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1. Spot

Definition : Exchange of two currencies at an agreed upon exchange rate for cash delivery. Cash delivery is considered to be two business days, except for the Canadian dollar, which is one business day.

Example :

Today : 8th of December.
Customer X buys EUR/USD 1´000´000.- for spot delivery at 0.9950.
Delivery : 10th of December.

2. Bid/Offer

Bids and Offers are quoted in terms of the base currency. 1 Base unit is how many units of the other currency.

Example :

EUR/USD : 0.9950/54
BID : 0.9950 is where the market maker buys the base currency and the customer sells the base currency.
OFFER : 0.9954 is where the market maker sells the base currency and the customer buys the base currency.

Example of a Spot Transaction :

Customer : "Hi, this is X Customer Reference x, could you show me a spot price in EUR/USD 1´000´000,-- please ?".
Broker : "EUR/USD is 0.9950/54".
Customer : "At 0.9954 I buy 1 Mio EUR ".
Broker : "OK at 0.9954 you bought EUR 1 Mio against USD value 10th of December".

3. Forward Outright

A Foreign Exchange Forward is an exchange of two currencies at a predetermined rate for any date other than spot delivery.

A Forward Outright is a single exchange of two currencies at a predetermined rate for future delivery. (Spot + Forward Points).

Calculation of forward exchange rate is base upon spot and interest rate differentials :
Today : 8th of December 2002 Spot EUR/USD 0.9954 (Value 10th of December)
Customer X buys EUR/USD 1´000´000,-- forward at 0.9942 for 1 month.
Exchange of Currencies on January 10th 2003.

Example of a Forward Outright Quote :

Spot EUR/USD 0.9950/54
1 Month 15 - 12 (Discount)
   
Forward Outright Quote 0.9935 - 0.9942

Example of a Forward Outright Transaction :

Customer : "Hi, this is X Customer Reference x, could you show me a forward outright price in EUR/USD 1´000´000,-- 1 month please ?".
Broker : "Forward outright EUR/USD 1 month is 0.9935/42".
Customer : "At 0.9942 I buy 1 Mio EUR ".
Broker : "OK at 0.9942 you bought EUR 1 Mio against USD value 10th of January 2003".

4. FX Swap

A Foreign Exchange Forward is an exchange of two currencies at a predetermined rate for any date other than spot delivery.

A FX Swap is an agreement to make an initial exchange of currencies for spot value with a reversal of that exchange at some future date. Differs from a forward outright in that two deliveries take place. Comparable to borrowing or lending.

Example of a FX Swap :

Spot Price 122.75/80
Forward Outright 48/44 (Discount)

Customer : "Hi, this is X customer reference x, Could you please show me a price for a Swap USD/JPY 3 Months please ?".
Broker : "Swap USD/JPY 3 months is -48/-44".
Customer "OK at - 48, I buy and sell 1 Mio USD/JPY".
Broker : "OK you bought 1 Mio USD/JPY at 122.75 value Spot 10th of December 2002 and sold 1 Mio USD/JPY at 122.27 value 10th of March 2003".

Remark : there is no spot exposure on FX SWAP

5. Premium/Discount

Premium/Discount is the interest rate differentials between two currencies.

Premium :

There is a Premium when Swap rate is positive (the Forward rate exceeds a spot rate). This is when the interest rates of the base currency are lower than the second quoted currency-pair.

Example of USD/CAD

US Dollar 3 months Interest rates 1.25 pct
Canadian Dollar 3 months Interest rates 2.75 pct

The Swap USD/CAD 3 months is 54 / 58.

Discount :

There is a Discount when Swap rate is negative (the Forward rate is lower than spot rate). This is when the interest rates of the base currency are higher than the second quoted currency-pair.
Example of EUR/USD

Euro 3 months Interest rates 2.65 pct
US Dollar 3 months Interest rates 1.30 pct

The Swap EUR/USD 3 months is - 38.5 / - 33.

6. Calculating Premium and Discount

Customer wants to sell EUR 3 Mio against USD 3 months forward.

Trade Date February 11th.
EUR/USD 1.0710/14
USD 3 Month rate 1.25 / 1.35 %
EUR 3 Month rate 2.60 / 2.70 %
Maturity 90 days

How calculate the bid price for EUR/USD 3 months Forward ?

1st Method :
Forward Points = ((Spot * (1 + (OCR rate * n/360))) / (1 + (BCR rate * n/360))) - Spot

OCR = Other Currency Rate
BCR = Base Currency Rate

Forward points = ((1.0710 * (1 + (0.0125 * 90/360))) / (1 + (0.027 rate * 90/360))) - 1.0710

SWAP = - 0.00385

Forward rate = 1.0710 - 0.00385 = 1.06715

Alternative Method :

Borrow   Lend
     
EUR 3´000´000 Spot 1.0710 USD 3´213´000
90 days at 2.70 %   90 days at 1.25 %
Interest = EUR 20´250   Interest = USD 10´040.625
     
TOTAL EUR 3´020´250.--   TOTAL USD 3´223´040.625

Forward rate = 3´223´040.625 / 3´020´250.-- = 1.06715

Customer sells EUR 3 Mio against USD at 1.06715 at 3 month (1.0710 - 0.00385).

Customer wants to Buy EUR 3 Mio against USD 3 months forward.

Trade Date : February 11th.
EUR/USD 1.0710/14
USD 3 Month rate 1.25 / 1.35 %
EUR 3 Month rate 2.60 / 2.70 %
Maturity 90 days

How calculate the bid price for EUR/USD 3 months Forward ?

1st Method :

Forward Points = ((Spot * (1 + (OCR rate * n/360))) / (1 + (BCR rate * n/360))) - Spot

OCR = Other Currency Rate
BCR = Base Currency Rate

Forward points = ((1.0714 * (1 + (0.0135 * 90/360))) / (1 + (0.026 rate * 90/360))) - 1.0714

SWAP = - 0.0033

Forward rate = 1.0714 - 0.0033 = 1.0681

Alternative Method :

Lend   Borrow
     
EUR 3´000´000 Spot 1.0714 USD 3´214´200
90 days at 2.60 %   90 days at 1.35 %
Interest = EUR 19´500   Interest = USD 10´847.925
     
TOTAL EUR 3´019´500.--   TOTAL USD 3´225´047.925

Forward rate = 3´225´047.925 / 3´019´500.-- = 1.0681

Customer buys EUR 3 Mio against USD at 1.0681 at 3 month (1.0714 - 0.0033).









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