to sell the CHF 20,000 for yen as a forward outright transaction rather
than a spot transaction. To calculate the forward rate, the bank will take additional factors into
account. Briefly explain in your own words what these factors are and why the bank needs them
to calculate forward rates.
BankingToday 2.0 39
C] A client wants to sell CHF 20,000 as a spot transaction and buy Australian dollars. What
AUD/CHF rate will the bank offer him and how will the rate be calculated? The following average
rates are available:
USD/CHF 1.2020
AUD/USD 0.6529
Task 7 How is foreign exchange trading used?
A] Explain in your own words what the original meaning of “arbitrage” was and what it is
understood to mean today.
B] How does the bank achieve its earnings if it does not demand any charges or commission
from the client for a foreign exchange transaction? Please also state the technical term for these
earnings.
C] Think up an example of a foreign exchange transaction and calculate the bank’s earnings.
Task 8 Types of transactions in foreign exchange trading
A] Please explain in your own words what a swap transaction is and what it can be used for.
40 BankingToday 2.0
B] In connection with a future goods delivery, Mr Müller has concluded a forward outright
transaction to buy USD and sell CHF in 3 months’ time. Shortly afterwards he finds out that the
goods will be delivered a month earlier. Mr Müller therefore needs the USD a month sooner to
be able to pay the invoice. Explain what Mr Müller could do in this situation and illustrate this
with a diagram.
C] An investor has a “short call” position in USD/CHF at a strike price of 1.2020. Today is the
expiry date and the spot rate is 1.2650. Explain what the parties involved will do and why.
BankingToday 2.0 41
3 Precious metals and coins
• distinguish between direct and indirect investment opportunities for precious metals.
• describe how precious metals are quoted.
• explain the safekeeping options for precious metal investments.
• explain under which conditions precious metal investments are subject to value-added tax.
• describe the opportunities and risks associated with precious metal investments.
Key concepts: bar, certificate, derivative, direct investment, fineness, forward, future, indirect
investment, numismatics, option, ounce, premium, primary markets, secondary markets, share,
troy ounce, value-added tax, wafer, warrant
People have always been fascinated by precious metals. In various cultures gold and silver
were regarded as symbols of the gods. Today, when we hear the expression “precious met-
als”, we immediately think of gold bars stacked up in the vaults of banks, but the term does
not necessarily have to refer to gold bars. A very popular item that you will come across in
many Swiss households is the “Vreneli”, the most famous gold coin in Switzerland. The
Vreneli once served as legal tender. Nowadays it is a popular collectors’ item and its value is
closely linked to the price of gold.
3.1 Gold and other precious metals
Precious metals are rare and extremely durable metals. They hardly react at all with air and
acids, which means that they do not rust. The four most important precious metals traded
across the world are gold, silver, platinum and palladium.
Figure 27 The precious metals traded across the world
Gold Silver Platinum Palladium
The most widely distributed precious metal is gold. For this reason, in the following pages, we
will focus in particular on the properties of gold and also explain precious metals trading using
gold as an example.
3.1.1 Composition of gold

Gold is traded as gold bars, gold wafers (small bars) or in the form of gold coins. However,
the gold is often mixed with other metals (e.g. copper or silver).
The portion of pure gold in an alloy is expressed in parts per thousand (thousandths). A gold
bar of 995 fineness therefore consists of 995 parts gold and 5 parts of another material. The
following table shows a number of common degrees of fineness relating to gold:
42 BankingToday 2.0
Figure 28 Degrees of fineness of gold
Trade name Fineness Explanation
Gold 999 999.9 parts gold Fine gold (pure gold).
Gold 995 995 parts gold Standard fineness for gold bars in international gold
trading (referred to as “good delivery”).
Gold 750 750 parts gold This quality of gold is often used for jewellery. Thanks to
the addition of 250 parts of another metal, the gold,
which is intrinsically very soft, becomes sufficiently
hard.
Gold 375 375 parts gold According to Swiss statutory requirements, an alloy may
be referred to as gold as long as it contains at least this
proportion of gold. Also used for jewellery.
Comment The term “carat”

In the case of jewellery in particular, the term “carat” is often used to describe the fineness of gold
rather than “parts per thousand”. This system is divided into 24 units. For example, 24 carat gold sig-
nifies a degree of purity of 999 (fine gold), 22 carat gold indicates 917 fineness (1,000 : 24 · 22) and
18 carat gold means 750 fineness (1,000 : 24 · 18), etc.
Please note that the term “carat” used in relation to gold has nothing to do with the term “carat” used
for precious stones. In the case of precious stones, a carat is a unit for measuring weight and not
purity.
3.1.2 Certificate and stamp

The authenticity of bars and wafers is guaranteed by means of a (written) certificate from
an internationally recognised mint.
In addition, all bars and wafers must show the following information: the fineness, the serial
number and the assayer and caster stamp of a recognised mint (also known as a refinery). In
the case of bars this information is incorporated directly in the casting mould. Wafers have
these details stamped onto them in a second processing step. For this reason wafers are also
relatively more expensive than bars.
3.2 Gold trading
Ounces or grams – quantities used in international gold trading
A special weight measurement is employed for gold (and other precious metals) in interna-
tional gold trading. It is called the ounce, fine ounce or troy ounce (abbreviation: oz). The fol-
lowing applies here:
• One fine ounce of gold = approximately 31.10348079 g.
• One standard bar = 400 ounces = 12.5 kg with at least 995 fineness (“good delivery”).
Apart from the standard bars, banks offer a whole range of bars in a variety of sizes (see sec-
tion 3.3.1, p. 45).
BankingToday 2.0 43
Quoting of gold prices
Gold prices are quoted as follows:

• On the world market, the price of gold is stated in USD per troy ounce and 995 fineness.
• In Switzerland, the price of gold is given in CHF per kg and 999.9 fineness (1 kg = approx-
imately 32.1507425 oz).
Due to the higher processing costs and higher degree of fineness, a premium has to be paid
for wafers.
Figure 29 Trading units of gold
World market Switzerland

– 995 – – 999.9 –
USD CHF
per troy ounce per kg
The price of gold has fluctuated greatly on the international markets over the last few decades.
In 1972 it was USD 45 per ounce. In the 1980s the price rose to as much USD 843, only to
fall back to below USD USD 200 per ounce in the 1990s. In March 2008, 1 ounce of gold
would have cost you the considerable sum of approx. USD 1,000. How can these huge fluc-
tuations in price be explained?
From a conservative investment perspective it can be said that the value of gold is more stable
than money, stakes in companies or property. Gold is an ideal store of value that is accepted
across the world. In times of economic crisis or war, gold is more attractive than shares in
companies, which will perhaps fail to make a profit or even go bankrupt. When the rate of
inflation is high, investors will favour “safe” gold over banknotes. For this reason, the eco-
nomic and political situation have a considerable influence on the price of gold. Like the
exchange rate and prices of other goods, the price of gold is, therefore, completely dependent
on its supply and demand.
Gold markets
In international gold trading a distinction is made between primary markets (principal markets)
and secondary markets (side-line markets):
• The new production of gold flows from mines to the primary markets, e.g. London, Zu-
rich and New York. London has been the principal trading centre for precious metals since
around 1680. Zurich followed in around 1960 and, over the last few decades, New York
has also made a name for itself with precious metal derivatives.
• The gold acquired on the primary markets is distributed on the secondary markets, e.g.
Frankfurt, Paris, Los Angeles, Hong Kong and Singapore. On the secondary markets pre-
cious metals can be traded in a wide variety of forms and types of transactions. We will
find out what forms of investment these are in the next section.
44 BankingToday 2.0
3.3 Gold investments
Investment in gold is an example of an alternative investment, as the gold markets do not

develop in the same way as conventional investments in equity or debt securities.
Like other alternative investments, gold is used for investment purposes for the following rea-
sons (amongst others): risk spreading (hedging) and protection against inflation.
There are many forms of investment in gold. These can be subdivided into direct and indirect
investments:
• If investors invest directly in gold, they buy or sell the gold itself. This will either take
place physically (e.g. in the form of gold bars or gold coins) or in the form of an account
(metal account).
• If investors invest indirectly in gold, they do not buy the gold itself but securities or rights
which are dependent on the price of gold, e.g. shares in a gold mine. The investor there-
fore holds an indirect interest in gold. Transactions of this type are also called precious
metal derivatives or, more precisely, gold derivatives.
Figure 30 Overview of direct/indirect investments
Forms of investment
Direct investments Indirect investments

• Bars and wafers • Precious metal derivatives
• Coins (e.g. certificates, options)
• Medals • Stakes in companies in the gold
industry (e.g. shares and funds)
3.3.1 Direct investments

In the case of direct investment, the precious metals themselves are traded. Whether they are
traded physically or not is irrelevant. As we have already seen above, precious metals may
come in the form of a bar or wafer, but coins and medals are also very popular.
Figure 31 Forms of precious metal in direct investment
Forms of precious metal
Bars and wafers Coins Medals
At this point, take a look at the e-lesson entitled “Precious metals and coins”.
Discover which precious metals are most widely traded, and locate areas where they are mined
on an interactive map of the world. Learn about gold trading and the various types of invest-
ments in this metal. This e-lesson concludes with a foray into the world of numismatics.
BankingToday 2.0 45
Bars and wafers
Although the 12.5 kg (400 ounce) bar is referred to as a standard bar, there is no standardisa-
tion of gold bars. They can be found in a wide range of forms (e.g. round or oval) across the
world. There are also no regulations regarding who may manufacture gold bars. For a gold
bar to be traded on the gold markets, however, it must meet certain requirements and condi-
tions. This means that the bar must qualify as “good delivery” gold (995 gold).
Using a special technique, gold bars can be furnished with the kinebar® security device. This
is a special shimmering, metallic foil that is applied directly to the reverse of the gold bars.
Some big banks even have their own kinebar® design. The technique is a further development
of the Kinegram® technology, which is already used for banknotes and identity cards.
Trading gold bars on an exchange for large sums of money is not the only option. Thanks to
the many smaller units of measurement, gold is also accessible to the general public. The
smallest wafers to be traded weigh just 1 gram. Below you will find an overview of the com-
mon units of gold in Switzerland.
Figure 32 Common units of gold in Switzerland
Wafers
Standard bars Bars
50 g, 20 g, 10 g, 5 g,
12.5 kg 1 kg, 500 g, 250 g
2.5 g, 2 g, 1 g
Coins and medals
Coins and medals both enjoy very broad popularity as collectors’ items. The term numismat-
ics is often used to describe the activity of collecting coins. This is, however, not entirely cor-
rect. Numismatics deals with rare, antique coins and a few valuable medals originating from
a certain period. (The word “numismatics” comes from the Greek for “coin” or “what has
been sanctioned by custom or usage”.)
While numismatists collect antique gold coins for their strike and rarity, investors buy restrikes
with the intention of spreading the investment of their assets. As in the case of gold wafers,
many gold coins can be acquired at a reasonable price.
In order to describe coins more precisely, they are subdivided into four categories by year of
issue, precious metal content and degree of rarity (see Fig. 33).
Medals are not regarded as coins. Although they look like coins, they have no nominal value.
They are struck to commemorate a special event such as the Olympic Games.
46 BankingToday 2.0
Figure 33 Overview of coins and medals
Coins Medals
Numismatic Semi-numis- Full-bodied
Bullion coins
coins matic coins coins
Numismatic coins Coins from antiquity through to circa 1800 are numismatic or collectors’ coins. Their value is
determined primarily by their rarity and the condition of the individual coins and not by their pre-
cious metal content. Numismatic coins are always bought and sold as individual items. Some
banks trade coins in their specialist numismatic departments.
Semi-numismatic Semi-numismatic coins originate from the period up to circa 1850. They are not as rare as numis-
coins matic coins and their value is loosely linked to the price of gold.
Full-bodied coins Coins minted after 1850 are regarded as full-bodied coins. They can be purchased in any amount;
their value is closely linked to the price of gold. A different premium is charged depending on their
mintage and popularity. Well-known full-bodied coins: Vreneli (Switzerland), Sovereign (UK),
Double Eagle (USA).
Bullion coins Bullion coins are restrikes of old coins that were previously legal tender. These coins are availa-
ble in very large numbers and, therefore, a minimal premium is charged. They are mainly pur-
chased for investment purposes in place of gold bars. Well-known bullion coins: Krugerrand
(South Africa), Maple Leaf (Canada).
Medals Medals are struck in the shape of coins but have no monetary value (they do not have a nominal
value). They are issued to commemorate special events. They may also be issued by private
organisations or companies. Medals are popular collectors’ items, but are not particularly suitable
for investment purposes.
Example Mr Gerber wants to give his granddaughter a gold Vreneli for her birthday. He goes to his bank and
enquires about prices. The bank employee explains to him that the price of the Vreneli varies accord-
ing to the year of issue, strike and condition. The most-purchased coin is the 20-franc Vreneli, which
has the most examples in circulation. The 10-franc coin, on the other hand, is only half the size of the
20-franc coin and also rarer. The most valuable Vreneli is the 100-franc coin, of which there are only
5,000 examples.
Mr Gerber knows that the purchase price includes a premium. He wants to know what proportion this
accounts for in the case of the 10 and 20-franc coin. This is calculated as follows (not including cen-
times):
Coin 10-franc gold Vreneli 20-franc gold Vreneli
Fineness of gold 900 fineness, weight 3.226 g 900 fineness, weight 6.4561 g
Market price CHF 155 CHF 179

(as at 18 Nov. 2008)
Calculation of pure gold 3.226 g- 6.4561

------------------- ⋅ 900 = 2.9034 g ----------------------g- ⋅ 900 = 5.81049 g
portion: 1 000 1 000
Price of gold CHF 28 524/kg CHF 28 524/kg

(as at 18 Nov. 2008)
in CHF per kilogram:
Calculation to determine CHF 28 524 CHF 28 524

------------------------------- ⋅ 2.9034 = CHF 83 ------------------------------- ⋅ 5.81049 = CHF 165
value of pure gold portion: 1 000 1 000
BankingToday 2.0 47
Coin 10-franc gold Vreneli 20-franc gold Vreneli
Value of the premium: Premium 86.7 % of the value of the gold Premium 8.5 % of the value of the gold
portion portion
CHF 83 CHF 165-

-------------------- ⋅ 86.7 = CHF 72 premium ---------------------- ⋅ 8.5 = CHF 14 premium
100 100
or or
coin price – value of gold portion = pre- coin price – value of gold portion = pre-
mium mium
CHF 155 – CHF 83 = CHF 72 premium CHF 179 – CHF 165 = CHF 14 premium
Safekeeping of precious metals
When precious metals are purchased, the bars and coins are either physically delivered or
booked to a metal account.
• Physical safekeeping. Physical precious metal is generally held in safekeeping in a
strongroom or safe-deposit box.
• The strongroom is used for the collective custody of standard and 1 kg bars. The
gold holding is entered into the safekeeping account and the physical gold is held in
the bank’s vault
• Safe-deposit boxes are a service provided for clients who wish to have access to
their bars and coins at any time. The advantage of safe-deposit boxes is the guarantee
that you will be handed over the actual precious metal that you deposited. They are
therefore particularly suitable for coins.
• Metal account. In the same way that clients can pay their money into a current account,
it is also possible for them to have their precious metal purchases booked to a metal ac-
count. The client has the right to withdraw the corresponding amount of precious metal
at any time. Clients may only open metal accounts, however, if they comply with the min-
imum holding requirement. In the case of gold this is 1 kg or 32 ounces. In the case of
coins the minimum amount is 50 Vreneli or 32 Krugerrands, for example. Precious metal
holdings do not yield interest and the bank charges a fee for maintaining the account.
Figure 34 Safekeeping of precious metal
Safekeeping of precious metal
Physical safekeeping Book value
Strongroom Safe-deposit box Metal account
48 BankingToday 2.0
The type of safekeeping employed has consequences if the bank becomes insolvent. In such
a case, the following regulations apply to the client’s gold holdings:
• Physical safekeeping: With his or her acquisition, the client becomes the owner of the
precious metal. That is to say, the holdings in the strongroom or safe-deposit box belong
to the client. If the bank becomes insolvent, the precious metal (like other contents of
safe-deposit boxes or a safekeeping account) is set apart; the assets are surrendered to
the client.
• Metal account: Clients who execute precious metal transactions via a metal account are
not the owners. They only have a claim against the bank. If the bank that maintains the
account becomes insolvent, the claims for the surrender of the precious metals are con-
verted into ordinary monetary claims. This means that clients cannot insist that the gold
be handed over. For this reason, the credit balances of metal accounts appear in the
bank’s balance sheet as “Other liabilities towards clients”. Like other accounts, metal ac-
counts also benefit from depositor protection. Bank insolvency and depositor protection
will be studied in more detail in the “Banking 2” module.
Example Ms Tanner has several accounts, including a metal account, with a small bank. She has gold and silver
worth CHF 70,000 in the metal account, and CHF 55,000 in the other accounts. One day the bank files
for bankruptcy. Ms Tanner is very worried and consults a friend’s lawyer about the chances of her
assets being paid out to her. The lawyer explains to her that the precious metals will be converted into
monetary claims. She is therefore not entitled to the gold or silver being handed over. He explains to
Ms Tanner that, under Swiss insolvency law, as a deposit creditor she is entitled to receive a maximum
of CHF 100,000 from the second creditor class. That means that, of her total assets worth CHF
125,000, CHF 100,000 will be repaid from the second class, while the remaining CHF 25,000 will fall
under the third creditor class.
3.3.2 Indirect investments

If a person wishes to invest in gold indirectly, it is possible to choose between innumerable
investment products. We will only deal with a few of the investment options here.
Figure 35 Overview of indirect forms of investment
Indirect forms of investment
Shares Funds Derivatives
Certificates Forwards and futures Options
Gold mining company shares and funds
Shares Gold mining companies issue shares which are closely linked to the price of gold. Unlike the
price of gold, however, the shares fluctuate around three to five times as much. This opportunity
to make quick profits makes such shares very popular amongst those investors prepared to take
risks.
Funds In the case of gold mining share funds, the money of clients is collected together and invested
in the shares of various mining companies. This means that the price risk is lower than when one
particular share is purchased.
BankingToday 2.0 49
Forward transactions on the gold price
Certificates Gold certificates are exchange-traded securities or, to be more precise, bonds. The investor
does not receive gold, but the equivalent monetary amount. The price (value) of gold certificates
depends on the price movements of gold. There are also gold certificates with prices based on an
index, e.g. the Amex Gold Bugs Index (which, in turn, is composed of shares in gold mines).
Some certificates have investment protection. This means that, in the event of a negative price
trend at the time of maturity, the issuer of these certificates undertakes to pay the monetary value
stated on the certificate. Issuers are usually banks or financial institutions and they are able to
determine the conditions of the certificates (time to maturity, price) freely.
Forwards and Precious metal forwards and futures are both unconditional forward transactions.
futures • Precious metal forwards are OTC transactions and are therefore negotiated individually be-
tween the issuer and investor (e.g. fineness, price, amount, date and place of settlement).
These contracts are traded off the floor. The buyer of a forward undertakes to buy a certain
amount of precious metal for a certain price on a certain date.
• Precious metal futures are standardised contracts and are therefore traded on an exchange.
An important commodity futures exchange is the New York Mercantile Exchange (which
merged with the New York Commodities Exchange in 1994). The buyer is obliged to buy a
certain amount of precious metal for a certain price on an agreed date, and the seller to sell.
The buyer and seller must make an advance payment upon conclusion of the contract (mar-
gin).
Precious metal Precious metal options, like currency options, are conditional forward transactions. They can
options be subdivided into the following types of transaction:
• OTC (over the counter) precious metal options. Options traded off the floor for which the
strike price and expiry date can be chosen freely.
• Exchange-traded precious metal options. Options for which the strike price and expiry
date are pre-defined.
• Precious metal warrants. Warrants are securitised options. This means they are documents
that record a right on paper. Unlike options, warrants cannot be sold short. Clients may not
therefore enter a short position. They may, however, resell the warrants they have bought at
any time and do not have to hold on to them, as is the case with options.
3.3.3 Value-added tax on precious metals

Trade in gold bars, wafers and coins is exempt from value-added tax. Regardless of whether
they are traded physically or booked to a metal account, the client is not required to pay value-
added tax.
The situation is different for silver, platinum and palladium. As long as purchases and sales
are effected via a metal account, value-added tax does not have to be paid on these metals
either. However, as soon as clients trade the metals physically or have the metals delivered to
them from their account, value-added tax of 7.6 % is charged.
3.4 Opportunities and risks of gold
As we have already seen above, the price of gold can fluctuate considerably. A short-term
investment in gold is not usually recommended, as the return is likely to be small. Gold is suit-
able if an investor is planning a longer investment phase or fears a global crisis. In times of
economic crisis, people will favour the stability of the value of gold over other investments.
50 BankingToday 2.0
Figure 36 Overview of opportunities and risks of gold
Opportunities and risks of gold
Opportunities Risks
• Stability of value • Considerable short-term price fluctuations
• Gold favoured in times of crisis • Relatively small returns on short-term in-
vestments
• No direct earnings (interest/dividend)
Traded precious metals
The precious metals traded across the world are gold, silver, platinum and palladium.
Direct investment in precious metals
The most common forms in which precious metals are traded are: bars and wafers, coins
(numismatic, semi-numismatic, full-bodied and bullion coins), medals.
Forms of safekeeping
• Physical safekeeping (strongroom or safe-deposit box); if the bank becomes insolvent,

the contents are surrendered immediately.
• Book value (metal account); if the bank becomes insolvent, the monetary value of the
account forms part of the bankruptcy estate.
Indirect investment in precious metals
• Gold certificates
• Shares in mining companies
• Precious metal forwards
• Precious metal futures
• Precious metal options (OTC, exchange-traded and warrants)
Value-added tax
• Gold is always exempt from value-added tax.

• Silver, platinum and palladium are exempt from value-added tax, provided that they are
booked to a metal account. As soon as they are physically delivered or traded, value-add-
ed tax of 7.6 % is charged.
Opportunities and risks of gold
• Opportunities: stability of value, gold favoured in times of crisis.

• Risks: strong price fluctuations, small returns likely on short-term investments, no direct
earnings.
BankingToday 2.0 51
Exercises
Task 9 A] Which four precious metals are traded regularly across the world? List them below.
1.
2.
3.
4.
B] Gold is the most popular of the traded precious metals. Explain how the price and fineness
of gold are quoted in Switzerland and on the world market:
In Switzerland:
On the world market:
C] Gold is traded on primary and secondary markets. Explain the role of these markets and, for
each one, give an example of a city in which such a market can be found.
Primary markets:
City:
Secondary markets:
City:
Task 10 A] Precious metals can be traded in a variety of forms. In the case of direct investment, a dis-
tinction is made between the following forms:
• Bars and wafers
• Coins
• Medals
Coins are subdivided further. Name the four official terms. In addition, provide an example of
such a type of coin in each case or, where possible, name a well-known coin.
1. example:
2. example:
3. example:
4. example:
52 BankingToday 2.0
B] What are the ways in which precious metals can be held in safekeeping? Please list the
options that a bank offers for physical and non-physical safekeeping.
Physical safekeeping:
Non-physical safekeeping:
C] In the event that a bank becomes insolvent, the surrendering of gold holdings is precisely
regulated. Explain in your own words which regulations apply to which method of safekeeping.
Physical safekeeping:
Non-physical safekeeping:
Task 11 A] Indirect investment in precious metals is understood to mean derivatives. Name three such
derivatives:
1.
2.
3.
B] Transactions involving precious metals are subject to value-added tax. There are, however,
exceptions. Explain when the four precious metals are subject to tax and when they are not.
BankingToday 2.0 53
Task 12 Gold is a very popular investment product. Explain briefly why it is so popular and list two
opportunities and two risks associated with its trade.
Opportunities:
1.
2.
Risks:
1.
2.
At this point, test your knowledge by doing the Self Check.
Have you learned everything you need to know?
54 BankingToday 2.0
Answers
Answers
Answer 1 page 16 A]
Exchange rate used: DKR 100 = CHF 21.55 (ask rate)
300
Calculation: --------------- = 13.9211 13.9211 ⋅ 100 = DKR 1392.11
21.55
300
Or: ------------------ = DKR 1392.11
0.2155
Amount given to Ms Sommer: DKR 1390
B]
Exchange rate used: GBP 1 = CHF 1.7400 (bid rate)
Calculation: 100 ⋅ 1.7400 = CHF 174
Answer 2 page 17 A] A currency is a country’s official means of payment.
Notes are cash (banknotes and coins).
Foreign exchange refers to claims on payments in foreign currencies.
B]
Example 1: JPY/CHF 1.3250 JPY 100 corresponds to CHF 1.3250
Form of quotation: direct quotation.
Example 2: CHF/JPY 75.47 CHF 1 corresponds to JPY 75.47.
Form of quotation: indirect quotation.
Bid rate: Refers to the purchase price set by the bank
Ask rate: Refers to the selling price set by the bank
C]
Example Factor Effect

number
The central bank buys large amounts of the local cur- 3 Due to the increased demand for the domestic
rency and sells foreign currencies. currency, its value goes up.
Exports are very high in a country and consequently the 2 Due to the increased demand for the domestic
local currency is very much in demand abroad. currency, its value goes up.
Parliamentary elections are imminent in a country. Citi- 1 There is an excess supply of the domestic cur-
zens have lost confidence in the government and its rency. As a result its value goes down..
policy and are transferring their assets abroad.
Swiss foreign exchange traders are buying British 5 There is an excess supply of the Swiss franc. Its
pounds in large quantities with Swiss francs. They value goes down.
expect the rate to rise.
Clara has invested her assets abroad. Like many of her 4 There is an excess supply of the domestic cur-
fellow citizens, she is taking advantage of the better rency. As a result its value goes down.
conditions on offer abroad
BankingToday 2.0 55
Answers
Answer 3 page 18 1. Full convertibility

Explanation: There are no restrictions. The currency can be freely exchanged.
Example of currency: CHF, USD, EUR
2. Limited convertibility
Explanation: Restrictions apply, e.g. cash may only be imported or exported in certain
amounts.
Example of currency: Thai baht, Indonesian rupiah
3. Non-convertibility
Explanation: Foreign exchange and note transactions with other countries are subject to
strict controls.
Example of currency: Cuban peso, most currencies in developing countries
Answer 4 page 18 A] The bank charges a discount (1 %). Although Ms Graf pays in USD 5,000, the amount cred-
ited to her account is USD 4,950.
B] The bank charges a premium (1 %). Mr Cremer receives EUR 10,000, but the amount deb-
ited from his account is EUR 10,100.
Answer 5 page 19 Interest is not generally paid on foreign currency accounts, although the euro is an exception
here. You can use this kind of account for deposits or withdrawals and also to make pay-
ments, just as you can with your Swiss franc current account.
However, when deposits and withdrawals are made, the bank charges corresponding premi-
ums and discounts. In other words, if you pay euros into the account, the bank will charge a
discount. If you request a withdrawal, the bank will charge a premium to the account.
Answer 6 page 39 A] The bank will take the USD/CHF rate and the USD/JPY rate and calculate the cross rate.
97.0650 / 1.2020 für CHF/JPY 80.75
B] The interest rates for CHF and JPY need to be taken into account. For this transaction the
bank would have to invest yen and take out the CHF as a loan. The resulting interest income
and interest expense is incorporated into the forward price.
C] The bank will take the USD/CHF rate and the AUD/USD rate and calculate the cross rate.
0.6529 · 1.2020 für AUD/CHF 0.7848
Answer 7 page 40 How is foreign exchange trading used?
A] In the past foreign currencies were not quoted in a standardised way against the USD, but
against the domestic currency concerned. This resulted in price differentials, which banks
took advantage of to earn profits. It was possible to buy a certain currency and sell it simulta-
neously in another location at a more expensive rate. Today, standardised quotation and mod-
ern communication technology have made this kind of arbitrage impossible. Arbitrage now
refers to professional trading between banks.
B] The bank covers its expenses by making corresponding adjustments to the foreign
exchange prices. In its role as a broker between the supply of and demand for foreign
exchange it tries to achieve the highest possible gains. The difference between the purchase
and selling price is referred to as the spread.
56 BankingToday 2.0
Answers
C] A client asks his bank for a USD/CHF rate. The trader calls another bank in order to pass
this position on straight away. The trader is given the rate 1.2025/30. He adjusts this rate and
passes it on to his client as 1.2024/31. The client enters into the deal and sells USD 1 million,
which the trader immediately sells on. He has therefore bought USD 1 Million at 1.2024 and
sold this on at 1.2025. This means he has realised a gain of CHF 0.0001 on USD 1 Million =
CHF 100.
Answer 8 page 40 A] A swap transaction is a combination of a spot and a forward outright transaction or of two
forward outright transactions with different value dates. You could say that a swap involves
swapping foreign exchange for a limited period of time.
Swaps are used to:
• extend or shorten existing forward outright transactions

• obtain foreign currencies for a limited period
• avoid exchange risks
• control the money supply (one of the instruments of central banks)
B] Mr Müller can conclude a swap in which he buys USD and sells CHF a month earlier and
then sells the USD and buys the CHF again on the same value date as the original transaction.
Mr Müller will then have the money he needs to pay the invoice and the positions will be auto-
matically closed out when the forward outright transactions mature.
Forward
Forward outright
outright settlement
deal date date
USD bought
CHF sold
Swap
settlement dates
Swap
deal date
USD bought USD sold
CHF sold CHF bought
Time
1 month ago today month 1 month 2 month 3
C] The investor has a short call position, which means he is the seller of an option. He is the
writer and therefore does not have a right to take any action. He has to wait until the buyer
exercises his right to buy USD/CHF at 1.2020. As the spot rate is higher than the strike price,
the buyer is certain to exercise the option. The seller is obliged to deliver the CHF. He will incur
a loss, which will only be reduced by the premium he has received.
BankingToday 2.0 57
Answers
Answer 9 page 52 A]
1. Gold
2. Silver
3. Platinum
4. Palladium
B]
In Switzerland: fineness of 999.9, price in CHF per kg
On the world market: fineness of 995, price in USD per troy ounce
C]
Primary markets: This is where the new production of gold is traded. City: Zurich, London
or New York.
Secondary markets: These markets distribute the gold from the primary markets. City: (sev-
eral possible answers) Frankfurt, Paris, Los Angeles, Hong Kong or Singapore.
Answer 10 page 52 A]
1. Numismatic coins – example: coins up to 1800

2. Semi-numismatic coins – example: coins up to 1850
3. Full-bodied coins – example: Vreneli, Sovereign or Double Eagle
4. Bullion coins – example: Krugerrand, Maple Leaf
B]
Physical safekeeping: safe-deposit box, strongroom
Non-physical safekeeping: metal account
C]
Physical safekeeping: The precious metal is surrendered immediately. The bank has only
held it in safekeeping for the client.
Non-physical safekeeping: The value of the precious metal is converted into its monetary
value, and allocated to the second creditor class up to a value of CHF 100,000 per deposit.
The remaining assets fall into the third creditor class.
Answer 11 page 53 A] Possible answers:
1. Gold certificates
2. Shares in mining companies
3. Precious metal forwards
4. Precious metal options
5. Precious metal futures
B] Gold is not subject to value-added tax. Silver, platinum and palladium are also not subject
to value-added tax as long as they are traded in a metal account. If they are delivered and
traded physically, value-added tax is charged.
58 BankingToday 2.0
Answers
Answer 12 page 54 Gold is very popular because it is very durable. It does not rust, is easy to process and looks
attractive.
Opportunities:
1. The value of gold is stable.

2. Gold is favoured over other investment options, e.g. shares, in times of crisis.
Risks:
1. The price of gold fluctuates considerably..

2. Gold is not suitable for short-term investments, as in this case returns are likely to be
small.
BankingToday 2.0 59
Index
Index
Alternative investment 45 Good delivery 46

A
Arbitrage 26 Hedging 27, 35, 36

H
Ask rate 8 Indirect investment 45, 49

I
Banknote trading 7 Indirect quotation 10, 24

B
Bar 43, 45, 46 Intraday transaction 27

Bid rate 8 Limit order 28
L
Call option 36, 37 Market order 28

C M
Cash 7 Medal 45, 46

Central bank 26 Metal account 48, 49
Certificate 43, 50 Note 7, 14
N
Coin 42, 45, 46 Numismatics 46

Coin and note-issuing privilege 6 Over-the-counter trading 20
O
Convertibility 12, 13 Over-the-counter transaction 37, 50

Cross rate 23 Physical safekeeping 48, 49
P
Currency 6 Precious metal 42, 48

Currency carry trade 32 Precious metal derivative 45
Currency future 30 Precious metal option 50
Currency option 36 Premium 14, 30, 44, 47
Degree of fineness 43 Primary market 44
D
Direct investment 45 Put option 36, 37

Direct quotation 10 Secondary market 44
S
Discount 14, 30 Self-contracting party 26

European monetary union (EMU) 6 Speculation 27, 36
E
Exchange rate 8, 11 Spot transaction 27

Exchange rate quotation 8 Spread 8
Fineness 42 Standard bar 43, 46
F
Foreign currency account 14 Strike price 36, 37, 38

Foreign exchange settlement note 25 Swap 33, 35
Foreign exchange trading 20 Tom/next 34
T
Forward 50 Troy ounce 43

Forward outright transaction 29, 38 Value date 27
V
Forward rate 30 Value-added tax 50

Future 50 Wafer 43, 45, 46
W
Gold derivative 45 Writer 36

G
Gold trading 43
60 BankingToday 2.0

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Foreign exchange and precious metals

Technical coaching: CYP, Center for Young Professionals in Banking

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Foreign exchange and precious metals

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2 Foreign exchange trading 20

3 Precious metals and coins 42

At this point, have a look at the e-lesson entitled “Introduction”.

Length: approx. 20 minutes

What you will learn in this module

This module is structured as follows:

Useful study material

To complement this lesson, the following e-media material is also available:

E-lesson: Foreign currency transactions

Simulation: FOREX trading

E-lesson: Precious metals and coins

1 Currencies, notes and foreign exchange

1.1 What is a currency?

Figure 1 Important currencies with their symbol and ISO abbreviation

Country Symbol ISO code Currency

Switzerland SFr. CHF 1 franc = 100 centimes

Eurozone € EUR 1 euro = 100 cents

United Kingdom £ GBP 1 pound = 100 pence

Sweden SEK SEK 1 krona = 100 öre

Japan ¥ JPY 1 yen = 100 sen

USA US$ USD 1 dollar = 100 cents

Canada kan$ CAD 1 dollar = 100 cents

Australia austr$ AUD 1 dollar = 100 cents

1.1.1 What are notes and foreign exchange?

Notes Foreign exchange

1.2 The exchange rate

1.2.1 Exchange rate quotation

Bid rate and ask rate

Foreign exchange Banknotes The USD/CHF

Example In our previous example, the bank is prepared to:

Figure 4 Ask rate, bid rate and spread

Notes Foreign exchange

Direct and indirect quotation

A currency purchase is an exchange of two currencies. In most cases people want to

There are rules relating to how exchange rates are quoted:

Figure 5 Exchange rate quotation and base currency

Figure 6 Direct and indirect quotation

Direct quotation Indirect quotation

Foreign currency / local currency Local currency / foreign currency

Common in, for example: Common in, for example:

1.2.2 How are exchange rates influenced?

Figure 7 Factors that determine rates

A country’s central bank can influence the value of its currency.

Interest rate level

2nd level Typical restrictions are:

1.4 The foreign currency account

A currency is a country’s official means of payment.

• Notes are cash (banknotes and coins).

Exchange rate quotation

• Exchange rates are always quoted from the bank’s perspective:

Direct and indirect quotation

There are three different levels of convertibility:

• Fully convertible currencies: No restrictions apply. Examples: CHF, EUR, USD.

Foreign currency accounts

Foreign exchange and banknote rates as at 25.11.2008

Foreign exchange Banknotes