Characteristics and Kinds of Spot Transactions Currency Conversions

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 FOREX 1. 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 v 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

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Classification of ERs 1. Types of trade - prompt - forward - futures - option 2. Time point of view - prompt - term 3. Financial tools - foreign exchange (devízové, valutové)