Characteristics and Kinds of Spot Transactions:

Currency Conversions and Currency Arbitrage

Menu of Main Points

1. Basics of Foreign Exchange Market

2. Spot Transactions

• Types of Spot Transactions

Basics of FOREX1. Exchange Market

• a place, where the supply of foreign currencies meets the demand for them

2. Market participants• Banks• Commercial companies• Central banks• Hedge funds as speculators• Investment management firms • Retail foreign exchange brokers

3. Types of trades in the FOREX• Forward trades • Swap • Spot trades

Spot Transaction• a foreign exchange transaction in which each party

promises to pay a certain amount of currency to the other on the same day or within one or two days

• the spot rate• a trade day

Pricing Spot Transactions• 2 prices: 1. the buying price (bid)

2. the selling price (offer)• the spread

Exchange Rates• is the price of one currency expressed in other

currency, it’s the relative price of two national currencies

Quotation• Direct: x home currency units = 1 foreign currency unit (e.g. in US – 1.25 USD = 1 EUR) • Indirect: x foreign currency units = 1 home currency unit (e.g. in US - 0.80 EUR = 1 USD)

– Term currency– Base currency e.g. EURUSD exchange rate is 1.3 (1.3 USD per EUR)

term base

Types of Spot Transactions

• Currency Arbitrage• Two-currency arbitrage• Three-currency arbitrage• Arbitrage between prompt and term market

• Currency Conversions

Currency Arbitrage• purchase of one currency in one financial EM and its selling in other• the aim - reach the profit from the price difference in two or three

financial exchange markets• involves: - no negative cash-flow at any probabilistic or

temporal state

- a positive cash-flow in at least one state

Conditions for Arbitrage• the law of one price• 2 A with identical cash-flows do not trade at the same price• A with a known price in the future does not today trade at its future

price discounted at the risk-free interest rate

Types of Arbitrage• Two-currency • Three-currency• Arbitrage between prompt and term market

• two-currency arbitrage• two different brokers offering different spreads • at least one quote which differs between the brokers,

either the bid, the ask, or both

• A. between prompt & term market• Influenced by: - the size of prompt & term rates

- the size of interest rates between

2 currencies

• three way forex arbitrage• the exchange rates of three currencies don't match all

ratios, and there is a gap between expectation and reality

• the process of converting one currency to another, converting it again to a third currency and, finally, converting it back to the original currency within a short time span.

Currency Conversions

• prompt spot transaction, in which is one currency changed for another one and vice versa

Thank you for your attention

Classification of ERs

1. Types of trade - prompt

- forward

- futures

- option

2. Time point of view - prompt

- term

3. Financial tools - foreign exchange

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