How does a FX Forward transaction work?

| 27-11-2017 | treasuryXL |

 

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FX Forward Contract

A Foreign Exchange Swap (also known as a FX Forward) is a two-legged transaction where one currency is sold or bought against another currency at a determined date, and then simultaneously bought or sold back against the other currency at a future date. Normally this means the first transaction would take place at the prevailing spot rate and settle on the spot date, whilst the forward transaction would prevail at an agreed forward rate and settle on the agreed forward date. The difference between the Spot price (or first price) and the Forward price (or second price) represents the FX Forward and is expressed as Swap points.

 

Read more about the types of Forward Contracts


What are Swap points?

Swap points represent the cost of borrowing one currency, whilst simultaneously lending another currency for a time period equal to the swap period. Swap points are therefore the cost of carry netted out between two currencies and used to adjust the existing Spot price to express the Forward price.

Worked example

Currency 1 ABC
Currency 2 XYZ
Period 6 months
Days in period 183
Interest rate 6 months ABC 4%
Interest rate 6 months XYZ  7%
Spot ABC/XYZ 2.1025

For ABC 1,000,000.00 there are XYZ 2,102,500.00

ABC 1,000,000.00 * (1+4/100*183/360)     = ABC 1,020,000.00
XYZ 2,102,500.00 * (1+7/100*183/360)      = XYZ 2,177,313.96

XYZ 2,177,313.96/ABC 1,020,333.33 = 2.1339

Swap points = +/+ 314 pips

What does this mean?

The Forward price of 2.1339 is higher than the Spot price of 2.1025 and means that the currency ABC trades at a forward premium to currency XYZ. Therefore, the Swap points of 314 pips are added to the current Spot price. A bank that is quoting would only quote the Swap points. A two-way quote would look something like 304/324. At 304 the bank would sell and buy ABC – spot against 6 months – against buying and selling XYZ. At 324 they would do the complete reverse.

So is the Forward price the same as a future?

No, the Forward price is not an attempt to determine the future value of currency ABC expressed in the price of currency XYZ. It is a price that is derived by notionally hedging the notional values of both currencies against their respective interest rates that are applicable at that moment in time. The Forward price is an example of interest rate parity – a state of non-arbitrage or equilibrium where traders are indifferent to either as there is no monetary advantage in either. Forwards are traded ‘Over the Counter’ and not via an exchange. Regardless of what the future value of spot ABC/XYZ is, once the trade has been executed there can only ever be opportunity loss or profit in the bookkeeping.

Variations

FX Forwards can also be forward starting – a client might wish to create/hedge an exposure starting in 4 months’ time and with a tenor of 6 months. This would be seen as a 6 month starting in 4 months’ time – or a 4m*10m. Such a Forward would be calculated from the present spot to both 4 months and 10 months, with the present Spot rate adjusted for the Forward price for 4 months to reflect the new starting price.

Alternatively, instead of swapping a position, a client might just wish to hedge their exposure/obligation in the future by trading ‘Outright’. If they were to buy ABC forward they would enter into a FX Swap (sell ABC at spot and buy forward) and then immediately buy ABC at spot, offsetting the spot leg of the FX Swap.

What moves the price?

Changes in the underlying interest rates of both currencies will affect the calculation. Also as the interest rate differential of the two currencies is expressed as a price of the existing spot rate, changes in the spot rate will also cause changes in the outcome of the calculation – though generally smaller than those caused by changes in interest rates.

Why trade FX Forwards?

FX Forwards allow a company to hedge future exposure/obligations. Once the contract has been struck that value is confirmed and is not subject to ‘mark-to-market’ variation orders as happens with an off-balance-sheet instrument. An exposure in one currency can be transformed into another currency via use of a FX Forward. An expected inflow or outflow that is delayed can be rolled forward by using a FX Forward.

Lionel Pavey

 

 

Lionel Pavey

Cash Management and Treasury Specialist

 

 

The treasurer plays with fire, when hedging foreign currencies to his sole gut feelings

| 24-11-2017 | Rob Beemster |

Hedging

 

The foreign exchange market is a highly volatile market and therefore full of surprises. For more than 20 years, I was a spot currency trader in the dealing room of a large international bank. One of the things I liked the most in being a trader was the unpredictability of the markets. Never a dull moment. The management of the bank gave us a lot of freedom, once you had proven the ability to handle this. But always we had to take care of some very important requirements, like the VAR (Value At Risk), and we had to protect our positions with stop-loss orders.

 

Executing a stop-loss was the worst part of my job. It proved that you had been wrong in judging a certain move of a currency. It sometimes felt like being a loser. However, executing at a stop-loss level gives you the freedom  to restart a new currency position.  We were never blamed by colleagues or the management for having executed a stop-loss. It was part of the risks, and by using a stop everyone knew that overall business would never be hurt.  If losses taken by stops were in line with the profits taken (relatively speaking) everything would be fine, considering that a good trader makes more positive decisions then negative ones.

Now let’s consider the controller who decides on his hedges, based on his gut feelings. Most probably this is based on old nonsensical ideas like, “what goes up must go down”, and, “It will come back to old levels”. Because of my business today, I speak with finance managers about their hedging strategies. Sometimes they make me feel embarrassed because of their self-created strategies; “I like to play foreign currency strategy myself”, or; “we have had good years and less good years”. From a business economic point of view this can be very painful. Volatility in foreign currencies is a very important component of international business. But one has to realize that this component can be managed. Companies should install a risk management procedure on their foreign currency exposure/obligations, to preserve their profit margins. A proper strategy not only protects the margins and cash flow but will also create prudency within the entire company.

A currency strategy is an implemented structure, necessary for the finance department. However, others that are responsible for the flows, like sales departments, procurement or production, should be involved and be aware of the importance of the strategy as well. Our models do describe the tasks of all the departments. A communication plan is part of the currency strategy. When the implemented processes are understood by everyone within the company, then and only then the strategy will work.

Our foreign currency risk models are very useful within international operating corporations.  We can help you to implement the processes that will secure cash flows. A controller, who makes decisions on FX out of the blue, is unacceptable and too dangerous for the continuity of the business, moreover, it is intolerable in modern finance departments.

Barcelona valuta experts can be of assistance to you. After precise research of the current status of your company we can implement the right models. And this will protect you against negative or unwelcome currency moves.

 

Rob Beemster

Owner of Barcelona valuta experts BV

The impact of blockchain technology on central counterparty clearing houses

| 23-11-2017 | Treasurer Development | Minor Treasury @ Hogeschool Utrecht | Frans Boumans |

Today’s blog has been written by Youri Toepoel, Romy Steegwijk & Dirk Heesakkers , who are 3 students studying for the minor Treasury Management at the University of Applied Sciences in Utrecht. We welcome their contribution – it is good to see the youth engaging in Treasury matters! Here is their opinion on Blockchain technology and its impact on central counterparty clearing houses.

A central counterparty clearing house can reduce counterparty risks associated with doing business with unfamiliar counterparties in unfamiliar markets. When businesses lack the capabilities, resources and expertise required to reduce counterparty risks, a central counterparty clearing house might be the solution. In recent years new disruptive technologies have been developed. Cryptocurrencies are becoming more known worldwide and the underlying technology, the blockchain, might be able to decentralize current services offered by financial institutions like banks.

Counterparty risk

Counterparty risk is the possibility that someone you do business with is unable to meet his/her obligations with you. Events during the recent credit crunch, particularly with Lehman Brothers, showed that banks and businesses had put too much trust in the credit ratings formed by the credit agencies. Corporates based creditworthiness of counterparties mainly, or even only, on the credit ratings given by credit rating agencies, expecting those ratings to be accurate and trustworthy. This has proven to be wrong and since the credit crunch many businesses started to measure and control counterparty risk based on other factors beside the credit rating received from the credit rating agencies (Treasury Today, 2014).

The counterparties

For the treasury function the counterparty risk is mainly associated with the banks and other financial institutions since these are the parties the treasury function is mostly dealing with. Additionally, also governments are important given they supply the “risk free” government bonds, but as seen with the government of Greece even governments show the ability to get into financial problems. The treasury function will often deal with these parties to attract or repel liquidity, derivatives or long-term loans to support the business’s day-to-day operations. In the end, exposure to suppliers and customers are also important to the counterparty risk.

Central Counterparty Clearing House (CCP)

A central counterparty clearing house (CCP) is an organisation that exists in various European countries to help facilitate trading done in European derivatives and equities markets. These clearing houses are often operated by the major banks in the country to provide efficiency and stability to the financial markets in which they operate. CCPs bear most of the credit risk of buyers and sellers when clearing and settling market transactions (Investopedia).

Blockchain versus central counterparty clearing house

A CCP offers a good solution to the counterparty risk that most companies face when doing business with counterparties. But this service, as it basically provides a settlement between two parties, might be a prey for decentralization by technology based on the Blockchain.

The Blockchain is often simply described as a distributed ledger and has the capability to replace services being provided by central service providers like banks. The unique part is the absence of a trusted third party (a bank that we visit or to which we log in with a key, an Amazon.com, eBay or whoever you know and trust…) (Servat, 2015).

Currently, the only obstacle seems to be regulation since the blockchain already shows numerous application possibilities. Lots of banks and other financial institutions are currently investing big money in the blockchain technology to find out in which way they can use it (or save themselves with?) (Scuffham, 2017).

Whether the blockchain totally replaces or gets integrated by financial institutions like the CCP, these innovations are surely interesting to follow and keep track of (Treasury Today, 2014).

Sources/bronnen/aanvullend

https://medium.com/@colin_/central-counterparties-ccps-in-decentralised-blockchains-f2cf671f5787

http://www.investopedia.com/terms/c/ccph.asp

http://treasurytoday.com/2016/05/blockchain-technology-ttqa

https://www.treasury-management.com/article/1/354/2920/blockchain-%96-disruption-or-hype-.html

http://treasurytoday.com/2017/09/the-rise-and-rise-of-blockchain-tttech

https://www.reuters.com/article/us-rbc-blockchain/exclusive-royal-bank-of-canada-using-blockchain-for-u-s-canada-payments-executive-idUSKCN1C237N

https://fd.nl/beurs/1222842/nieuwkomer-ripple-provoceert-betaalbedrijf-swift-op-eigen-terrein

Minor Treasury Management

More information about the minor Treasury Management at the University of Applied Sciences?
Please contact Frans Boumans.

 

Frans Boumans

Manager Minor Treasury Management @ University of Applied Sciences in Utrecht

 

 

 

TIS (Treasury Intelligence Solutions) at the DACT Treasury Fair

| 22-11-2017 | treasuryXL | TIS Treasury Intelligence Solutions |

The DACT (Dutch association of Corporate Treasurers) will be holding their annual Treasury Fair in Noordwijk at the Hotel van Orange on 23rd and 24th November 2017 – the most important annual treasury event in the Netherlands. Discover treasury best practices, learn about the latest trends and exchange experiences. It will contain 9 practical workshops spread out throughout the day on topics including, among others, trade finance, supply chain finance, liquidity forecasting, cyber security and the Blockchain. There are more than 50 exhibitors present at the Trade Fair including Treasury Intelligence Solutions GmbH- a partner of treasuryXL.

Company Profile

TIS is the leading cloud platform for managing corporate payments, liquidity and banking relationships worldwide. The company delivers SMART PAYMENTS to help customers make BETTER DECISIONS. TIS enable companies to make more efficient, more secure and more cost-effective payment transactions. In addition, TIS enables customers to make better decisions when analysing financial and operational performance based on real-time payment flows. All mission-critical processes related to payment transactions are integrated into a multibank-capable, audit-proof cloud platform. This is a single point of contact for enterprise customers when managing and analysing their payment flows across the organisation. TIS take care of managing various payment formats, communication channels with banks, and ERP-agnostic integration. Offered as Software as a Service (SaaS), the ISO certified TIS solutions are quickly up and running without the complexity and cost of a long IT project.

If you are at the Treasury Fair, please take your time to visit their stand and mention treasuryXL.

Last week TIS raised $12 million in additional financing from international VC firm 83North. Read more on their website

This is TIS’s own announcement on their website announcing their participation.

We wish TIS success at the DACT Treasury Fair!!

If you want to find out more about TIS and their services and products please refer to their company profile on treasuryXL.

Het Treasury statuut als beheersinstrument voor woningcorporaties

| 21-11-2017 | Roger Boxman |

Het onderstaande korte artikel gaat in op de eisen van het  Treasury statuut. In een Treasury statuut wordt aangegeven wat het doel van de Treasuryfunctie is van de organisatie en in welke producten mag worden belegd en op welke wijze op hoofdlijnen gelden worden aangetrokken. Na het Vestia debacle, waarbij derivaten speculatief werden ingezet, heeft de overheid de wetgeving aangescherpt voor woningcorporaties. Een van de eisen is dat woningcorporaties verplicht een Treasury statuut moeten opstellen.

Treasury Commissie

De Woningwet 2015 verplicht om woningcorporaties een Treasury statuut op te stellen.  In de sociale woningsector zijn de circa 2,4 miljoen sociale huurwoningen gefinancierd met  € 88 miljard.  Het  Treasurystatuut geeft aan wat de lange termijn richtlijnen zijn met betrekking tot de treasuryfunctie en wordt mimimaal om de drie jaar geactualiseerd. Er wordt een Treasury commissie ingesteld als adviesorgaan van het bestuur.  . Hier kunnen externe partijen van deel uit maken mits deze onafhankelijk zijn. De Treasurycommissie adviseert het bestuur gevraagd en ongevraagd over de uit te voeren transacties en overige treasuryvraagstukken. Het bestuur neemt deel aan de Treasurycommissie in de hoedanigheid van toehoorder.

Treasury jaarplan

Het treasuryjaarplan wordt afzonderlijk opgesteld en is een onderdeel van de (meerjaren)begroting. Dit plan bevat het beleid, de doelstellingen, het mandaat en de treasury taken voor het komende jaar, waarbij rekening wordt gehouden met het in het Treasury Statuut geformuleerde beleidskader en een risico beheersingsparagraaf. In het treasuryjaarplan worden o.a. de volgende zaken vastgelegd: liquiditeitsplanning, bestaande renterisico en de uit te voeren treasury activiteiten.

Risicomanagement

De belangrijkste risico’s die gemanaged worden zijn het beschikbaarheidsrisico, liquiditeitsrisico en renterisico en in mindere mate het tegenpartijrisico. Het Treasurystatuut bevat bepalingen over uitgezette gelden per tegenpartij met limieten. Veelal wordt voor het renterisico een maximum van 15% van de leningen aangegeven waarover een renteherziening worden toegepast.

Samenvatting

Bovenstaande is een summiere opsomming van alle eisen die aan een Treasury statuut bij een woningcorporatie gesteld worden. De wetgever heeft een model Treasurystatuut dat tientallen pagina’s beslaat. Belangrijk is te beseffen dat er beperkingen aan de Treasuryfunctie worden gesteld en dat er formeel een mandaat is vastgesteld waarbinnen de Treasurer dient te opereren en zich te verantwoorden.

Roger Boxman

Senior Advisor Internal Control

 

Treasury Services at the DACT Treasury Fair

| 20-11-2017 | treasuryXL | Treasury Services |

The DACT (Dutch association of Corporate Treasurers) will be holding their annual Treasury Fair in Noordwijk at the Hotel van Orange on 23rd and 24th November 2017 – the most important annual treasury event in the Netherlands. Discover treasury best practices, learn about the latest trends and exchange experiences. It will contain 9 practical workshops spread out throughout the day on topics including, among others, trade finance, supply chain finance, liquidity forecasting, cyber security and the Blockchain. There are more than 50 exhibitors present at the Trade Fair including Treasury Services- a partner of treasuryXL.

Company Profile

Treasury Services structurally improves the bottom line of its clients by cutting their costs and by improving their efficiency in finance. We create a competitive advantage for our clients by implementing innovative solutions. Treasury Services offers Treasury Consultancy & Advice, Treasury Management Software, Treasury Training & Education and Financial Engineering Solutions. With these building blocks we can create complete solutions in Treasury Management, Cash Management, Risk Management, Corporate Finance and Treasury Control. Treasury Services has an international portfolio of corporates, financial institutions and non-profit organisations as clients.

Treasury Services recently strengthened its FX Risk Management Advisory services by entering into a partnership with Rob Beemster of Barcelona Currency Experts. (See Press release). Rob will also be present personally during the DACT Treasury Fair.

For the DACT Treasury Fair we have developed an FX Quick Scan which gives interested companies an immediate insight into their FX situation. As a result of this “few minutes” survey, companies can decide to make an appointment with Treasury Services for a more in-depth discussion / analysis of the FX situation of their company. Read more on their website.

If you are at the Treasury Fair, please take your time to visit their stand and mention treasuryXL.

We wish Treasury Services success at the DACT Treasury Fair!!

If you want to find out more about Treasury Services and their services and products please refer to their company profile on treasuryXL.

How does liquidity forecasting accelerate growth: Cashforce @ DACT Treasury Fair

| 17-11-2017 | treasuryXL | Cashforce |

DACTThe DACT (Dutch association of Corporate Treasurers) will be holding their annual Treasury Fair in Noordwijk at the Hotel van Orange on 23rd and 24th November 2017 – the most important annual treasury event in the Netherlands. Discover treasury best practices, learn about the latest trends and exchange experiences. It will contain 9 practical workshops throughout the day on topics including,  trade finance, supply chain finance, liquidity forecasting, cyber security and the Blockchain. There are more than 50 exhibitors present at the Trade Fair including Cashforce – a partner of treasuryXL, who are also presenting a Workshop.

Company Profile

Cashforce is an innovative Cash & Treasury Management System, focused on automation and integration. As a ‘next-generation’ Cash management solution, Cashforce helps finance/treasury departments save time and money by offering accurate cash flow forecasting, flexible treasury reporting & automation.Cashforce is unique in its category, because it allows users to drill down to the transaction level details and the system integrates seamlessly with ERP systems & banking systems. In addition, an intelligent simulation engine enables companies to consider multiple cash flow scenarios and measure their impact. As a result, finance / treasury departments can be turned into business catalysts for cash generation opportunities throughout the company.

Workshop

Cashforce will be co-presenting a Workshop at 13:45, entitled How does Liquidity forecasting accelerate growth and what’s the role of the treasurer

The 2017 Global Treasury Benchmark Survey from PwC shows that companies worldwide hold a staggering $ 1.1 trillion (!) of excess liquidity in their business operations. These hidden liquidities can be tracked by an accurate and automated cash management and forecasting process. These can then be used to lower the company’s working capital or to realise additional growth.

Setting up an automated cash management & forecasting process has at last been made possible as a result of technological progress. Currently, 87% of treasurers still use manual spreadsheets. However, this process can be organised much more efficiently.

To demonstrate how this can be achieved, this workshop sets out the challenges of accurate cash flow forecasting, supported by a case study presented by the Interfood Group.

With $ 1.4 billion in annual revenue, Interfood is one of the leading global dairy traders and suppliers. Through 15 global offices worldwide, Interfood distributes over 800,000 MT of dairy products a year. Together with Cashforce, Interfood has set up an automated cash forecasting process. The case will be presented by Vincent Almering (Finance Director Interfood B.V.). Vincent has led the project from start to finish and acts as the key lynchpin for the different users (Traders / Treasury / Finance / CFO). Vincent will share the challenges and benefits of cash flow forecasting as well as his experiences. Finally, there will be a discussion on the main lessons learned, aimed at treasurers who are looking for a solution for an automated and accurate cash forecasting process.

Speakers: Vincent Almering, Financial Director Interfood B.V. – Nicolas Christiaen, CEO Cashforce. Moderator: Martijn Duijnstee, Manager Business Development Cashforce NL

Language: Dutch

If you are at the Treasury Fair, please take your time to visit their stand and mention treasuryXL.

We wish Cashforce success at the DACT Treasury Fair!!

If you want to find out more about Cashforce and their services and products please refer to their company profile on treasuryXL.

Surveys Treasury Training & Education + “Post HBO Leergang Treasury Management”

| 16-11-2017 | Treasurer Development |

Both from student perspective as well as from educators we receive signals they want to invest in training and education. Some articles have been written about what is out there (read article 1 and article 2), nothing comprehensive as far as we can oversee. In order to help both parties make a proper match we think two surveys are in place. 

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Survey – Treasury Training & Education

In this survey we want to focus on what is essential for potential students. What content, investment in time & money, with or without degree, etcetera? Do students need the education to do a proper treasury job, to improve their labour market position or do they have other reasons?

[button url=”https://nl.surveymonkey.com/r/6YY58V8″ text=”Complete the survey” size=”small” type=”primary” icon=”” external=”1″]

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Vragenlijst – “Post HBO Leergang Treasury Management” (in Dutch)

De Hogeschool Utrecht is bezig met de ontwikkeling van de Post HBO leergang Treasury Management en stelt een aantal vragen over de praktische opzet van het aanbod, zodat ze het toekomstige aanbod zoveel mogelijk op uw behoeften of die van uw collega kan toespitsen.

[button url=”https://nl.surveymonkey.com/r/6YMWL9P” text=”Vul de vragenlijst in” size=”small” type=”primary” icon=”” external=”1″]

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These questionnaires are a cooperation between treasuryXL, Hogeschool Utrecht, Vrije Universiteit and Treasurer Search. We appreciate your input and will post the results in December 2017.

Thank you for your input.

Due to the improved economy and other factors we notice a rising interest in the development of the treasurer as a person. Education, competence development and labour market changes are the most obvious topics this concerning. This is why we started the Treasurer Development initiative. 

Read more about the Treasurer Development Initiative

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Tipco at the DACT Treasury Fair

| 15-11-2017 | treasuryXL | TIPCO Treasury Technology GmbH |

The DACT (Dutch association of Corporate Treasurers) will be holding their annual Treasury Fair in Noordwijk at the Hotel van Orange on 23rd and 24th November 2017 – the most important annual treasury event in the Netherlands. Discover treasury best practices, learn about the latest trends and exchange experiences. It will contain 9 practical workshops spread out throughout the day on topics including, among others, trade finance, supply chain finance, liquidity forecasting, cyber security and the Blockchain. There are more than 50 exhibitors present at the Trade Fair including Tipco Treasury & Technology GmbH- a partner of treasuryXL.

Company Profile

Treasury Reporting at the push of a button! TIPCO is the leading expert for treasury reporting in Germany, Switzerland and Austria. We develop customised solutions for our clients that are fast, flexible and easy to use. Our software TIP is a web-based application containing a diverse range of modules to support everyday reporting needs: Banking Account Administration, Financial Status, Liquidity Planning, Risk Management, Bank Fee Controlling, Compliance & Reporting and our Survey Tool.

With these modules, our clients can overcome problems created by heterogeneous system landscapes and find an easy way to communicate with their subsidiaries. Furthermore TIP is able to use existing data and avoids manual data input where it is not necessary. Huge amounts of data can be interpreted in seconds and reports are available by the push of a button. As a spin-off of the Austrian treasury consulting firm Schwabe, Ley & Greiner TIPCO unites treasury expertise with business intelligence competence.

Due to this unique combination, we are able to realise our projects with a holistic view and to the complete satisfaction of our clients.

If you are at the Treasury Fair, please take your time to visit their stand and mention treasuryXL.

This is Tipco’s own message via LinkedIn announcing their participation.

We wish Tipco success at the DACT Treasury Fair!!

If you want to find out more about TIPCO and their services and products please refer to their company profile on treasuryXL.

How does a FX spot transaction work?

| 14-11-2017 | treasuryXL |

Every day we enter into transactions in our own domestic market. Goods are priced in our own currency and we settle purchases in our own currency. Here in the Netherlands that means everything is priced and settled in Euro’s. It is a clear and concise system – of course we might argue about the price of goods, but that is another matter. Now consider what happens when we sell our goods to a counterparty domiciled in a different country – we shall assume from the United States. We would prefer to invoice in EUR as this is our domestic currency, whilst our counterparty would prefer to settle in USD. This makes sense as in both instances neither of us would be exposed to fluctuations in the exchange rate between the EUR and USD.

There are 3 basic choices to trade with a foreign based counterparty:

  • Price in our currency, but run the risk that they will not trade with us
  • Price in their currency, win the trade but do nothing about the risk
  • Price in their currency, but adjust our price for the perceived FX risk and sell their currency for our currency as soon as the deal is closed

As we are keen to expand our export markets we agree to charging the buyer in USD, but what price should we charge in USD? By accepting payment in USD we are now assuming a foreign exchange risk as the value of the USD could fall in relationship to the EUR before we have sold the USD for EUR. If the fall was large it could take away all our profit from the original transaction, possibly even leading to a loss on the order.

We must therefore enter into a transaction to sell USD and to receive EUR to book our profit and to neutralize the FX risk. This leads us into the world of Foreign Exchange (FX) trading.

In FX trading quotations are always shown for a pair of currencies such as EUR/USD – but what does this mean?

  • The first currency – EUR – is called the base currency
  • The second currency – USD – is called the quoted currency
  • The spot rate is shown as 1.1595
  • This means that every unit of the base currency is equal to 1.1595 units of the quoted currency

If our order was for EUR 100.000,00 then the USD equivalent would be USD 115.950,00

In this example it is the USD price that fluctuates as it is the quoted currency, but this does not mean that fluctuations are only caused by changes in the value of USD. The value can also fluctuate because of changes in the value of EUR – even though this is the base currency.

Most major currency pairs are quoted to 4 decimal places – with the 3rd and 4th places being called “pips”. Pips are the expression traders use to describe their profit or their market spread.

If we traded EUR 1 million into USD, we would have an equivalent of USD 1.159.500,00

The value of 1 “pip” would be USD 100,00

When we approach a bank for a quotation in spot EUR/USD, the bank quotes a 2-way price such as 1.1592/97

The lower price – 1.1592 – represents the bank’s bid price. This is the price at which the bank buys EUR and sells USD.

The higher price – 1.1597 – represents the bank’s offer price. This is the price that at which the bank sells EUR and buys USD.

If the bank quoted this price into the market and one clients hit the bid at 1.1592 and another took the offer at 1.1597, both in EUR 1 million, then the bank would book a profit of USD 500,00 – or a profit of 5 pips on EUR 1 million.

FX is one of the largest markets in the world – daily turnover exceeds USD 5 trillion per day. That means 5 followed by 12 zeros – every working day.

With such a large daily turnover, prices are constantly changing. The market consists of price makers (who make the prices), price takers (who take the prices), intermediaries like brokers who assist the market by transmitting the prices and placing orders, and clients who place orders at specific levels. Prices are only valid for a few seconds before they change either because the market has traded on the quoted price or a new order replaces the existing price.

When you trade on the quoted price then you have entered into a binding contract with the counterparty. Settlement is normally 2 working days after the trade date. If you sell USD then you must ensure your counterparty receives the agreed USD amount on their account in 2 working days, and you receive the agreed EUR amount on your account in 2 working days.

Trade settlement is very important and means that you must have a complete operational procedure in placing to effect settlement, establish positions, agree counterparties, have trading limits etc.

Traditionally spot FX trades were done with banks. Now trades can also be transacted via electronic exchanges, electronic brokers etc. It is always important to know who your counterparty is – it could be that your internal operational control prohibits you from trading with specific counterparties.

Most major currencies can be traded against each other without restrictions such as exchange control. Therefore, currency pairings can be found everywhere such as USD/JPY and EUR/GBP and ZAR/CHF.

Spot FX transactions are not traded on listed exchanges; these trades occur “over the counter” with a clearly identifiable counterparty.

 

Lionel Pavey

 

 

Lionel Pavey

Cash Management and Treasury Specialist