What is a FX Rate?
- - Foreign Exchange is the swap (trade) between different currencies and the price at which one currency can be converted into another’s is the Foreign Exchange Rate.
Notation Method of FX Rates
- Base currency / Counter currency = FX rate
- - When US dollar (USD) is a base currency and Japanese Yen is a counter currency, the FX rate of 1USD = 101.75JPY which can be marked as: e.g. USD/JPY = 101.75
- Quotation Method of FX Rates
- - The FX rate is the exchange rate between the two currencies. Depending on which currency is set as the base currency, there are various ways of expressing it.
- - Currency that is the basis of FX rate indication (Base Currency) vs. currency that is exchanged with that base currency (Counter Currency)
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Base Currency Unit Currency Commodity Currency Fixed Currency -
Counter Currency Term Currency Quoted Currency Variable Currency
- European Terms vs. American Terms
- European Terms : International standard
- - Method of setting US Dollar (USD) as the base currency and quoting the FX rate at the number of units of the counter currency equivalent to the exchange of US Dollar of one unit.
e.g. USD/JPY = 101.28, USD/KRW = 769.65
- American Terms : EUR, GBP, AUD, NZD, IEP, ZAR, SDR
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- Method of setting other currency as the base currency and quoting the FX rate at the number of units of US Dollars (USD) equivalent to the exchange of other currency of on unit.
e.g. JPY/USD = 0.009874, KRW/USD = 0.001299
※ Inverse relationship between the FX rates indicated in European Terms and American Terms
- Direct Quotation vs. Indirect Quotation
- - Direct Quotation (Local currency quotation method) : FX rate quotation by setting the foreign currency as the base currency and the local currency as the counter currency
- - Indirect Quotation(Foreign currency quotation method) : FX rate quotation by setting the local currency as the base currency and the foreign currency as the counter currency
※Inverse relationship between the FX rates indicated in Direct Quotation and Indirect Quotation
- Bid Rate vs. Offer Rate
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- When the trade is made between the banks, the bank, who is the market maker, quotes a bid rate and an offer rate at the same time.
This quotation method is called "two-way quotation".
e.g. USD/CHF = 1.7925 - 30
For Instance, the two-way quotation of the above means that the firm quotation that the market maker will buy 1 unit of US Dollar (USD), which is the base currency, at the price of 1.7925CHF and will sell at 1.7930CHF. - - Market makers (the parties quoting the price) are the International Banks who are providing the liquidity in FX market through a continuous offering of “two-way quotation” and making a bulk of FX deals to get the trading gain as per the “Buy low, Sell high” principle. They are called “Quoting Bank.” Meanwhile, the banks other than the market makers, who are making FX deals based on the FX rate quoted by the market makers are the market users (market followers) and they are called “Calling Bank”.
- - As the Foreign Exchange is the trade between the two different currencies, if one currency is bought, the other currency should be sold. The relationship of Market maker & Market user and Base currency & Quotation currency can be illustrated as shown in the table below.
| Bid Rate Transaction | Offer Rate Transaction | |
| Market Maker (Party quoting the price) | + Base Currency / -Quotation Currency | - Base Currency / +Quotation Currency |
- - In order to save the time during direct trade between the banks over the phone, eliminate the first 3 digits of “1.79” and quote Bid rate and Offering rate.
e.g. USD/CHF = 25/ 30
The number of “1.79” eliminated from the above FX quotation is said as “Big Figure” and it is the number that is not frequently changed during the day. Meanwhile, on the FX quotation, the number down to the 4th decimal point is used to be said as “Pip” or “Point (Base Point)”. (Exceptionally in the case of KRW, JPY, the number down to the 2nd decimal point)※ Spread: the gap between offer rate and bid rate.
e.g. Spread = Offer Rate - Bid Rate
- - On the example above, the spread is “5pips” and that is the margin that the market maker gains from FX trade.
- - Narrower the market maker's spread is, more competitive the price becomes. When the market fluctuates, the market makers extend the spread.
- Cross Rate
- > In the international money market, all currencies are quoted in the exchange rate against US Dollar. Through this practice, the FX rate between the currencies other than US Dollar can be calculated which is the Cross Rate.
e.g. By using USD/KRW, USD/JPY, Cross Rate of JPY/KRW can be generated.
- > How to calculate Cross Rate
- In the case when the two currencies are quoted in European Terms: Cross rate can be calculated by dividing two FX rates
e.g. - USD/CHF = 1.5180 / 90
- USD/JPY = 123.92 / 97
- CHF/JPY = 81.58 / 67
① Bid : 123.92 / 1.5190 = 81.58
② Offer : 123.97 / 1.5180 = 81.67
- In the case when one FX rate is quoted in European Terms, and the others is quoted in American Terms: Cross Rate can be calculated by multiplying each Bid and Offer rate
e.g. - EUR/USD = 1.3283 / 91
- USD/JPY = 123.92 / 97
- EUR/JPY = 164.60 / 77
① Bid : 1.3283*123.92 = 164.60
② Offer : 1.3291*123.97 = 164.77
Value Date/Delivery Date
- - FX trade starts from the determination of terms and conditions, i.e., FX rate and Trading amounts, etc on the trade date, and completed when two concerned banks transfer the fund to the accounts of each of counter banks on the settlement date (Value Date, Delivery Date).
- - After FX deal is done between two banks, it will take a time for back office to confirm the transaction details and do all necessary follow-up actions for the settlement. As such amount of time is required, the settlement date of FX trade is generally the next day of Trade date.
- - In principle, same settlement date is applied to those two concerned parties. In the case when the one of relevant currency issuance countries is on Holiday, the settlement date will be automatically delayed to the next business day as per the same date principle.
- Settlement Date of Spot Transactions
- - As per the international practice, the Spot Transaction is the FX trade of which Delivery & Receipt is made on the following business day (Value Spot) from the date of Trade. However, in a broad sense, it is the FX trade of which settlement is made within 2 business days and it includes the FX trade at Value Today and Value Tomorrow.
- Settlement Date of Forward Transactions
- > As per the international practice, the Forward Transaction is the FX trade of which settlement date is Value Forward (settlement on 3rd business day and afterwards).
- > Forward Value Date = Spot Value Date + Forward Maturity Date
- Forward Value Spot Value Date Date
Standard Date Trade (Standard Date, Even Date)
1 month(1mo, 30days), 2 months (2mo, 60days), 3 months (3mo, 90days), 6 months (6mo, 180days), 1 year (1yr, 360days)
- Broken Date Trade (Broken Date, Odd Date)
Trade with Value date on a specific date other than the Standard Date at both concerned parties’ convenience
