FINM8007 Chap.1 Foreign Exchange Markets and Quotations
Foreign Exchange Markets and Quotations
The market every later topic relies on
The opening chapter explains why firms go global and what the foreign exchange market does for them: it moves purchasing power between countries, sets the price of currencies, finances trade and lets risk pass to those willing to carry it.
It sorts the five groups of participants by whether they trade for liquidity or for profit and describes the over-the-counter, two-tier structure of the market.
Reading and building quotes
The core skill is mechanical and heavily tested: write a quote as base over price currency, tell a direct quote from an indirect one for a named home country, recognise European and American terms, and build a two-way cross rate through the dollar using the side of each quote that favours the dealer.
Where marks are won and lost
The tutorial solutions model three habits.
First, rewrite every quote in base over price form before deciding whether it is direct or indirect for the stated home country, then take the reciprocal to convert it. Second, when bid and ask are given, pick each leg with the rip-off rule and finish with the economic reading from the client’s side, which the cross-rate questions ask for explicitly.
Third, for a position question, say which way the base currency moved, whether that helps or hurts the trader, and then compute the change in the liability.
How it connects
Every later chapter reuses these skills.
Mint parity in Chapter 2 is a cross rate through gold, percentage changes in Chapter 4 depend on knowing the base currency, triangular arbitrage in Chapter 6 is a cross rate tested against a quote, and every hedge in Chapter 8 is valued by converting at the right side of a quote. Errors made here repeat through the whole course.
What this chapter covers
- 01
Why firms go global
- 02
Purposes of the FX market
- 03
Liquidity and profit seekers
- 04
Spot, forward, swap and option deals
- 05
Base and price currency
- 06
Direct and indirect quotes
- 07
Cross rates with bid and ask
- 08
Drivers of the bid-ask spread
Worked example · free
Build a two-way AUD/CHF cross rate from two dollar quotes
- 1Chain the quotes so the dollar cancels: AUD/USD times USD/CHF gives AUD/CHF.
- 1Cross bid uses both bids: 0.6620 × 0.8840 = 0.5852.
- 1Cross ask uses both asks: 0.6625 × 0.8850 = 0.5863.
- 1The firm sells AUD, so the bank buys them at its bid: 100,000 ÷ 0.585208 = A$170,879.
Key terms
- Market Maker
- A dealer that quotes two-way prices and holds currency inventory to supply liquidity.
- Base Currency
- The currency of which one unit is being priced in a quote.
- Forward Rate
- An exchange rate agreed today for delivery on a later value date.
- Pip
- The smallest price step in a currency quote, usually 0.0001.
- Bid Quote
- The rate at which a dealer is willing to buy the base currency of a quote.
Foreign Exchange Markets and Quotations FAQ
How do I tell a direct quote from an indirect one?
Ask which country is home. A direct quote prices one unit of a foreign currency in home units, so the home currency is the price currency; an indirect quote prices one unit of the home currency in foreign units. The same quote can be direct in one country and indirect in another.
Why do I multiply bid by bid to get a cross bid?
Selling the base currency for the price currency runs through two trades, and in each one the dealer buys from you at its bid. Chaining the two bids gives the rate at which the dealer will buy the cross, which is always the lower of the two cross quotes.
Who earns the bid-ask spread?
The dealer. It buys at the bid and sells at the higher ask, and the gap covers its costs and profit; to a client the spread is a transaction cost. Brokers, by contrast, never take a position and earn a commission for matching buyers and sellers.
What is a pip, and why do traders quote only pips?
A pip is the smallest step in a quote, usually 0.0001. Interbank dealers trading standard amounts of ten million dollars quote only the last two digits, because everyone already knows the big figure and speed matters more than repeating it.
Exam move
Drill quotes until they are reflexes: name the base currency, the home country and the side of the quote before any arithmetic, then build three cross rates a day from fresh two-way quotes. When you finish, explain each cross rate in one line from the client’s side: what they sell, what they receive and why the spread made it worse.
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