Republic of the Philippines

University of Rizal System

Province of Rizal
[Link]..ph
Email Address: ursmain@[Link]

Module 9: The Foreign Exchange Market

Module Introduction
Foreign exchange trading refers to trading one country’s money for that of
another country. The kind of money specifically traded takes the form of bank deposits
or bank transfers of deposits denominated in foreign currency. The foreign exchange
market typically refers to large commercial banks in financial centers, such as New York
or London, that trade foreign-currency-denominated deposits with each other.
This chapter provides a big picture of foreign exchange trading and its basic
understanding on Foreign Market, Market Participants and other related issues such as
the determinants of exchange rates, geographic trading patterns, spot exchange rates,
and other related topics.

Module Objectives:
At the end of this module, the students should be able to:
1. Understand the Foreign Exchange transactions;
2. Learn the different terminologies used in foreign exchange;
3. Determine players in foreign exchange operation.

Module 9: The Foreign Exchange Market

 Republic of the Philippines
University of Rizal System
Province of Rizal
[Link]..ph
Email Address: ursmain@[Link]

Discussion Proper

What is Foreign Exchange Market?

The foreign exchange market is a global decentralized or over-the-counter
market for the trading of currencies. This market determines foreign exchange rates for
every currency. It includes all aspects of buying, selling and exchanging currencies at
current or determined prices
The main participants in this market are the larger international banks. Financial
centers around the world function as anchors of trading between a wide range of
multiple types of buyers and sellers around the clock, with the exception of weekends.
Since currencies are always traded in pairs, the foreign exchange market does not set a
currency's absolute value but rather determines its relative value by setting the market
price of one currency if paid for with another. Ex: US$1 is worth X CAD, or CHF, or JPY,
etc.
The foreign exchange market works through financial institutions and operates
on several levels. Behind the scenes, banks turn to a smaller number of financial firms
known as "dealers", who are involved in large quantities of foreign exchange trading.
Most foreign exchange dealers are banks, so this behind-the-scenes market is
sometimes called the "interbank market" (although a few insurance companies and
other kinds of financial firms are involved). Trades between foreign exchange dealers
can be very large, involving hundreds of millions of dollars. Because of the sovereignty
issue when involving two currencies, Forex has little (if any) supervisory entity
regulating its actions.
The foreign exchange market assists international trade and investments by
enabling currency conversion. For example, it permits a business in the United States to
import goods from European Union member states, especially Eurozone members, and
pay Euros, even though its income is in United States dollars. It also supports direct
speculation and evaluation relative to the value of currencies and the carry
trade speculation, based on the differential interest rate between two currencies.

The foreign exchange market is unique because of the following characteristics:

1. its huge trading volume, representing the largest asset class in the world leading
to high liquidity;

Module 9: The Foreign Exchange Market

 Republic of the Philippines
University of Rizal System
Province of Rizal
[Link]..ph
Email Address: ursmain@[Link]

2. its geographical dispersion;

3. its continuous operation: 24 hours a day except for weekends, i.e., trading from
22:00 GMT on Sunday (Sydney) until 22:00 GMT Friday (New York);
4. the variety of factors that affect exchange rates;
5. the low margins of relative profit compared with other markets of fixed income;
and
6. the use of leverage to enhance profit and loss margins and with respect to
account size.

BASIC CONCEPT OF FOREIGN EXCHANGE MARKET

1) BASIC CONCEPT:

What is Foreign Currency VS Foreign Exchange?

1. "Foreign Currency" means any currency other than Philippine Currency;

2. "Foreign Exchange" means includes any instrument drawn, accepted, made or
issued by the Central Bank, all deposits, credits and balance payable in any
foreign currency, and any drafts, traveler’s checks, letters of credit and bills of
exchange expressed or drawn in Country’s currency but payable in other foreign
currency

2) FINANCIAL MARKETS:

Financial market is a place where resources/funds are transferred from those having
surplus/excess to those having a deficit/shortage or;

A market in which financial instruments are traded. The financial markets are stock
exchanges, commodity exchanges, bonds markets and the foreign exchange markets
or;

A financial market is a mechanism that allows people to easily buy and sell financial
securities, commodities at low transaction cost.

Financial markets facilitates:

1) The raising of capital.2) The transfer of risk.3) International trade.

3) FOREIGN EXCHANGE MARKETS:

Just as other prices in the economy are determined by interaction of buyers and
sellers, exchange rates are determined by the interaction of the households, firms, and

Module 9: The Foreign Exchange Market

 Republic of the Philippines
University of Rizal System
Province of Rizal
[Link]..ph
Email Address: ursmain@[Link]

financial institutions that buy and sell foreign currencies to make international payments.
The market in which international currency trades takes is called the Foreign Exchange
Markets. ( International Economics - Krugman,Obstfeld,Melitz)

4) MAJOR CURRENCIES SYMBOLS:

1. USD : US DOLLAR
2. EUR : EURO
3. JPY : JAPANESE YEN
4. GBP : BRITISH POUND
5. CAD : CANADIAN DOLLAR
6. AUD : AUSTRALIAN DOLLAR
7. CHF : SWISS FRANC

5) EXCHANGE RATE:

The price of one currency in terms of another is called exchange rate.

The price of one currency expressed in terms of another currency. For example,
if the U.S. dollar buys 1.20 Canadian dollars, the exchange rate is 1.2 to [Link] in
exchange rates have significant effects on the profits of international corporations.
Exchange rate changes also affect the value of foreign investments held by individual
investors. For a U.S. investor owning Japanese securities, a strengthening of the U.S.
dollar relative to the yen tends to reduce the value of the Japanese securities because
the yen value of the securities is worth fewer dollars. Also called foreign exchange rate

6) FOREIGN EXCHANGE TRANSACTION:

Any financial transaction that involves more than one currency is a foreign
exchange transaction. Foreign exchange trading, which is commonly called forex
trading, is the swapping of currencies from different countries. For example, you could
trade US Dollars for Euros. In the modern age of computers and digital trading, forex
trading has become less dependent on a physical exchange of currencies. These days
a trader can make a foreign exchange trade simply by placing an order using a
computer. The trade can be held anywhere from minutes to years depending on the
intention of the trader

7) PARTICIPANTS IN FOREIGN EXCHANGE MARKET

Module 9: The Foreign Exchange Market

 Republic of the Philippines
University of Rizal System
Province of Rizal
[Link]..ph
Email Address: ursmain@[Link]

Unlike a stock market, the foreign exchange market is divided into levels of
access. At the top is the interbank foreign exchange market, which is made up of the
largest commercial banks and securities dealers. Within the interbank market, spreads,
which are the difference between the bids and ask prices, are razor sharp and not
known to players outside the inner circle. The difference between the bid and ask prices
widens (for example from 0 to 1 pip to 1–2 pips for currencies such as the EUR) as you
go down the levels of access. This is due to volume. If a trader can guarantee large
numbers of transactions for large amounts, they can demand a smaller difference
between the bid and ask price, which is referred to as a better spread. The levels of
access that make up the foreign exchange market are determined by the size of the
"line" (the amount of money with which they are trading). The top-tier interbank market
accounts for 51% of all transactions. From there, smaller banks, followed by large multi-
national corporations (which need to hedge risk and pay employees in different
countries), large hedge funds, and even some of the retail market makers.

1. Commercial Companies

An important part of the foreign exchange market comes from the financial activities
of companies seeking foreign exchange to pay for goods or services. Commercial
companies often trade fairly small amounts compared to those of banks or speculators,
and their trades often have a little short-term impact on market rates.

2. Central Banks

National central banks play an important role in the foreign exchange markets. They
try to control the money supply, inflation, and/or interest rates and often have official or
unofficial target rates for their currencies. They can use their often substantial foreign
exchange reserves to stabilize the market. Nevertheless, the effectiveness of central
bank "stabilizing speculation" is doubtful because central banks do not go bankrupt if
they make large losses as other traders would. There is also no convincing evidence
that they actually make a profit from trading.

3. Foreign exchange fixing

Foreign exchange fixing is the daily monetary exchange rate fixed by the national
bank of each country. The idea is that central banks use the fixing time and exchange
rate to evaluate the behavior of their currency. Fixing exchange rates reflect the real
value of equilibrium in the market. Banks, dealers, and traders use fixing rates as a
market trend indicator.

4. Investment management firms

Module 9: The Foreign Exchange Market

 Republic of the Philippines
University of Rizal System
Province of Rizal
[Link]..ph
Email Address: ursmain@[Link]

Investment management firms (who typically manage large accounts on behalf of

customers such as pension funds and endowments) use the foreign exchange market
to facilitate transactions in foreign securities. For example, an investment manager
bearing an international equity portfolio needs to purchase and sell several pairs of
foreign currencies to pay for foreign securities purchases.

Some investment management firms also have more speculative specialist

currency overlay operations, which manage clients' currency exposures with the aim of
generating profits as well as limiting risk. While the number of this type of specialist
firms is quite small, many have a large value of assets under management and can,
therefore, generate large trades.

5. Retail Foreign Exchange Traders

Individual retail speculative traders constitute a growing segment of this market.

Currently, they participate indirectly through brokers or banks. Retail brokers, while
largely controlled and regulated in the US by the Commodity Futures Trading
Commission and National Futures Association, have previously been subjected to
periodic foreign exchange [Link] deal with the issue, in 2010 the NFA required its
members that deal in the Forex markets to register as such (I.e., Forex CTA instead of a
CTA). Those NFA members that would traditionally be subject to minimum net capital
requirements, FCMs and IBs, are subject to greater minimum net capital requirements if
they deal in Forex. A number of the foreign exchange brokers operate from the UK
under Financial Services Authority regulations where foreign exchange trading using
margin is part of the wider over-the-counter derivatives trading industry that includes
contracts for difference and financial spread betting.

There are two main types of retail FX brokers offering the opportunity for speculative
currency trading: brokers and dealers or market makers.

1. Brokers serve as an agent of the customer in the broader FX market, by seeking

the best price in the market for a retail order and dealing on behalf of the retail
customer. They charge a commission or "mark-up" in addition to the price
obtained in the market.
2. Dealers or market makers, by contrast, typically act as principals in the
transaction versus the retail customer, and quote a price they are willing to deal
at.

6. Non-bank foreign exchange companies

Module 9: The Foreign Exchange Market

 Republic of the Philippines
University of Rizal System
Province of Rizal
[Link]..ph
Email Address: ursmain@[Link]

Non-bank foreign exchange companies offer currency exchange and international

payments to private individuals and companies. These are also known as "foreign
exchange brokers" but are distinct in that they do not offer speculative trading but rather
currency exchange with payments (i.e., there is usually a physical delivery of currency
to a bank account).

7. Money transfer/remittance companies and bureau de change

Money transfer companies/remittance companies perform high-volume low-value

transfers generally by economic migrants back to their home country. In 2007, the Aite
Group estimated that there were $369 billion of remittances (an increase of 8% on the
previous year). The four largest foreign markets (India, China, Mexico, and the
Philippines) receive $95 billion. The largest and best-known provider is Western Union
with 345,000 agents globally, followed by UAE Exchange Bureau de change or currency
transfer companies provide low-value foreign exchange services for travelers. These
are typically located at airports and stations or at tourist locations and allow physical
notes to be exchanged from one currency to another. They access foreign exchange
markets via banks or non-bank foreign exchange companies.

8) COMPONENTS OF A FOREX DEAL:

A Forex deal is a contract agreed upon between the trader and the market-maker
(i.e. the Currency Trading Platform).The contract is comprised of the following
components:

1. The currency pairs (which currency to buy; which currency to sell)

2. The principal amount (or "face", or "nominal": the amount of currency
involved in the deal)
3. The rate (the agreed exchange rate between the two currencies).

FX trading is always done in currency pairs. For example, imagine that the
exchange rate of EUR/USD (euros to US dollars) on a certain day is 1.1999 (this
number is also referred to as a 'spot rate', or just 'rate', for short). If an investor had
bough 1,000 euros on that date, he would have paid 1,199.00 US dollars. If one year
later, the Forex rate was 1.2222, the value ofthe euro has increased in relation to the
US dollar. The investor could now sell the 1,000 euros in order to receive 1222.00US
dollars. The investor would then have USD 23.00 more than when he started a year
earlier

Module 9: The Foreign Exchange Market

 Republic of the Philippines
University of Rizal System
Province of Rizal
[Link]..ph
Email Address: ursmain@[Link]

9) METHODS OF QUOTING FOREIGN EXCHANGE RATES:

Currently, domestic banks will determine their exchange rates based on

international financial markets. There are two common ways to quote exchange rates,
direct and indirect quotation.

1. Direct Quotation:

This is also known as price quotation. The exchange rate of the domestic
currency is expressed as equivalent to a certain number of units of a foreign currency. It
is usually expressed as the amount of domestic currency that can be exchanged for 1
unit or 100 units of a foreign currency. The more valuable the domestic currency, the
smaller the amount of domestic currency needed to exchange for a foreign currency unit
and this gives a lower exchange rate. When the domestic currency becomes less
valuable, a greater amount is needed to exchange for a foreign currency unit and the
exchange rate becomes higher. Under the direct quotation, the variation of the
exchange rates are inversely related to the changes in the value of the domestic
currency. When the value of the domestic currency rises, the exchange rates fall; and
when the value of the domestic currency, the exchange rates rise. Most countries uses
direct quotation. Most of the exchange rates in the market such as USD/JPY, USD/HKD
and USD/RMD are also quoted using direct quotation.

2. Indirect Quotation:

This is also known as the quantity quotation. The exchange rate of a foreign currency is
expressed as equivalent to a certain number of units of the domestic currency. This is
usually expressed as the amount of foreign currency needed to exchange for 1 unit or
100 units of domestic currency. The more valuable the domestic currency, the greater
the amount of foreign currency it can exchange for and the lower the exchange rate.
When the domestic currency becomes less valuable, it can exchange for a smaller
amount of foreign currency and the exchange rate drops. Under indirect quotation, the
rise and fall of exchange rates are directly related to the changes in value of the
domestic currency. When the value of the domestic currency rises, the exchange rates
also rise; and when the value of the domestic currency falls, the exchange rates fall as
well. Most Commonwealth countries such as the United Kingdom, Australia and New
Zealand use indirect quotation. Exchange rates such as GBP/USD and AUD/USD are

Module 9: The Foreign Exchange Market

 Republic of the Philippines
University of Rizal System
Province of Rizal
[Link]..ph
Email Address: ursmain@[Link]

quoted indirectly. Direct Quotation Indirect Quotations/JPY = 134.56/61 EUR/USD =

0.8750/55USD/HKD = 7.7940/50 GBP/USD = 1.4143/50USD/CHF = 1.1580/90
AUD/USD = 0.5102/09

There are two implications for the above quotations:

(1) Currency A/Currency B means the units of Currency B needed to exchange

for 1 unit of Currency A

(2) Value A/Value B refers to the quoted buy price and sell price. Since the
difference between the buy price and sell price is not large, only the last 2 digits of the
sell price are shown. The two digits in front are the same as the buy price

10) SPOT MARKET:

The most common type of foreign exchange transaction is for immediate

exchange at the so called spot rate. The market where these transactions occurs is
known as spot market. The average daily foreign exchange trading by banks around the
world exceeds $1.5 trillion. (JEFF MADURA- INTERNATIONAL FINANCIAL MANAGEMENT)

The rate of a foreign-exchange contract for immediate delivery. Also known as

"benchmark rates", "straightforward rates “or "outright rates”, spot rates represent the
price that a buyer expects to pay for a foreign currency in another currency. This is the
exchange rate at the present time. The spot rate on FX changes every second and is
constantly updating.

11) SPOT MARKET INTERACTION AMONG BANKS:

At any given point in time, the exchange rate between two currencies should be
similar across the various banks that provide foreign exchange services. If there is a
large discrepancy, customers or other banks will purchase large amounts of a currency
from whatever bank quotes a relatively low price and immediately sell it to whatever
bank quotes a relatively high price. Such actions cause adjustments in the exchange
rate quotations that eliminate any discrepancy.

12) BID/ASK SPREAD OF BANKS:

Commercial banks charge fees for conducting foreign exchange transactions. At

any given point in time, a bank’s bid (buy) quote for a foreign currency will be less than
its ask (sell) quote. The bid/ask spread represents the differential between the bid and
ask quotes and is intended to cover the costs involved in accommodating requests to

Module 9: The Foreign Exchange Market

 Republic of the Philippines
University of Rizal System
Province of Rizal
[Link]..ph
Email Address: ursmain@[Link]

exchange currencies. The bid/ask spread is normally expressed as a percentage of the

ask quote. (JEFF MADURA- INTERNATIONAL FINANCIALMANAGEMENT)

13 PIP:

Based on the market practice, foreign exchange rates quotation normally

consists of 5 significant figures. Starting from right to left, the first digit, is known as the
“pip”. This is the smallest unit of movement in the exchange rate. The second digit is
known as “10 pips”, so on and so forth.

For example:1 EUR = 1.1011 USD; 1 USD = JPY 120.55If EUR/USD changes
from 1.1010 to 1.1015, we say that the EUR/USD has risen by 5 pipsIf USD/JPY
changes from 120.50 to 120.00, we say that USD/JPY has dropped by 50 pips

14 FORWARD EXCHANGE RATE:

In addition to the spot market, a forward market for currencies enables the
multinational corporations to lock in the exchange rate called a forward rate at which it
will buy or sell currency. A forward contract specifies the amount of particular currency
that will be purchased or sold by the multinational corporation at a specified future point
in time and at a specified exchange rate. Commercial banks accommodate the
multinational corporations that desire forward contracts. Multinational corporations
commonly use the forward market to hedge future payments that they expect to make
or receive in a foreign currency. In this way, they do not have to worry about fluctuations
in the spot rate until the time of their future payments

A corporation may make a deal that defers payment until some point in the
future. If the transaction requires exchanging currencies, there also must be an
agreement of what a fair exchange rate will be at that point in the future. This is called
forward contract; the forward exchange rate is established through combining inflation
expectations and the time value of money.

DETERMINANTS OF EXCHANGE RATES

In a fixed exchange rate regime, exchange rates are decided by the government,
while a number of theories have been proposed to explain (and predict) the fluctuations
in exchange rates in a floating exchange rate regime, including:

1. International parity conditions: Relative purchasing power parity, interest rate

parity, Domestic Fisher effect, International Fisher effect. To some extent the

Module 9: The Foreign Exchange Market

 Republic of the Philippines
University of Rizal System
Province of Rizal
[Link]..ph
Email Address: ursmain@[Link]

above theories provide logical explanation for the fluctuations in exchange rates,
yet these theories falter as they are based on challengeable assumptions (e.g.,
free flow of goods, services, and capital) which seldom hold true in the real world.

2. Balance of payments model: This model, however, focuses largely on tradable

goods and services, ignoring the increasing role of global capital flows. It failed to
provide any explanation for the continuous appreciation of the US dollar during the
1980s and most of the 1990s, despite the soaring US current account deficit.
3. Asset market model: views currencies as an important asset class for constructing
investment portfolios. Asset prices are influenced mostly by people's willingness to
hold the existing quantities of assets, which in turn depends on their expectations on
the future worth of these assets. The asset market model of exchange rate
determination states that “the exchange rate between two currencies represents the
price that just balances the relative supplies of, and demand for, assets
denominated in those currencies.”
Supply and demand for any given currency, and thus its value, are not influenced by
any single element, but rather by several. These elements generally fall into three
categories: economic factors, political conditions and market psychology.
1. Economic factors
Economic factors include: (a) economic policy, disseminated by government
agencies and central banks, (b) economic conditions, generally revealed through
economic reports, and other economic indicators.

1. Economic policy comprises government fiscal policy (budget/spending practices)

and monetary policy (the means by which a government's central bank influences
the supply and "cost" of money, which is reflected by the level of interest rates).
2. Government budget deficits or surpluses: The market usually reacts negatively to
widening government budget deficits, and positively to narrowing budget deficits.
The impact is reflected in the value of a country's currency.
3. Balance of trade levels and trends: The trade flow between countries illustrates
the demand for goods and services, which in turn indicates demand for a
country's currency to conduct trade. Surpluses and deficits in trade of goods and
services reflect the competitiveness of a nation's economy. For example, trade
deficits may have a negative impact on a nation's currency.
4. Inflation levels and trends: Typically a currency will lose value if there is a high
level of inflation in the country or if inflation levels are perceived to be rising. This
is because inflation erodes purchasing power, thus demand, for that particular
currency. However, a currency may sometimes strengthen when inflation rises
because of expectations that the central bank will raise short-term interest rates
to combat rising inflation.

Module 9: The Foreign Exchange Market

 Republic of the Philippines
University of Rizal System
Province of Rizal
[Link]..ph
Email Address: ursmain@[Link]

5. Economic growth and health: Reports such as GDP, employment levels, retail
sales, capacity utilization and others, detail the levels of a country's economic
growth and health. Generally, the more healthy and robust a country's economy,
the better its currency will perform, and the more demand for it there will be.
6. Productivity of an economy: Increasing productivity in an economy should
positively influence the value of its currency. Its effects are more prominent if the
increase is in the traded sector.

2. Political conditions
Internal, regional, and international political conditions and events can have a
profound effect on currency markets.
All exchange rates are susceptible to political instability and anticipations about the
new ruling party. Political upheaval and instability can have a negative impact on a
nation's economy.

3. Market psychology
Market psychology and trader perceptions influence the foreign exchange market in
a variety of ways:

1. Flights to quality: Unsettling international events can lead to a "flight-to-quality", a

type of capital flight whereby investors move their assets to a perceived "safe
haven". There will be a greater demand, thus a higher price, for currencies
perceived as stronger over their relatively weaker counterparts. The US dollar,
Swiss franc and gold have been traditional safe havens during times of political
or economic uncertainty.
2. Long-term trends: Currency markets often move in visible long-term trends.
Although currencies do not have an annual growing season like physical
commodities, business cycles do make themselves felt. Cycle analysis looks at
longer-term price trends that may rise from economic or political trends.
3. "Buy the rumor, sell the fact": This market truism can apply to many currency
situations. It is the tendency for the price of a currency to reflect the impact of a
particular action before it occurs and, when the anticipated event comes to pass,
react in exactly the opposite direction. This may also be referred to as a market
being "oversold" or "overbought".[75] To buy the rumor or sell the fact can also be
an example of the cognitive bias known as anchoring, when investors focus too
much on the relevance of outside events to currency prices.
4. Economic numbers: While economic numbers can certainly reflect economic
policy, some reports and numbers take on a talisman-like effect: the number itself

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 Republic of the Philippines
University of Rizal System
Province of Rizal
[Link]..ph
Email Address: ursmain@[Link]

becomes important to market psychology and may have an immediate impact on

short-term market moves. "What to watch" can change over time. In recent
years, for example, money supply, employment, trade balance figures and
inflation numbers have all taken turns in the spotlight.
5. Technical trading considerations: As in other markets, the accumulated price
movements in a currency pair such as EUR/USD can form apparent patterns that
traders may attempt to use. Many traders study price charts in order to identify such
patterns.

FINANCIAL INSTRUMENT
1. Spot
A spot transaction is a two-day delivery transaction (except in the case of trades
between the US dollar, Canadian dollar, Turkish lira, euro and Russian ruble, which
settle the next business day), as opposed to the futures contracts, which are usually
three months. This trade represents a “direct exchange” between two currencies, has
the shortest time frame, involves cash rather than a contract, and interest is not
included in the agreed-upon transaction. Spot trading is one of the most common types
of forex trading. Often, a forex broker will charge a small fee to the client to roll-over the
expiring transaction into a new identical transaction for a continuation of the trade. This
roll-over fee is known as the "swap" fee.
2. Forward
One way to deal with the foreign exchange risk is to engage in a forward transaction. In
this transaction, money does not actually change hands until some agreed upon future
date. A buyer and seller agree on an exchange rate for any date in the future, and the
transaction occurs on that date, regardless of what the market rates are then. The
duration of the trade can be one day, a few days, months or years. Usually the date is
decided by both parties. Then the forward contract is negotiated and agreed upon by
both parties.
3. Non-deliverable forward (NDF)
Forex banks, ECNs, and prime brokers offer NDF contracts, which are derivatives
that have no real deliver-ability. NDFs are popular for currencies with restrictions such
as the Argentinian peso. In fact, a forex hedger can only hedge such risks with NDFs,
as currencies such as the Argentinian peso cannot be traded on open markets like
major currencies.[77]
4. Swap
The most common type of forward transaction is the foreign exchange swap. In a swap,
two parties exchange currencies for a certain length of time and agree to reverse the
transaction at a later date. These are not standardized contracts and are not traded

Module 9: The Foreign Exchange Market

 Republic of the Philippines
University of Rizal System
Province of Rizal
[Link]..ph
Email Address: ursmain@[Link]

through an exchange. A deposit is often required in order to hold the position open until
the transaction is completed.
5. Futures
Futures are standardized forward contracts and are usually traded on an exchange
created for this purpose. The average contract length is roughly 3 months. Futures
contracts are usually inclusive of any interest amounts.
Currency futures contracts are contracts specifying a standard volume of a particular
currency to be exchanged on a specific settlement date. Thus the currency futures
contracts are similar to forward contracts in terms of their obligation, but differ from
forward contracts in the way they are traded. In addition, Futures are daily settled
removing credit risk that exist in Forwards. [78] They are commonly used by MNCs to
hedge their currency positions. In addition they are traded by speculators who hope to
capitalize on their expectations of exchange rate movements.
6. Option
A foreign exchange option (commonly shortened to just FX option) is a derivative
where the owner has the right but not the obligation to exchange money denominated in
one currency into another currency at a pre-agreed exchange rate on a specified date.
The FX options market is the deepest, largest and most liquid market for options of any
kind in the world.

Module 9: The Foreign Exchange Market

 Republic of the Philippines
University of Rizal System
Province of Rizal
[Link]..ph
Email Address: ursmain@[Link]

Self-Assessment Questions
1. Define Foreign Exchange, Foreign Exchange Rate and Foreign Currency.
2. Differentiate Foreign Exchange Trading to Foreign Exchange Market.
3. Enumerate the Determinants of Exchange Rate.
4. Explain the Financial Instruments.

Reference/s:

Foreign Exchange Market

Fahad Khan, Https://[Link]/5535414/Foreign_Exchange_Market

Rajesh Kumar, in Strategies of Banks and Other Financial Institutions, 2014

[Link]
exchange-market

Michael Melvin, Stefan Norrbin, in International Money and Finance (Ninth Edition),
2017
[Link]
exchange-market

([Link]

Module 9: The Foreign Exchange Market