CHAPTER 2

THE FOREIGN EXCHANGE MARKET

Too many of us look upon Americans as dollar chasers. This is a cruel libel, even if it is
reiterated thoughtlessly by the Americans themselves Albert Einstein.
Chapter Learning Objectives:

To explain the distinctive characteristics of foreign exchange market.

To distinguish between different methods of foreign exchange quotation and convert from
one method to another.
To identify the major participants in the Foreign Exchange Market.
To identify profitable currency arbitrage opportunities and calculate the profits that could be
made through currency arbitrage.
To understand the Purposes of Foreign Exchange Trading.
To describe various types of transactions take place in the spot and forward market.
To explain how forward contracts can be used to minimize risk and who are the major users
of forward contracts and their motives.
To understand the historical exchange value of Bangladeshi taka and Forex dealing entity in
Bangladesh (BAFEDA).
To understand the importance of Asian Clearing Union (ACU) in foreign exchange market.

THE FOREIGN EXCHANGE MARKET- DEFINITION

As defined in The Economist's Guide to Financial Markets, foreign exchange, more popularly
referred to as FX or FOREX" is a worldwide decentralized over-the-counter financial
market for the trading of currencies, wherein financial centers around the globe serves as anchors
of trading between a wide range of different types of buyers and sellers 24 hours a day, five days
a week. So the foreign exchange market is a market where foreign currencies are bought and
sold. If a Bangladeshi firm imports Apple computer from USA then he/she would have to pay in
US Dollars. So he/she will have to come to foreign exchange market to buy dollars in exchange
of Bangladeshi taka. On the other hand, a RMG exporter would have to convert foreign currency
to Bangladeshi taka and for that he/she would have to approach foreign exchange market as well.
Virtually every country, with some small exceptions, has its own currency, and most of them can
be traded. However, the currencies of a few countries are the most actively traded, and constitute,
by far, the largest volume of trades. The big 5 are the United States dollar (USD), Euro (EUR),
Japanese yen (JPY), the British pound (GBP), and the Swiss franc (CHF).
Each currency is symbolized using 3-letter ISO (International Organization for Standardization)
codes: the 1st 2 letters designate the country, the 3rd designates the currency. The most famous
illustration of this is for the United States dollarUSD. However, sometimes the country name
or currency that is symbolized is not the most common name. Thus, the symbol for the Swiss
franc is CHF, where CH stands for Confederation Helvetica, which refers to Switzerland, and
MXN stands for the Mexican Nuevo Peso, even though the most common name for Mexicos
currency is simply the peso.
The foreign exchange market is the generic term for the worldwide institutions that exist to
exchange or trade the currencies of different countries. It is loosely organized in two tiers: the

retail tier and the wholesale tier. The retail tier is where the small agents buy and sell foreign
exchange. The wholesale tier is an informal, geographically dispersed, network of about 2,000
banks and currency brokerage firms that deal with each other and with large corporations. The
foreign exchange market is open 24 hours a day, split over three time zones. Foreign exchange
trading begins each day in Sydney, and moves around the world as the business day begins in
each financial center, first to Tokyo, London and New York. Computer screens, around the
world, continuously show exchange rate prices. A trader enters a price for the USD/EUR
exchange rate on her machine, and can then receive messages from anywhere in the world from
people willing to meet that price. It does not matter to her whether the counterparties are sitting
in London, Singapore, or, in theory, Dhaka. The foreign exchange market has no physical venue
where traders meet to deal in currencies. When the financial press and economic textbooks talk
about the foreign exchange market they refer to the wholesale tier. In this chapter we will follow
this convention.
Currency markets are the largest of all financial markets in the world. A typical transaction in
USD is about 10 million. In the last triennial survey conducted by the Bank of International
Settlements (BIS) in April 2010, it was estimated that the average daily volume of trading on the
foreign exchange market spot, forward, and swapwas close to USD 3.98 trillion. It is a 20%
increase, compared to April 2007. The daily average volume is about ten times the daily volume
of the entire worlds equity markets and sixty times the U.S. daily GDP. The exchange market's
daily turnover is also equal to 40% of the combined reserves of all central banks of IMF member
states.
In April 2010, the major markets were London, with 32% of the daily volume, New York (17%),
Tokyo (6.3%), Zurich (6.1%), and Singapore (5.8%). Frankfurt, Paris, and Hong Kong are small
players. The top traded currency was the USD, which was involved in 85% of transactions. It
was followed by the EUR (39%), the JPY (19%), and the GBP (12%). The USD/EUR was by far
the most traded currency pair in 2010 and captured 28% of global turnover, followed by
USD/JPY with 14% and USD/GBP with 9%. Trading in local currencies in emerging markets
captured about 20% of foreign exchange activity in 2010.
Given the international nature of the market, the majority (57%) of all foreign exchange
transactions involves cross-border counterparties. This highlights one of the main concerns in the
foreign exchange market: counterparty risk. A good settlement and clearing system is clearly
needed.
SETTLEMENTS OF TRANSACTIONS
At the wholesale tier, no real money changes hands. There are no messengers flying around the
world with bags full of cash. All transactions are done electronically using an international
clearing system. SWIFT (Society for Worldwide Interbank Financial Telecommunication)
operates the primary clearing system for international transactions. The headquarters of SWIFT
is located in Brussels, Belgium. SWIFT has global routing computers located in Brussels,
Amsterdam, and Culpeper, Virginia, USA. The electronic transfer system works in a very simple
way. Two banks involved in a foreign currency transaction will simply transfer bank deposits
through SWIFT to settle a transaction.
For example, Suppose Citibank, an American private bank sells Swiss francs (CHF) to Bank of
India, an Indian private bank, for Japanese yens (JPY). A transfer of bank deposits will settle this
transaction. Citibank will turn over to Bank of India a CHF deposit at a bank in Switzerland,

while Bank of India will turn over to Citibank a JPY deposit at a bank in Japan. The SWIFT
messaging system will handle confirmation of trade details and payment instructions to the banks
in Switzerland and Japan. Citibank will have a bank account in Japan, in which it holds JPY, and
Bank of India will have a bank account in Switzerland, in which it holds CHF.
The foreign accounts used to settle international payments can be held by foreign branches of the
same bank, or in an account with a correspondent bank. A correspondent bank relationship is
established when two banks maintain a correspondent bank account with one another. The
majority of the large banks in the world have a correspondent relationship with other banks in all
the major financial centers in which they do not have their own banking operation. For example,
a large bank in Tokyo will have a correspondent bank account in a Malayan bank, and the
Malayan bank will maintain one with the Tokyo bank. The correspondent accounts are also
called nostro accounts or due from accounts. They work like current (checking) accounts. The
foreign exchange market is largely an unregulated market. Only exchange-traded derivative
contracts are subject to formal regulation. Banks in Bangladesh participating in the spot market
are supervised by Bangladesh Bank and must report their foreign exchange position on a periodic
basis.
ELECTRONIC BROKERAGE SYSTEMS
In 1992, Reuters introduced an automated, electronic brokerage system, Reuters Dealing 2000-2.
The Reuters system allows dealers to enter their live prices. Prices appear on a screen as
anonymous live quotations. Traders from around the world can hit a price from their terminals,
and then Reuters 2000 checks for mutual credit availability between the two counterparties and
completes the transaction with ticket writing and confirmations. Since the introduction of
Reuters 2000, other competing systems were developed. The main competitors of Reuters 2000
are MINEX, developed by Japanese banks and Dow Jones Telerate, and Electronic Brokering
Service (EBS), developed by Quotron and a consortium of U.S. and European banks. Today, the
main electronic platform is EBS, followed closely by Reuters Dealing Electronic trading offers
greater transparency compared to the traditional means of dealing described above. Spot foreign
exchange markets have been traditionally opaque, given the difficulty of disseminating
information in the absence of centralized exchanges. Before the introduction of electronic
trading, dealers had to enter into a number of transactions just to obtain information on prices
available in the market. Traders using an electronic brokerage system are able to know instantly
the best price available in the market.
The increasing appeal of electronic brokerage system shows up in the BIS triennial reports.
According to the BIS, in 2010, the share of electronic trading in the spot foreign exchange
market was close to 60%. Historically, the share of electronic trading went from 2% in 1993 to
almost 50% in 1998. For certain market segments, such as those involving the major currencies,
electronic brokers reportedly covered 90% of the interbank market. The bid-ask spreads for the
major currencies have fallen to about two to three hundredths of a US cent.
While electronic trading has come to dominate the inter-dealer market, systems have made
far less impact on the business of large corporate customers. This may be changing,
however, as several internet-based systems aimed at this area are being rolled out. These
systems promise more flexibility (e.g. tailored quantities and currency pairs available) and
use the internets ability to connect distant parties at low cost. The largest are two
multibank systems (FXall and LavaFx, which has been acquired by FXall in 2010)

automating the process of customers obtaining a range of executable quotes from member
banks.
MAJOR PARTICIPANTS IN THE FOREX
There are several types of market participants that engage in forex transactions to hedge risk, to
speculate for profits, or to facilitate business and other transactions like tourism.
1. Banks and other financial institutions are the largest volume traders, where roughly 2/3 of all
FX transactions involve banks trading directly with each other.
2. Brokers sometimes act as intermediaries between banks. Brokers with more extensive
contacts can often find better exchange rates for the banks than they could find themselves,
and they also offer anonymity to banks seeking to buy or sell large amounts of currency.
3. Business customers require foreign currency to transact foreign business or to make
investments. Multinational Companies with large foreign exchange requirements even have
their own trading desks.
4. Institutional investors, such as pension funds, hedge funds, mutual funds, and insurance
companies engage in forex trading to either hedge risk or to speculate for profits.
5. Retail customers need foreign currency to travel abroad or to make online purchases from
foreign-based companies. Some retail customers also engage in forex trading, using their
own computers or even mobile devices, in the hope of earning profits.
6. And, what are called foreign exchange interventions, central banks, which act either on
behalf of their own or foreign governments, sometimes participate in the FX market to offset
the influence of short-term shocks that can sometimes cause temporary large movements in
the exchange rate of some currencies.
PURPOSE OF FOREIGN EXCHANGE TRADING
The primary purpose of the foreign exchange market is to facilitate international trade, tourism
and international investment. Foreign exchange market permits transfer of purchasing power
denominated in one currency to another that is, to trade one currency for another currency.
The foreign exchange market is the most liquid market in the world. Since Forex Dealers are
spread all over the world, it is virtually open 24/7 because of different time zone. Forex traders
include large multinational banks, central banks, institutional investors, currency speculators,
multinational corporations, governments, other financial investors, and retail investors. The daily
turnover in the global foreign exchange market is around US$3.98 trillion in April 2010. Of this
US$3.98 trillion, almost $1.5 trillion was spot foreign exchange transactions and $2.5 trillion
was traded in outright forwards, FX swaps and other currency derivatives. Trading in the UK
accounted for 32% of the total, making it by far the most important global center for foreign
exchange trading. USA and Japan ranked second and third respectively which accounted for 16%
and 9%. Most developed countries permit the trading of FX derivative products (like currency
futures and options on currency futures) on their exchanges. All these developed countries
already have fully convertible capital accounts. A number of emerging countries do not permit
FX derivative products on their exchanges in view of controls on the capital accounts. The use of
foreign exchange derivatives is growing in many emerging economies. Countries such as Korea,
South Africa, and India have established currency futures exchanges, despite having some
controls on the capital account. In Bangladesh, we dont have the permission of trading currency
derivative but international traders can lock a forward exchange rate with some of the
commercial banks.

Figure: 2.1
As from the above pie chart, we can see London (UK) is the city that dominates the global forex
trading. USA has a leading market share basically to all of the asset markets but due to time zone
advantage London is the hub for forex dealers. So when it is 9 A.M in New York City it is 2 P.M
in London and 6 P.M in Dubai. So London can serve both American and Asian currency traders
along with Europe. Of course, U.S Dollar is still used as the principle currency worldwide as a
means of foreign exchange. Most commodity values (i.e. gold, crude oil, wheat, soya beans) are
quoted in dollar terms. After the U.S Dollar, it is the Euro which got increased popularity even
though at this point of time it is bit under attack due to the threat of some big European
economies recession like Greece and Spain. Other than the USD and EURO, other currencies
that dominate the Forex market are GBP, JPY, CAD, AUD, and CHF. As a currency pair
USD/EUR is the most popular one in the forex market.

Figure 2.2
When currency is exchanged to conduct business, to invest in foreign countries, or to hedge risk,
the primary concern of the forex participants is not the short-term movements in exchange rates
but to conduct business with a minimal exchange risk. Speculators, on the other hand, hope to
profit from short-term movements in the exchange rates by either buying low or selling high or
by selling short and buying long, usually over a period of minutes, hours, or sometimes days.
However, it is difficult to make profit by speculating in foreign transactions, since short-term
movements are governed by the instantaneous supply and demand of any currency, which cannot
be predicted by any single trader. Traders attempt to forecast currency movements by using
either fundamental analysis or technical analysis which we will study further in Chapter 7.
CURRENCY TRADING BETWEEN BANKS
Banks, who are the largest forex participants by volume, either trade with each other directly or
use the services of a broker. Direct transactions account for 2/3 of forex trades between banks,
while brokers mediate the remaining 1/3, charging a commission on the transaction. A bank that
wishes to buy or sell currency directly will offer bid/ask prices bid prices are the prices that the
bank is willing to pay for a currency and ask prices are the prices that the bank is willing to sell.
The dealing bank profits by the spread between the bid and the ask price.
The size of the spread depends on how frequently the currencies are traded. Hard currencies,
such as the US dollar, Euro, Japanese yen, and British pound, constitute about 80% of the FX
market, and thus, the spread between these currency pairs is usually quite narrow, often less than
4 pips. (1 pip = 1/10,000th of a currency unit for most currencies.) Soft currencies, such as those
of less developed economies, are traded less frequently, which increases their spreads. In
Bangladesh we can see a lower spread between USD and BDT but a bit higher spread between
GBP and BDT and much higher on Swiss Franc CHF and BDT.
Currency Abbreviations,

Symbols, Characters, and exchange rate against BDT per unit

Country

Name

Symbol

Bangladesh

Taka

BDT

United States
United Kingdom
European Monetary Union
Japan
Canada
Australia
New Zealand
Vietnam
Turkey
Norway
Denmark
Sweden
Brazil
Thailand
S. Korea

Dollar
Pound
Euro
Yen

USD
GBP
EUR
JPY
Dollar

Dollar
Dollar
Dong
New Lira
Krone
Krone
Krona
Curziero
Baht
Won

Character

1
$

CAD

AUD
NZD
VND
TRY
NOK
DKK
SEK
BRL
THB
KRW

Exchange rate*

82.05
129.88
108.04
0.98
C$

A$
NZ$

NKr
DKr
SKr

82.65
86.87
67.64
0.00394
45.66
14.31
14.53
12.16
45.55
2.67
0.07

South Africa
Nigeria
Costa Rica
India
Mexico
Saudi Arabia
Malaysia
Pakistan
Sri Lanka
Afghanistan
Myanmar
Nepal
Maldives
Libya

Rand
Naira
Colon
Rupee
Peso
Riyal
Ringgit
Rupee
Rupee
Afgani
Kyat
Rupee
Rufiyaa
Dinar

ZAR
NGN
CRC
INR
MXN
SAR
MYR
PKR
LKR
AFN
MMK
NPR
MVR
LYD

$
SR
RM
Rs

Afs
K

Rf
LD

10.83
0.52
0.16
1.63
6.47
21.86
26.82
0.90
0.65
1.580091
12.55
1.02
5.34
65.0178

Iran
Iraq
Bhutan
Singapore
Bahrain
Egypt
Kuwait
Switzerland

Rial
Dinar
Ngultrum
Dollar
Dinar
Pound
Dinar
Swiss Franc

IRR
IQD
BTN

SGD
$
BHD
EGP
KWD
SFR or CHF SFr

0.0067
0.0704
1.6537
65.18
217.48
13.58
293.68
89.48

Cuba

Peso

CUO

81.775

Uzbekistan

UZS

SOM

0.043979

Philippines
China*

Peso
Yuan

PHP
CNY

1.9048
12.8736

* Exchange rate against Bangladeshi taka is quoted from interbank rate on 17th March, 2012
rate.
* The distinction between Yuan and Renminbi (RMB) is analogous to that between the pound
and sterling; the pound (Yuan) is the unit of account while sterling (Renminbi) is the actual
currency.
* The amount shown in the above quoted Exchange rates 5th column are that amount of
Bangladeshi Taka will buy one unit of that foreign quoted currency on that 17th March, 2012.
TYPES OF FX TRANSACTIONS
There are several types of FX transactions: spot transactions, forward transactions, swaps,
futures, and options. Other than spot transactions, the remaining types of FX transactions span
over a period of time. These types of transactions can help to prevent or hedge FX risks that may
result from changes in the exchange rate. From the below pie-chart 2.3 we can see 54%
Transactions take place on Foreign Exchange Swaps, 32% on Spot Transactions, 11% on
Outright Forwards, and 3% on Estimated Gaps in.

Figure 2.3
SPOT MARKET
The foreign exchange market is classified either as spot market or as forward market. It is the
timing of actual delivery of foreign exchange that separates spot market from the forward
market. In the spot market transactions, it does require immediate delivery (normally 1-2
business days) of the traded currency whereas in the forward market, currencies are delivered at
a future date. Spot trade represents a direct exchange between two currencies, has the shortest
time frame, involves cash rather than a contract; and interest is not included in the agreed-upon
transaction. In view of the huge amounts involved in the transactions, there is seldom any actual
movement of currencies. Rather, debit and credit entries are made in the bank accounts of the
seller and the buyer. Most of the markets effect the transfer of funds electronically thus saving
time and energy. In Bangladesh, we have a very strict regulation in dealing with foreign currency
trade. In the later part of this chapter we will get to know the legal authority BAFEDA who are
authorized dealers in dealing with foreign currency in Bangladesh. It is very important to
understand foreign currency quotes since it could be very confusing at times. Sometimes we may
travel to a new country where you are not familiar about the exchange value of our taka with
their currency but most likely that alien countrys FOREX trader can quote you an exchange
value between US$ and their currency and thus it would be easier for you to figure out the
exchange value of our taka with that countrys currency using USD as common currency.
FORWARD MARKET
A forward contract in the forex market locks in the price at which an entity can buy or sell a
currency on a future date. Also known as "outright forward currency transaction", "forward
outright" or "FX forward".
In currency forward contracts, the contract holders are obligated to buy or sell the currency at a
specified price, at a specified quantity and on a specified future date. These contracts cannot be
transferred.

Forward currency markets have a very old history. In the medieval European fairs, traders
routinely wrote forward currency contracts. A forward transaction is simple. It is similar to a spot
transaction, but the settlement date is deferred much further into the future. No cash moves on
either side until that settlement date. That is, the forward currency market involves contracting
today for the future purchase or sale of foreign currency. Forward currency transactions are
indicated on dealing room screens for intervals of one, two, three and twelve month settlements.
Most bankers today quote rates up to ten years forward for the most traded currencies. Forward
contracts are tailor-made to meet the needs of bank customers. Therefore, if one customer wants
a 63-day forward contract a bank will offer it. Nonstandard contracts, however, can be more
expensive. A more elaborated discussion of forward and future currency market will be discussed
further in Currency Derivatives Chapter 6.
Forward quotes are given by "forward points." The points corresponding to a 180-day forward
GBP might be quoted as .0100-.0108. These points can also be quoted as 8-100. The first number
represents the points to be added to the second number to form the ask small figure, while the
second number represents the small figure to be added to the bid's big figure. These points are
added from the spot bid-ask spread to obtain the forward price if the first number in the forward
point "pair" is smaller than the second number. The forward points are subtracted from the spot
bid-ask spread to obtain the forward price, if the first number is higher than the second number.
The combination of the forward points and the spot bid-ask rate is called the "outright price."
Suppose St=1.5670-1.5677 USD/GBP. We want to calculate the outright price.
(A) Addition
The 180-days forward points are .0100-.0108 (8-100), then Ft, 180 = 1.5770-1.5785 USD/GBP.
(B) Subtraction
The 180-days forward points are .0072-.0068 (68-4), then Ft, 180 = 1.5602-1.5605 USD/GBP.
Forward contracts allow firms and investors to transfer the risk inherent in every international
transaction. Suppose a U.S. investor holds British bonds worth GBP 1,000,000. This investor
believes the GBP will depreciate against the USD, in the next 90 days. This U.S. investor can
buy a 90-day GBP forward contract to transfer the currency risk of her British bond position.
A forward transaction can be classified into two classes: outright and swap. An outright forward
transaction is an uncovered speculative position in a currency, even though it might be part of a
currency hedge to the other side of the transaction. A foreign exchange swap transaction helps to
reduce the exposure in a forward trade. A swap transaction is the simultaneous sale (or purchase)
of spot foreign exchange against a forward purchase (or sale) of approximately an equal amount
of the foreign currency.
In 2010, the daily volume of outright forward contracts amounted to USD 475 billion, or 12% of
the total volume of the foreign exchange market. Unlike the spot market, 35% of transactions
involved a non-financial customer. These non-financial customers typically use forward contracts
to manage currency risk. The majority of the forward contracts had very short maturities: 51% of
the contracts had a maturity of up to 7 days. Less than 4% of the forward contracts had a
maturity of over one year.
In the foreign exchange market sometimes it gets confusing how to translate a quote since there
are different types of foreign exchange quotes and understanding how to read foreign exchange
quotes is crucial not only for a successful currency trader but also to have a clear idea about the

real valuation of a currency. Most confusion arises out of direct and indirect quotations which
could be pretty confusing if you are not familiar with the currency.
Here are different types of foreign exchange quote:
Foreign Exchange Quotes

Indirect rate

Direct rate

Single Quote

Cross rate

Two-way Quote

Spot rate

Interbank rate

TT rate

Forward rate

Bill rate

Source: Based on description of foreign exchange markets by Jeevanandam (1999), Foreign

exchange and risk management, Sultan Chand and Sons.
In Bangladesh, direct quote is showing where the BDT (Bangladeshi Taka) is shown per unit of
foreign currency. For example, 83.5 BDT per dollar or 105.5 BDT per euro. Buying and selling
rates are quoted separately. There are different rates prevailing in the Bangladesh foreign
exchange market. For example, government banks and private banks have separate buying and
selling rate due to different bid-ask spread. Of course, the U.S Dollar bid-ask has the lowest
spread percentage compare to any other foreign currency in Bangladesh. Interbank rate has lower
percentage spread whereas TT or Telegraph transfer is normally applicable to inward
remittances. Suppose, a Bangladeshi exporter gets a bank draft issued by a bank based in Los
Angeles, USA on a bank based in Dhaka. The Dhaka based bank, on the presentation of draft by
the Bangladeshi exporter, will buy the U.S dollar at the TT buying rate which is fixed after
deducting exchange margin on account of bank charges from the interbank bid rate. If the
interbank bid rate is BDT 80/US$ and the exchange margin is 2 percent, the TT buying rate
would be BDT 80 (1-0.02) = 78.40 BDT per dollar.
The TT selling rate is applicable when the bank is selling a foreign currency draft. Suppose a
Bangladeshi importer asks Dhaka Bank to issue a draft in favour of Citi bank, NA. Dhaka bank
will charge TT selling rate in BDT. The rate is equal to the interbank selling rate plus the
exchange margin. If the interbank selling rate is BDT 80.50/US$ and the exchange margin is 2%,
then TT selling rate will be BDT 80.5(1+0.02) = 82.11 BDT per dollar.

There are also bill buying and bill selling rates. Suppose a Bangladeshi exporter draws a bill on a
U.S importer in New York, a Dhaka based bank may collect the amount from the US based
importer. The rate will be equal to TT buying rate minus the additional margin.
CURRENCY QUOTES
One of the purposes of money is as a convenient form of barter. Money is desired not so much
for the thing itself, but what it can be exchanged for. Thus, in virtually every transaction, money
constitutes one side of the transaction. Thus, money is exchanged for a car, for groceries, for
services, and so on. Because money is the universal barter, everything else is measured in terms
of it. For instance, say one can buy a loaf of bread for 12 BDT and a car for 12,00000 BDT. Both
prices are expressed as the amount of money that would have to be given in exchange for the
item.
However, there is an equivalent way of thinking about these transactions that allows a better
understanding of currency exchanges. Buying a loaf of bread for 12 taka is the same as selling 12
taka for a loaf of bread. In other words, it is nothing more than an exchange. Since money is the
medium of exchange, everything is priced in terms of money. So, it could be said 1 lac loaf of
bread is equivalent to a car. That means a citizen can exchange a car for 1 lac loaf of bread. But
when you buy currency, then both items exchanged is money. When you are looking at currency
quotes, it is important to understand the format of the quote.
Currency is always quoted in pairs. The 1st quote is for the base currency, and is a unit of that
currency. The 2nd currency is the quote currency, which is the amount of the currency equal to a
unit of the base currency.
Exchange Rate = Base Currency/Quote Currency
Example: If GBP/USD = 1.5, then it takes 1.5 U.S. dollars to buy 1 British pound.
Quote Currency/Base Currency = 1/(Base Currency/Quote Currency)
Example: If GBP/USD = 1.5, then USD/GBP = 1/1.5 = 0.66; thus, 1 USD can be exchanged for
2/3 GBP.
Thus, a quote for GBP/USD is the number of United States dollars (USD) needed to buy 1 Great
Britain pound (GBP), or how much USD would be received for 1 GBP.
PIPS
When you buy something in a store in Bangladesh, the smallest unit of price is 1 paisa. This is
because the coin with the least value is the paisa, and so it would not be possible to sell or buy
something for less than that, if only a single item is purchased, as is usually the case. But
currently in Bangladesh we rarely use paisa as a means of exchange and thats why we dont see
the price of any products which states 12.10 taka. Thus, a grocery store cant sell a loaf of bread
for 12.10 taka, because there would not be any way for the customer to give the grocer 10 paisa,
since there is no coin available in the market for that. The only way that the grocer can actually
get 12.10 taka per loaf of bread is to require that the customer buy at least 10 loafs of bread for
121 taka. But the customer is not likely to buy so many loaves of bread, so the grocer cant sell
the bread for 12.10 taka.
However, because the quote currency is valued as a unit of the base currency, which makes it
easier to compare different currency values and changes in currency values, and because a large
amount of currency is usually traded, a smaller unit of measure is convenient in expressing
currency prices. This smaller unit is called a pip, which is equal to .0001 of the base currency, for

most currencies. In U.S. dollars, it is equal to 1/100 of a cent. Thus, 10,000 pips = 1 dollar. A
well known exception to the value of a pip is the Japanese yen. Because the yen has much less
value than the United States dollar, a pip is considered to be only 1% of the yen (Currently, 78
yen $1). Thus, most currency quotes are expressed by 4 significant digits, and the Japanese yen
is expressed to 2 significant digits. The pip is the smallest value quoted by brokers and dealers.
In Bangladesh, the exchange rate between U.S Dollar and BDT may be quoted as 83.62 bid and
84.14 ask but as it has been mentioned paisa is not commonly traded. So if an exporter wants to
sell $1 million then he/she will receive 83620000 TK. whereas an importer would have to pay
84140,000 TK and thus the currency dealer will make 84140000-83620000 = 520000 TK. profit
when the broker buys and sell $1 m.
BID/ASK QUOTES
When you go for currency conversion you notice that there are two different prices. This is not a
"sale price" and an "everyday price" for your favorite currency pair. The first price that you see is
the bid price. The second price that you see is the ask price. The bid price is the price at which
the market is ready to buy right now. The ask price is the price at which the market is ready to
sell immediately. When you place a buy order on a currency pair, you will have to pay the ask
price. The broker will then keep the difference between the bid and ask price. This is referred to
as the "spread." This is how Forex brokers are compensated. If you place a sell order, you will
have to pay the bid price. The broker will then keep the difference between the bid and ask price
again.
Most investors buy currencies from market makers, or dealers, in those currencies, who are
commonly referred to as brokers. A dealer makes money by buying at one price and selling a
little bit higher. When the dealer sells, the trader is buying, and when the dealer buys, and then
the trader is selling. The trader pays the broker's ask price, and the trader sells to the broker for
the broker's bid price, and the difference between the prices is the spread, which in currencies, is
usually at least 4 pips. The bid price for the trader is always lower than the ask price, because
thats how forex dealers make money. If you want to buy currency, you have to pay the higher
ask price, but if you want to sell currency, you have to sell it at the lower bid price. So if you
were to buy currency, then immediately sell it back to the same dealer, the dealer would make
money, and you would lose money. Thus, the spread is the transaction cost of trading currency.
For major currencies, the spread is usually about 3 to 5 pips or more, depending on the dealer.
For less frequently traded currencies, or for major currencies during high volatility or low
volume, the spread can be much greater. Although many brokers advertise 2-pip spreads, you
will rarely see spreads less than 4 pips.
The actual transaction cost is determined not only by the spread, but also by the lot sizes of
currency trades. Most regular accounts trade in lots of 100,000 units, and so a pip, when
multiplied by the size of the account, will equal 10 units of currency. Most mini-accounts trade in
lot sizes of 10,000 units, and so a pip will equal 1 unit of currency. If the quote currency is the
USD, then a lot size in a regular account is $100,000 and each pip difference is $10. For a miniaccount, a pip would be equal to $1. If the quote currency is other than USD, then the pip value
would have to be converted if you wanted to know your profit or loss in USD. Since there are
10,000 pips to each unit of currency, and most lot sizes are either 100K or 10K, the total pip
value can be found by the following formula:
Total Pip Value = Lot Size/10,000 X Conversion Rate

When the quote currency is the trader's native currency, then there is no need to multiply by the
conversion rate for that currency.
In the foreign exchange market, banks act as market makers. They realize their profits from the
bid-ask spread. Market makers will try to pass the exposure from one transaction to another
client. For example, a bank that buys JPY from a client will try to cover its exposure by selling
JPY to another client. Sometimes, a bank that expects the JPY to appreciate over the next hours
may decide to speculate, that is, wait before selling JPY to another client. During the day, bank
dealers manage their exposure in a way that is consistent with their short-term view on each
currency. Toward the end of the day, bank dealers will try to square the banks' position. A dealer
who accumulates too large an inventory of JPY could induce clients to buy them by slightly
lowering the price. Thus, because quoted prices reflect inventory positions, it is advisable to
check with several banks before deciding to enter into a transaction.
DIRECT RATE
The exchange rate of a currency is said to be quoted on a direct rate when it fluctuates while the
other currency in the currency pair remain constant. Simply it is units of local currency per
foreign currency. Consider the exchange value between Bangladeshi Taka and US Dollar. Today
it may be BDT 83/USD, the next day it may be BDT 83.5/USD. What it tells us our home
currency Taka is fluctuating everyday against US dollar while Dollar is quoting constant. Or, it
could be quoted as 0.01197 USD/BDT. It simply means 1 BDT would buy you 0.01197 USD.
From a US perspective, a direct quote is expressed as US$/BDT.
Most currencies are quoted in terms of units of currency that one USD will buy. This quote is
called "European" quote. Exceptions are the "Anglo Saxon" currencies (British Pound (GBP),
Irish punt (IEP), Australian dollar (AUD), the New Zealand dollar (NZD)), and the EUR. This
second type of quote is also called "American quote."
Problem 2.1: If direct quote is Rs, 45/US $, how can this exchange rate be presented under
indirect quote?
Solution: Indirect quote = 1/Direct quote
= 1/ Rs. 45/US$ = US $ 0.0222/Rs
Which simply means 45 Indian Rupee will buy 1 US$ or 0.0222 US$ will buy 1 Indian Rupee.
INDIRECT RATE
The exchange rate of a currency is said to be quoted on an indirect rate when it remain constant
while the other currency in the currency pair fluctuates. The indirect rate is one in which the
foreign currency fluctuates and the home currency remain constant. Simply it is units of foreign
currency per local currency.
It is easy to generate indirect quotes from direct quotes and vice versa.
S(direct)bid = 1/S(indirect)ask,
S(direct)ask = 1/S(indirect)bid.
The discussion about exchange rate movements sometimes is confusing because some comments
refer to direct quotations while other comments refer to indirect quotations. Direct quotations are
the usual way prices are quoted in an economy. For example, a gallon of milk is quoted in terms
of units of the domestic currency. Thus, unless stated otherwise, we will use direct quotations.

That is, the domestic currency will always be in the numerator while the foreign currency will
always be in the denominator.
From Bangladesh perspective an indirect quote is expressed as US$/BDT. So when in a direct
quote BDT 83/US$; under the indirect quote it would be $.012/BDT. So the relationship between
direct and indirect quote is one is the reciprocal of the other.
Problem 2.2: If indirect quote is US $ 0.018/Rs, how can this exchange rate be shown under
direct quote?
Solution: Rs. 1/US $ 0.018 = Rs. 55.55/US $.
Problem 2.3: Suppose the direct quote for pound sterling in New York is 1.60-65. What is the
direct quote for dollars in London?
Solution: The direct quote for the dollar in London is just the reciprocal of the direct quote for
the pound in New York or 1/1.65 - 1/1.60 = 0.606-0.625
[Note: While converting direct to indirect or indirect to direct quote the bid will become ask
while changing the quotation]
Problem 2.4: Convert the following exchange rates provided by HSBC in Dhaka, into direct
rates.
0.666 INR /BDT,
1.11 PKR/BDT,
0.046 SAR/BDT
Solution: Since the above quotes are indirect rate from Bangladesh perspective the direct rate
would be:
BDT per INR = 1/0.666 = 1.50, BDT per PKR =1/1.11=0.90, BDT per SAR=1/0.046 = 21.739.
Or in a direct quote it would be 1.50 BDT/INR, 0.90 BDT/PKR, and 21.739 BDT/SAR.
In words, one INR could be exchanged for 1.5 BDT or one Pakistani Rupee for 0.90 BDT or one
Saudi Riyal for 21.739 BDT.
Problem 2.5: If the bid quote of USD is 81.3 BDT and ask quote 83.4 BDT, what would be the
indirect quote? [You need to find the U.S direct quote]
Solution: Remember; when you are converting direct to indirect quote the bid will become ask
while changing the quotation.
So the bid will be 1/83.4 = 0.012 and the ask will be 1/81.3 = 0.0123.
Simply speaking, you must notice bid is lower than ask. Ask can never ever be lower than bid.
CROSS RATES
A cross rate is an exchange rate involving two currencies other than the most commonly
accepted US dollar. The complications in the exchange market arise when both currencies related
to the transactions are not quoted in either of the currency. To find the exchange rate between the
currencies we should work out through the relationship to the currency in which each currency is
quoted. The rate obtained is called cross rate.
Therefore, cross rate is the exchange rate between two currencies derived from their exchange
rates against another currency.
The usefulness of cross rates is:
to determine the exchange rates between currencies.
to check if the opportunities for inter market arbitrage exist.

We need the cross rate for various reasons. For example, you are visiting Costa Rica; a less
known country for most Bangladeshis and you have got no clue about their currency Colon. If
you go to any bank and ask them their exchange value against US$, the currency dealer tells you
510 Colon equivalent to 1 USD and you know about 83 BDT equals to 1 USD. Now doing the
cross rate you should be able to find the exchange value of one Colon against our taka. It is
simply: (510 Colon/USD)*(0.012USD/BDT) = 6.15 Colon equals to 1 TK or 1 Colon can be
exchanged for 0.16 BDT or 16 paisa. Generally, cross rates are calculated from US dollar rates.
Another example, given the following dollar exchange rates:
76.25 /$
0.7850 /$
What is the exchange rate in between Euro and Japanese Yen?
The cross rate is:
(76.25 /$) / (.7850 /$) = 97.133 /
When expressing cross rates, keeping the units straight is crucial. How do we know, in the above
example, that the cross rate is 97.133 /, and not 97.133 /? Because:
(/$) / (/$) = (/$) * ($/) = /
When we divide or multiply the dollar rates to obtain the cross rate, we must do so in such a way
that the $ cancels out in the accompanying unit calculation, so we are left with one foreign
currency in terms of another.
Problem 2.6: Find Rs./Euro exchange rate if: the two exchange rates are: Rs. 43.93-43.95/US $
and Euro 0.83-0.84/US $.
Solution:
Bid rate = Rs. 43.93/0.84 = Rs. 52.30
Ask rate = Rs. 43.95/0.83 = Rs. 52.95
= Rs. 52.30-52.95/Euro
Problem 2.7: Find BDT/SAR or BDT per SAR exchange rate if: USD per BDT is .0.0119 and
SAR per USD is 3.95.
Solution: BDT/SAR = BDT x USD
USD
SAR
= 1/0.0119 x 1/3.95
= 21.2743 BDT/SAR.
So, one Saudi Arabian Riyal will buy you 21.2743 Bangladeshi taka.
Problem 2.8: Say, you have found the price of 23 karat gold (10g) in Myanmar is 4000 Kyat
whereas it is selling for 48000 BDT in Bangladesh. The exchange value between USD and BDT
is known to you that 82 BDT can be exchanged for one dollar and you have asked a Myanmar
currency trader about the exchange value between USD and Kyat which was quoted at 6.5
Kyat/USD. If there is no restriction on buying and selling gold and no transaction cost or tariff
then where would you buy the gold and where would you sell it?
Solution: At first we need to find out the cross rate between BDT and Kyat.
BDT/Kyat = BDT x USD
USD Kyat
= 82 x 1/6.5

= 12.61 BDT per Kyat.

So, 10 gram 23 karat gold which is 48000 BDT should be priced at 48000/12.61 or 3806.50 Kyat
in Myanmar. But it is selling at 4000 Kyat. So you could very easily buy it from Bangladesh at
48000 BDT which is equivalent to 3806.50 Kyat and sell it to 4000 kyat and make a handsome
(4000 3806.50) = 193.5 Kyat profit from every 10g sale which is equivalent to 2440 BDT.
QUOTE CONVENTION (BID AND ASK SPREAD)
The quote convention in forex is based on the fact that there are 2 quotes for any currency, the
bid quote and the ask quote, both of which are expressed as a unit of the base currency. The
symbols show the currency pair, and the numbers list the bid/ask quote for the quote currency.
The bid price is usually expressed to 4 significant digits after the decimal point, which represents
the number of pips. The ask price is usually expressed as the significant digits that are different
in pips from the bid price. For instance, you may see a quote such as the following:
USD 1.2522-38/EUR
This means that if you wanted to sell Euros for dollars, you would get $12,522.00 for 10,000,
but if you wanted to buy Euros with U.S. dollars, then you would have to pay $12,538.00 to buy
10,000.
This quotation is expressed in terms of the dollar, but if the quote currency is the Euro, then it
would be quoted this way:
EUR 0.7975-85/USD
This is equivalent to the above quoted price, but it is expressed in Euros per dollar rather than
dollars per Euro. You can find the equivalent quote by dividing 1 by the quote. Thus, 1/1.2522
= 0.7985 (rounded) and 1/1.2538 = .7975. Converting it back: 1/0.7985 = 1.2522. Note that
rounding errors makes the round trip conversion inexact. It is important to notice that the bid
and ask rate mentioned above in direct quote will change when it is indirect quote since bid
price reciprocal will be ask price and ask price reciprocal will be bid price.
In forex trading software, currency quotes are generally displayed in 2 parts: the big figure and
the dealing price. The big figure is the main price that is usually the same for both the bid and
asks quotes. The dealing price is the last 2 digits of a currency quote that different for the bid and
ask quote. Because it is more important in regards to trades, the dealing price is usually displayed
in larger fonts in forex trading software.

Bid & Ask Percent Spread =

Ask Bid x 100

Ask

Problem 2.9: Suppose the spot quote for the Swedish Krona is $.1395-99, what is the percent
spread?
Solution:

(.1399 .1395) x 100

.1399
= 0.29% or 29 basis points.

Problem 2.10: Suppose a sterling pound is quoted at US$ 1.7019-36, what is the percentage
spread?
Solution: Percentage spread = (1.7036 1.7019) x 100 = 0.1%
1.7036
Problem 2.11: Find out the bid rate if ask rate is Rs. 40.50/US $ and the bid-ask spread is 1.23%.
Solution:

(40.50 x)/40.50 = 0.0123

Or 40.50 x = 0.0123 40.50
Or 40.50 0.50 = x
Or x = 40.00 Rs.
Problem 2.12: In the inter-bank Bangladesh currency market, the EUR is quoting BDT 103.5 per
EUR. If the bank charges .80% commission for TT selling and 0.90% for TT buying, what rate
should it quote?
Solution:
TT selling rate = 103.5 (1- .0080) =102.67 BDT/EUR
TT buying rate =103.5 (1+ .0090) =104.43 BDT/EUR.
CURRENCY VALUATION
Currency depreciation is the loss of value of a country's currency with respect to one or more
foreign reference currencies, typically in a floating exchange rate system. It is most often used
for the unofficial increase of the exchange rate due to market forces, though sometimes it appears
interchangeably with devaluation when the value of the currency is under fixed exchange system.
The opposite of it is called appreciation under floating exchange system.
The depreciation of a country's currency refers to a decrease in the value of that country's
currency. For instance, if Bangladeshi taka depreciates relative to the U.S Dollar, the exchange
rate (the BDT price of US$) rises - it takes more BDT to purchase one USD. When the BDT
depreciates relative to the US$, our BDT becomes more competitive in international trade
because the price of Bangladeshi goods when exchanged to US$ will be cheaper leading to a
larger Bangladeshi export. On the other hand, foreign goods that denominates its goods and
services in US$ will have lost competitiveness to the Bangladeshi taka. The price of foreign
products denominated in US $ will thus become more expensive in Bangladesh and Bangladeshi
goods relatively cheaper to foreigners. But it is not as straight forward as it seems since pricing is
just one criteria of export and import. Other important things are like quality, branding, image,
political situation and whether other competing countries like India, China are also depreciating
their currencies. If a country has a fixed exchange rate system then lowering the currency value
of their currency is not called depreciation, instead called devaluation. In the later part of the
book, it will be discussed in details the factors which affect the currency valuation.
Problem 2.13: If last year 1 USD could be exchanged for 71 BDT but currently it is trading at 85
BDT then what is the appreciation/depreciation rate of BDT?
Solution: The equation is: (Ending price Beginning price) X 100
Beginning price
So, (85 71)/71 = 19.72%. Since BDT has lost purchasing power we can say our currency has
depreciated almost 20% in the past one year.
Alternatively, we could also look at this way like last year 1 BDT was $1/71 but currently $1/85.
So, (1/85 1/70)/1/70 = 17.65% depreciation of BDT. [Negative sign signals depreciation]
Problem 2.14: The dollar is currently trading at Rs. 55. If Rupee depreciates by 10%, what will
be the spot rate? If dollar appreciates by 10% what will be the spot rate?
Solution: To find appreciation or depreciation of a rupee, we need to have a quote of Rs. Since
we are given $ quote, we need to convert the same to Rs. quote. (Which is simply the inverse)
I.e. Re. 1 = $1/55 = $ 0.018182

If rupee depreciates by 10%, then = 0.018182 0.0018182 = 0.016364

The new spot rate would be 1 Rs. = $.0.016364 which is equivalent to almost Rs. 61.1105 per
dollar.
And, if dollar appreciates by 10%, then we can apply 10% directly to the given $ quote.
Therefore, 55+ 55*0.1 = 60.5 Rs per dollar.
The new spot rate would be $1 = Rs.60.5.
As you could see 10% Rupee depreciation is not the same as 10% dollar appreciation.
Problem 2.15: The exchange rate for Mexican peso was 0.1086 in November 2004 and 0.0913 in
December 2004 against U.S dollar. How much did USD appreciate or depreciate?
Solution:
Nov 2004 rate: 1 Peso = $ 0.1086
Dec 2004 rate: 1 Peso = $ 0.0913
This means the US dollar has appreciated against Mexican peso since an American would have
to pay less USD from November to December to get 1 peso.
The rate of appreciation of USD can be calculated as:
(0.1086 0.0913)/0.0913 = 0.0173/0.0913 = 0.1895.
In other words, from November 2004 to December 2004, the USD appreciated 18.95% against
the Mexican peso.
Problem 2.16: A European company has shipped goods to an American importer under a letter of
credit arrangement, which calls for payment at the end of 90 days. The invoice is for $ 124000.
Presently spot rate is .70 EUR to the $; if the EUR were to strengthen by 5% by the end of 90
days what would be the transactions gain or loss in EURO? If it were to weaken by 5% what
would happen? Make calculations in per $.
Solution: Given spot rate $1 = Euro .70. If strengthens 5 % then $ weakens. Therefore $1 =
70*0.95 = 0.665.
However, if EUR weakens 5%, $ strengthens and therefore $1 = 70*1.05 = 0.735.
Problem 2.17: An Indian bank sells SFr 1,000,000 spot to a customer at Rs.6.40. At that point of
time, the following rates were being quoted.
SFr/$ : 5.5880/5.5920
Rs./$ : 35.50/35.60
How much profit do you think the bank has made in the transaction?
Solution: We first need to calculate only the Rs./SFr forward Bid/Ask rates. This is because
customer buys SF from the bank.
= 35.60 1/5.588
= 6.3708
Thus, the exchange rate at which the bank does the cover transaction is = Rs. 6.3708/SFr.
So, profit for the bank = (6.40 6.3708) (1,000,000) = Rs. 29,200.
Problem 2.18: Suppose the quote on British pounds is $1.624-31.
a) If you converted $10,000 to British pounds and then back to dollars, how many dollars would
you end up with?
Solution: For $10,000, you would buy pounds at the price of $1.631, giving you 6,131.21
($10,000/1.631) and resell them at the bid price of $1.624. The latter transaction would yield
$9,957.08, resulting in a round-trip cost of $42.92.

b) Suppose you could buy pounds at the bid rate and sell them at the ask rate. How many dollars
would you have to transact in order to earn $1,000 on a round-trip transaction (buying pounds for
dollars and then selling the pounds for dollars)?
Solution: For every pound you could buy at the bid and sell at the ask, you would earn the
spread of $0.007. To earn $1,000, you would have to transact 142,857.14 ($1,000/$0.0007). At
the current bid rate of $1.624, this is equivalent to $232,000 (142,857.14 x $1.624).
ARBITRAGE
Arbitrage involves no risk and no capital of your own. It is an activity that takes advantages of
pricing mistakes in financial instruments in one or more markets. This opportunity for risk less
profit arises when the currency's exchange rates do not exactly match up. As you recall, arbitrage
refers to the process by which an individual purchases a product ( in this case foreign exchange)
in a low-priced market for resale in a high-priced market for the purpose of making a profit. In
the process, the price is driven up in the low-priced market and down in the high-priced market.
This activity will continue until the prices in the two markets are equalized, or until they differ
only by the transaction costs involved. Because currency is being bought and sold
simultaneously, there is no risk in this activity and hence there are always many potential
arbitragers in the currency market.
There are 3 kinds of arbitrage
1) Local (sets uniform rates across banks)
2) Triangular (sets cross rates)
3) Covered (sets forward rates)
Note: The definition we used presents the ideal view of (riskless) arbitrage. Arbitrage, in the
real world, involves risk. Well call this arbitrage pseudo arbitrage.
[Note: We will discuss the covered interest arbitrage in chapter 4]
Local Arbitrage (One good, one market)
Example: Suppose two banks in Dhaka have the following bid-ask FX quotes:
Bank A
Bank B
Bid
Ask
Bid
Ask
BDT/GBP
131
132
134
135
Sketch of a Local Arbitrage strategy:
(1) Borrow 132 BDT
(2) Buy 1 GBP for 132 BDT from Bank A
(3) Sell 1 GBP to Bank B for 134
(4) Return BDT 132 and make a profit of 2 taka (1.51% per GBP on 132 taka borrowed)
Note I: All steps should be done simultaneously. Otherwise, there is risk! (Prices might change).
Note II: Bank A and Bank B will notice a book imbalance. Bank A will see all activity at the ask side
(buy GBP orders) and Bank B will see all the activity at the bid side (sell GBP orders). They will
notice the imbalance and theyll adjust the quotes. For example, Bank A can increase the ask quote to
134 BDT/GBP which will cancel any arbitrage opportunity.
TRIANGULAR ARBITRAGE
Triangular arbitrage is a process where two related goods set a third price. The typical process of
a triangular arbitrage is 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. In the
FX market, triangular arbitrage sets FX cross rates. Cross rates are exchange rates that do not
involve the USD. Most currencies are quoted against the USD. Thus, cross-rates are calculated
from USD quotations.
The cross-rates are calculated in such a way that arbitrageurs cannot take advantage of the
quoted prices. Otherwise, triangular arbitrage strategies would be possible. Triangular arbitrage
opportunities do not happen very often and when they do, they only last for a matter of seconds.
Traders that take advantage of this type of arbitrage opportunity usually have advanced computer
equipment and/or program to automate the process. Simply, triangular arbitrage process involves
the following steps: Acquiring the domestic currency
Exchange the domestic currency for the common currency
Convert the obtained units of the common currency into the second (other) currency
Convert the obtained units of the other currency into the domestic currency.
Lets take a look at an example, which well make easier by not considering the bid- ask spreads.
Assume the following three sets of hypothetical quotes:
New York: USD/CAD = 1.1651
Frankfurt: CAD/CHF = 1.1176
London:
USD/CHF = 1.3008
Arbitrageurs would find that there are discrepancies among these quotes. To capitalize on these
discrepancies, the arbitrageur may take the following steps:
Sell 1,000,000 USD and buy 1,165,100 CAD in New York
(Remember, if we exchange the base currency for the quote currency we multiply by the quote.)
Sell the 1,165,100 CAD and buy 1,302,116 CHF in Frankfurt
(Again, moving from CAD to CHF we must multiply by the quote.)
Sell 1,302,116 CHF and buy 1,001,012 USD in London
(As we move from quote currency to base currency we must divide by the quote.)
These actions can be better understood by Figure 2.4, which demonstrates the process of
triangular arbitrage:

Figure 2.4: Triangular Arbitrage.

The arbitrageur nets a profit of $1,012 by going through the above three legs of the triangle. In
reality, each step will not be taken individually as the arbitrageur would be exposed to execution
risk the risk of the quotes moving adversely during the time to set up the next trade. Instead,
once the computer program flags the opportunity, arbitrageur would enter the following trades
simultaneously:
1. Sell 1,000,000 USD/CAD in New York
2. Sell 1,165,100 CAD/CHF in Frankfurt
3. Buy 1,001,102 USD/CHF in London
These actions put the following pressures into action:
1. Selling pressure on the USD in New York. The quote will eventually FALL below USD/CAD
= 1.1651
2. Selling pressure on the CAD in Frankfurt. The quote will eventually FALL below CAD/CHF
= 1.1176
3. Buying pressure on the USD in London. The quote will eventually RISE above USD/CAD =
1.3008
Problem 2.19: If you find 1 USD equals to 85 BDT and 1 EUR equals to 1.2 USD and you have
found 1 Euro is trading for 110 BDT. Suppose if you can borrow one million BDT how much
money can you make out of conducting one arbitrage? Please draw a diagram.
Solution: We first need to find the cross rate of BDT/EUR whether it is 110 BDT per EUR or
not. If it is then there is no arbitrage opportunity but if not then we will conduct a triangular
arbitrage.
BDT = BDT x USD = 85 x 1.2 = 102 BDT/EUR. It is less than 110 which is in the market.
EUR USD
EUR
1078431.373 1000000
=PROFIT 78431.373 BDT

START: 1000000 BDT

SELL 9803.92 & BUY

1078431.373 BDT
(1=110BDT)

Sell 1000000 BDT and buy

$11764.706 ($1= 85 BDT)

The process of
Triangular
Arbitrage

9803.92
SELL $11764.706 AND BUY
9803.92 ($11764.7/1.2)

$11764.70

Starting with 1 million BDT arbitraging, an arbitrager makes 78431.373 BDT from 1 arbitrage.

Problem 2.20: If you find 1 USD equals 86.5 BDT and 50 INR but you have also found 1 INR is
trading for 1.6 BDT. If you can borrow 1 million BDT, how much money can you make from
one arbitraging? Please draw a diagram.
Solution:
Here, BDT/USD = 86.5
INR/USD = 50
So BDT/INR should be
BDT/INR = BDT/USD x USD/INR
= 86.5 x 1/50
= 1.73 BDT per INR.
But in the market it is trading at 1.6 BDT per INR. Obviously we can conduct an arbitrage.
(1081250 1000000) =
PROFIT 81250 BDT

START: 1000000 BDT

SELL 12500 USD & BUY

1081250 BDT (12500 x
86.5)

SELL 1000000 BDT & BUY

625000 INR (1000000/1.6)

The process of
Triangular arbitrage

12500 USD

SELL 625000 INR & BUY

12500 USD (6250000/50)

625000 INR

Starting with one million BDT arbitraging, an arbitrager will make 81250 BDT from single
arbitrage.
Note: Before conducting triangular arbitraging you need to confirm whether there is an
opportunity of doing it by finding the cross rate and if you find the cross rate is higher or lower
the market rate only then you can start the process of triangular arbitrage.
Problem 2.21: Suppose that the forward ask price for March 20 on Euros is $0.9127 at the same
time that the price of CME euro futures for delivery on March 20 is $0.9145. How could an
arbitrageur profit from this situation? What will be the arbitrageur's profit per futures contract
(contract size is 125,000)?
Solution: Since the futures price exceeds the forward rate, the arbitrageur should sell futures
contracts at $0.9145 and buy euro forward in the same amount at $0.9127. The arbitrageur will
earn 125,000(0.9145 - 0.9127) = $225 per euro futures contract arbitraged.
THE HISTORICAL EXCHANGE VALUE OF BANGLADESHI TAKA
When nations are formed, they commonly introduce their own currency as a mark of
independence, rather than share the currency of another country. For example, in January 1, 1972
the Bangladeshi Taka (Tk) was created to replace the Pakistani Rupee as national currency, and

was linked to the Pound Sterling at a fixed rate of Tk18.9677=1, resulting in an Official Rate at
Tk7.27927 per U.S. Dollar. (WCY 1984, p.91). In February 11, 1972 Bangladesh became a
member of the Sterling Area. In March 4 of the same year, all Pakistan Rupee in circulation was
considered legal tender until replaced by the new Taka currency on a one-for-one basis beginning
4 March, 1972. The currency changeover represented a devaluation of 34.6% in terms of gold. In
July 27, 1972 A Premium Taka or Secondary Exchange Market (SEM) Rate of Tk30.00=1.00
was created for foreign currency remittance from Bangladesh nationals abroad, under the Wage
Earners' Scheme (WES) and from freely negotiable Import Entitlement Certificates issued under
the Export Performance Licensing Scheme, a partial devaluation. (WCY 1985,
p.93).
In
February 13, 1973 following the devaluation of U.S. Dollar devaluation, Dhaka announced that
the Effective Rate for the Taka would continue to float through its link to Sterling. However,
based on the Taka's unchanged gold content, the Taka was realigned to Tk6.55 per U.S. Dollar.
(WCY 1984, p.91). In July 1, 1974 A Resident Travel Rate was created via a 30% tax on foreign
exchange authorized for travel abroad by residents. (WCY 1984, p.91) In May 17, 1975 The
exchange rate structure was unified by the abolition of the 30% exchange tax applicable to
certain purchases of travel exchange, and of the Premium Scheme for Home Remittance. (IMF
1976, p.67). The Taka's link to the Pound Sterling was changed from Tk18.9677 to Tk30.00 per
British unit, thereby devaluating the Bangladesh currency's theoretical gold content by 36.77%
and changing the inoperative Official Rate to Tk10.36 per U.S. Dollar. The Resident Travel Rate
was abolished. (WCY 1984, p.91) In April 26, 1976 Bangladesh established a Central/Middle
Rate for the Taka of Tk28.1=1 and availed itself of wider margins. (IMF 1976, p.64). In
January 11, 1983 The intervention currency was changed from British pounds to the U.S. Dollar.
(WCY 1984, p.91) Exchange rate for currencies other than the U.S. Dollar are based on the U.S.
Dollar closing rates in New York for the currencies concerned. (IMF 1984, p.82) . On that day,
one U.S Dollar would have bought 24.5 Bangladeshi taka. In July 7, 1984 the exchange rate
under the Wage Earners' Scheme (WES) previously negotiated freely, was now to be established
by a committee of authorized dealers set up by the Central Bank. (WCY 1986/87, p.404).
In July 1, 1985 The Export Performance Licensing Scheme was replaced with an Export
Performance Benefit Scheme (XPB) and Import Entitlement Certificates became available only
under the Wage Earners' Scheme. For most non-traditional exports, a rate based on 100% of the
Secondary/Premium Taka Rate was to be used, while other export receipts were governed by a
mix of either 1) 40% at the Secondary and 60% at the Effective Rate or 2) 70% at the Secondary
and 30% at the Effective Rate. Earnings from raw jute, loose tea and wet blue leather were
exchangeable at the Effective Rate. (WCY 1986/87, p.404)
The Secondary Exchange Market, comprised of the Wage Earners' Scheme and the Export
Performance Benefit Scheme, became a free inter-bank market and was made In December 31,
1985 The Official Exchange Rate for the Taka was adjusted on 14 different occasions during the
year, from Tk26.00=US$1 at the end of 1984 to Tk31.00=US$1 at the end of 1985, involving a
depreciation of 16.13%. (IMF 1986, p.114) In July 26, 1993 the dealings of Bangladesh Bank
with domestic authorized banks were restricted to U.S. Dollar and the currencies of member
countries of the Asian Clearing Union (ACU). Authorized banks are free to set their own buying
and selling rates for the U.S. Dollar and the rates for other currencies based on cross rates in
international markets (IMF 1994, p.45). Members of the Asian Clearing Union are Bangladesh,
India, the Islamic Republic of Iran, Myanmar, Nepal, Pakistan, and Sri Lanka.

Started from 1979, the Bangladesh Bank followed a semi-flexible exchange rate policy,
revaluing the Taka on the basis of a trade-weighted basket of currencies, with fluctuation margins
of 2.5% on either side. In 1992, the Secondary Exchange Market System was abolished. One
year later, the dealings of Bangladesh Bank with domestic authorized
banks were restricted
to U.S. Dollar and the currencies of member countries of the Asian Clearing Union (ACU).
Authorized banks are free to set their own buying and selling rates for the U.S. Dollar and the
rates for other currencies based on worldwide cross rates. However, Bangladesh Bank ceased to
deal in the currencies of the other ACU member countries in 1996. In January 1, 1996
Bangladesh Bank ceased to deal in the currencies of the other ACU member countries and deals
with authorized domestic banks only in U.S. Dollar and the rates for other currencies, based on
cross rates in international markets. (IMF 1997, p.65).

Major sources of reference include:

1) World Currency Yearbook (WCY)
2) IMF Annual Report on Exchange Arrangement and Exchange Restriction (IMF).
3) Bangladesh Economic Policy and Trade Practices 1993.
4) Bangladesh Economic Policy and Trade Practices 1995.
FOREIGN EXCHANGE MARKET IN BANGLADESH
Even though global currency market has started to grow after the fall of Bretton Woods
agreement in 1971 when Bangladesh became independence but our currency market hasnt
grown anywhere near that rate. World global currency market daily turnover is around $4
trillion or $4,000 billion or $40, 00,000 million dollar whereas it is around $1,900 million dollar
annually in Bangladesh in the year 2006- according to the statistics produced by BAFEDA.
Large as it may seem $1,900 million which is on annual basis compare to $4 trillion which is on
daily basis. Simply speaking, our annual FOREX turnover is just only 0.04% of the daily global
turnover.

Bangladesh Foreign Exchange Dealers Association abbreviated as BAFEDA was incorporated

as a non-profit organization under the companies act of 1994 to help the development of an
orderly inter-bank foreign exchange market in Bangladesh. Currently 44 banks are the member
of BAFEDA. It is gradually contributing to the development of the foreign exchange market
especially its efficiency, depth and liquidity with greater market discipline. It also acts as
facilitator between member banks and the Bangladesh Bank (BB), export Organizations and
other chamber of commerce bodies.
In Bangladesh, the inter-bank foreign exchange market is growing but the pace is rather slow.
Bangladesh Bank is very strict in foreign currency trading especially speculative trading is
heavily regulated. Also, the cap on foreign exchange balances of the authorized foreign exchange
dealing banks serves as a hindrance in taking a meaningful long or short position. In the forex
market the transaction shapes into spot, forward and swap and options but in Bangladesh forward
market is sluggish, and the swap and option market is non-existent.
ASIAN CLEARING UNION (ACU)
Asian Clearing Union (ACU) is the simplest form of payment arrangements whereby
the participants settle payments for intra-regional transactions among the participating central
banks on a multilateral basis. The main objectives of a clearing union are to facilitate payments
among member countries for eligible transactions, thereby economizing on the use of foreign
exchange reserves and transfer costs, as well as promoting trade among the participating
countries. The ACU is a clearing houses/payments arrangements operating in various regions of
the world.
The clearing arrangement under the Asian Clearing Union is not a new concept. It was used
extensively in the Western European countries after the World War II as a way of overcoming the
hurdles of converting currencies to carry on intra-regional trade. ACU was established with the
prime intention of fostering regional cooperation in Asia in regard to trade and payments. Even
though it is called Asian Clearing Union but most of the major Asian economies are not part of it
like China, Japan or any Middle-Eastern countries except Iran; instead, all the SAARC member
states and Myanmar are part of it.
The objectives of the ACU are:
1) To provide a facility to settle payments, on a multilateral basis, for current international
transactions among the territories of participants;
2) To promote the use of participants' currencies in current transactions between their respective
territories and thereby effect economies in the use of the participants' exchange reserves;
3) To promote monetary cooperation among the participants and closer relations among the
banking systems in their territories and thereby contribute to the expansion of trade and
economic activity among the countries of the ESCAP region; and
4) To provide for currency SWAP arrangement among the participants so as to make Asian
Monetary Units (AMUs) available to them temporarily.
The basic reasons for the formation of a clearing union, the following can be mentioned:
i) Exports and imports among members can expand relatively faster because of conservation of
foreign exchange in intra-group transactions, at least until the settlement date.

ii) Trade liberalization can be promoted initially among the members.

iii) Exploitation of scale economies would be made possible by enlarged trade.
iv) An adjustment process can be promoted that would raise the international competitiveness of
the members which have similar distortions in trade and production.
v) Measures and surveillance by the union can help to secure a more balanced current account
which in turn contributes to the creation of conditions for the future convertibility of each of the
currencies of member countries.
vi) Ground can be prepared for regional economic cooperation in general and for monetary and
financial cooperation in particular.
FOOD FOR THOUGHT: How would our living standards be if we still have had 1972s
exchange rate of one U.S dollar equivalent to 7.28 BDT?
SUMMARY:
The forex market represents the electronic over-the-counter markets where currencies are traded
worldwide 24 hours a day, five and a half days a week. The typical means of trading forex are on
the spot, futures and forwards markets.
Currencies are "priced" in currency pairs and are quoted either directly or indirectly.
Currencies typically have two prices: bid (the amount that the market will buy the quote
currency for in relation to the base currency); and ask (the amount the market will sell one
unit of the base currency for in relation to the quote currency). The bid price is always
smaller than the ask price.
Unlike conventional equity and debt markets, forex investors have access to large amounts of
leverage, which allows substantial positions to be taken without making a large initial
investment.
The adoption and elimination of several global currency systems over time led to the
formation of the present currency exchange system, in which most countries use some
measure of floating exchange rates.
Governments, central banks, banks and other financial institutions, hedgers, and speculators
are the main players in the forex market.
Unlike stock trades, forex trades have minimal commissions and related fees. But new
traders should take a conservative approach and use orders, such as the take-profit or stoploss, to minimize losses.
CASE STUDY 1: Currency dilemma Veltex is facing while keeping the export volume intact.
(April, 2008).
Veltex is a 100% export oriented readymade garment exporter mainly producing shirts. Veltex
exports 40% of production to the USA and 48% in Europe. The United Kingdom is their largest
Europe destination which amounts to 25%. It costs Veltex 620 BDT per piece to produce those
high quality shirts which they sold last year to USA for $10 and to UK for 5. Last year, the
exchange rate between USD and BDT were 70 BDT for 1 USD and British Pound 140 BDT for

1. So it was selling those shirts in both markets at 700 BDT and making 80 BDT profit from
each shirt. Now a sudden exchange rate drop of British Pound against BDT posed a dilemma to
Veltex authority since now 100 BDT is equivalent to 1 British Pound.
Veltex direct competitor is Swarna Textile, based in India who couldnt compete well in UK
market against Veltex. But Rupee has depreciated against Taka from a peak of 1.75 BDT for
1INR to now 1.4 BDT. Now Swarna Textile can export to UK since Indian Rupee didnt
appreciate against British Pounds. Vertex knows it takes hard work, dedication and long time to
establish a trading partnership with a western country especially U.S or U.K. It doesnt want to
lose the lucrative U.K market where it was sending 25% of its output. Also not exactly sure how
to keep the export intact given Indian Swarna Textile will take the market away if Veltex is
charging 700 BDT equivalent to 7 whereas Swarna can easily sell the same quality shirt for 6.
An emergency board of meeting is called and the matter will be discussed further there.

Question 1: Explain how currency appreciation affects the exporters?

Question 2: Why do you think exporters should diversify not only products but also their export
destinations?
Question 3: What should be the short term, mid-term and long term strategy Vertex should
follow to minimize the negative impact on their export revenue?
Question 4: What action plan Bangladesh Bank should adopt to minimize the impact?
CASE 2: Black markets and Parallel Markets in the Forex.
In developed economies, foreign exchange is openly sold and traded, and market ex-rates prevail
and are generally universal, and there is no black market for foreign currency. For example, if
you go to U.K. with dollars, you will get about 0.74 for every dollar, whether you go to a bank
or hotel or currency exchange, etc. You wont be about to go out on the street and find currency
dealers willing to give you .80 or more per dollar. But in developing economies, there are often
restrictions on foreign currency trading and foreign currency holdings, and the government often
imposes an artificial official exchange rate, which deviates significantly from the true market
rate. As a consequence, black markets for foreign currency develop, either illegally, or often as
a parallel market, where more of a true, market exchange rate is determined.
For example, suppose that in the Soviet Union, the official ex-rate is 30 Rubles to the dollar,
R30/$, indicating that the Soviet government will buy dollars for R30. Perhaps the true market

rate is closer to R50, so there is a black market or parallel market for dollars, where you can get
the official rate of R30 at a bank, but you can get R50 on the street, or at a hotel, or at a store.
The same picture sometimes has shown in Bangladesh especially in nineties when the exchange
value of BDT against USD was fixed. In the interbank rate buy/sell rate was like 36/37 BDT per
dollar but in the black market anyone could sell it above 40 BDT per USD. Even now you can
find official rate as 83.5 BDT per USD whereas in the Motijheel Bank area it is trading above 85.
On January 9, 2012, Bangladesh Bank has warned against dealing in foreign currency from
parties other than authorized dealers or moneychangers.
In media releases, the central bank cautioned many times that it had noticed some illegal
advertisements on training for online forex trading and dealing, promising large profits. The
adverts also promise currency load in debit cards. It warned against being tempted by these
illegal activities.
"Foreign currency can be purchased or sold only through dealers or moneychangers authorized
by Bangladesh Bank. So the forex trading by another entity or person is illegal and punishable
crime," it said.
Question 1: Why would Russians or foreigners in other countries be willing to pay a premium
for dollars, over the official exchange rate?
Question 2: What does it tell you if there is an existence of black market in forex?
Question 3: Should we manage the valuation of our currency or let the market decide the real
price of our currency?
Question 4: How does parallel market guide the Bangladesh bank in managing the valuation of
BDT?
Question 5: Write down the pros and cons of restrictions in forex trading in Bangladesh.
CASE STUDY 3: Case for rupee trade with Dhaka
JAYANTA ROY CHOWDHURY

The Telegraph, Kolkata

New Delhi, April 19, 2011: When Indias commerce minister Anand Sharma calls on
Bangladesh Prime Minister Sheikh Hasina next week to discuss a new trade deal, he wont be
talking about the possibility of trading in rupees.
However, many Indian and Bangladeshi businessmen would welcome trade in the rupee instead
of the volatile dollar with its attendant exchange risks.
India sells some $2.5 billion of merchandise annually to Bangladesh and buys about one-tenth of
that from its eastern neighbour, a trade imbalance which Sharma will try to address during his
visit with promises of opening up to more duty free imports.
Attiur Rahman, governor of the Bangladesh Bank, the coastal nations central banker, told The
Telegraph that he would not rule out trade in rupees, Provided the currency became fully
convertible.
For a currency to be acceptable globally by businesses and made part of reserves which central
banks around the world buy and keep, it has to be normally fully convertible and stable against
most major currencies.
Trade in local currencies with neighbouring countries would cut down forex risks and may be
the way forward, but for the rupee to be acceptable in the wider world, convertibility would be a
must, said D.K. Joshi, chief economist of Crisil.

Till June 6, 1966, the Indian currency was officially or unofficially the acceptable tender over a
wide area from Beirut to Hong Kong. In 1966, India devalued the rupee, forcing itself out of
global markets.
Aden, Oman, Bahrain, Qatar, Trucial Gulf states (present day UAE), Tanganyika (former name
for Tanzania), Uganda, Seychelles and Mauritius were among the nations where the rupee was
legal tender. But the currency as global tender is now history and accepted only in neighbouring
countries such as Nepal, Bhutan and Afghanistan.
The Chinese are doing trade deals in renminbi with many countries and we should do the
same, Joshi added.
Though none of the Brics (Brazil, Russia, India, China and South Africa) countries have
convertible currencies, they have agreed to their development banks opening lines of credit in
their respective currencies for mutual trade.
Rice trade in rupee could cut out exchange risks and keep the business coming, agreed
D.N.Pathak, executive director of the All India Rice Exporters Association. Though official trade
between India and Bangladesh was less than $3 billion, unofficial trade across the border
often by smugglers in medicines, cattle, rice and even eggs was estimated at over $1.5 billion.
This trade is carried out in rupee and taka (Bangladeshs currency) without any foreign currency
payments being involved.
Many neighbours often trade in a robust local currency if that reduces exchange related risks and
helps save scarce foreign exchange. However, in the case of India and Bangladesh, with both
currencies being defined by its relative value to the dollar, the currency risk would hardly be
reduced by converting the trade to rupees.
Explained Matlub Hussein, chairman of diversified Nitol Nilay Group, which among other things
assembles Tata trucks and vehicles in Bangladesh, Unless we change the base (dollar), it wont
make sense but if we can do that then yes its a far better of way doing business.
Question 1: How would it save Bangladeshi and Indian traders if we trade with Rupees?
Question 2: Write down the advantages and disadvantages of trading with India using Rupees.
Question 3: Why do you think illegal traders use Rupee instead of Dollar to trade with India?
Question 4: China is our number one importing nation before India. Do you think we should
target Chinese Yuan instead of Indian Rupee if we decide to abandon USD for regional trade?
TRUE/FALSE
1. Forex is open 24 hours a day five days in a week.
2. New York city is the hub for forex trading.
3. Currency bid quote must be higher than ask quote.
4. A cross rate is an exchange rate involving two currencies other than the USD.
5. Bangladesh Bank is the legal authority in managing the value of our taka.
6. GBP is the most popular currency in the forex dealings.
7. Currency black market exists due to disequilibrium in the forex market.
8. Daily turnover in the forex is around $4000 million dollar.
9. Foreign exchange market is the largest market in terms of volume in the world.
10. There is little risk involved in currency arbitraging.
MULTIPLE CHOICE QUESTIONS:
1. An exchange rate quoted in American terms
a) Says how many units of foreign currency you get for one U.S. dollar.

b) Says how many U.S. dollars one unit of foreign currency is worth
c) Is the same as the indirect quotation.
d) Is the inverse of the direct quotation.
2. If last year $1 was worth 69.50 BDT and now 75.25 BDT, how much did our currency
depreciate?
a) 8.27%
b) 7.64%
c) 4.6%
d) BDT has appreciated
3. A/An
quote in the United States would be foreign units per dollar, while a/an
quote would be in dollars per foreign currency unit.
a) direct; direct
b) direct; indirect
c) indirect; direct
d) indirect; indirect
4. A currency can depreciate only under ------system?
a) Fixed
b) Floating
c) Semi-fixed
d) Never
5. Suppose you observe the following exchange rates: 1 = $1.25; 1 = $2.00. What must the
euro-pound exchange rates be?
a) 1 = 1.20
b) 1 = 0.625
c) 1 = 1.25
d) 1 = 1.60
6. Suppose you observe the following exchange rates: 1 = 105 BDT; 1 = 1.25. What must
the Pound-BDT exchange rate be
a) 1 = 125 BDT
b) 1=131.25 BDT
c) 1= 100 BDT
d) None
7. Actual exchange market participants include
a) Banks
b) Governments
c) MNCs
d) All of them
8. A cross rate is an exchange rate between -------a) the US dollar and the Japanese yen
b) the domestic currency and a foreign currency
c) any two non-home currencies.
d) the Euro and the USD.
9. Foreign exchange markets are efficient if
.
a) you have inside information
b) markets are highly regulated
c) good information is available at no or little cost
d) most foreign exchange dealers are speculators
10. Which of the following is not a function of a commercial bank in the foreign exchange
market?
a) they operate the payment mechanism
b) they determine exchange rates
c) they help reduce foreign exchange risk
d) they buy and sell foreign exchange
11. If the Japanese yen was worth $.0035 six months ago and is worth $.0045 today, how
much has the yen appreciated or depreciated?
a) appreciated; about 29%
c) appreciated; about 19%
b) depreciated; about 29%
d) depreciated; about 19%
12. From the viewpoint of a British investor, which of the following would be a direct quote
in the foreign exchange market?
a) .66/$
b) $1.60/
c) $0.55/
d) 1.4/

13. The bid price is $0.64 for the Canadian dollar and the ask price is $0.68 for the
Canadian dollar. What is the bid-ask spread for the Canadian dollar?
a) 6.25%
b) 6.55%
c) 5.25%
d) 5.88%
14. A weaker value of taka will ------------------.
a) benefit exporters but hurt importers and thus consumers
b) benefit both importers and exporters
c) benefit importers but hurt exporters
d) benefit consumers but hurts importers
15. One USD is equal to 82 BDT. This is a/an -------- quote from Bangladesh perspectives.
a) direct quote
b) indirect quote
c) mixed quote
d) unknown
16. If one USD is 82.5 BDT and 55 INR then one INR is equivalent to -----a) 1.50 BDT
b) 0.75 BDT
c) 0.66 BDT
d) 1.75 BDT
17. BAFEDA stands for
a) Bangladesh Association of Foreign Exchange Dealers Association
b) Bangladesh Foreign Exchange Dealers Association
c) Bangladesh Foreign Exchange Dealings Association
d) Bangladesh Association of Foreign Expert Dealers Association
18. ACU stands for
a) Asian Clearing Union
c) Asian Currency Union
b) American Currency Union
d) American Clearing Union
19. Which country is not the member of ACU?
a) Afghanistan
b) Myanmar
c) Bangladesh
d) USA
20. Which one is not the objective of the ACU?
a) To provide a facility to settle payments.
b) To promote monetary cooperation among the participants
c) To provide for currency SWAP arrangement among the participants
d) To provide a discount for the participants.
21. Assume that a bank's bid rate on Swiss francs is 0.25 and its ask rate is 0.26. Its bidask percentage spread is:
a) 4%
b) 4.26%
c) 3.85%
d) 4.17%
22. _______ is not a bank characteristic important to customers in need of foreign
exchange.
a) Quote competitiveness
c) Speed of execution
b) Advice about current market conditions
d) Assurance of profit
23. The value of the Australian dollar (A$) today is 0.41. Yesterday, the value of the
Australian dollar was 0.38. The Australian dollar --------- by _______%.
a) depreciated; 7.90
c) appreciated; 7.90
b) depreciated; 7.30
d) appreciated; 7.30
24. If one USD equals to 82 BDT and 55 INR then one Indian rupee should be exchange for
how much BDT?
a) 1.59 BDT
b) 1.49 BDT
c) 1.69 BDT
d) 1.39 BDT
25. Arbitrage involves:
a) capitalizing on a discrepancy in quoted prices

b) an investment of funds tied up for a length of time

c) risk
d) all of the above
26. Brac Bank quotes a single rate for the Saudi Arabian riyal of $0.25. Dhaka Bank
quotes a single rate for the Saudi Arabian riyal of $0.27. Conducting locational arbitrage,
you would ________ riyals at Brac Bank, _______ riyals at Dhaka Bank, and make a profit
of ________ per unit.
a) sell; buy; $0.02
b) buy; sell; $0.02
c) sell; sell; $0
d) buy; buy; $0
SHORT ANSWER QUESTIONS:
1.
2.
3.
4.
5.
6.

Who are the major participants in the foreign exchange market?

What are the major purposes of foreign exchange trading?
What is a pip in currency valuation? Why is it so important for forex traders?
What is a bid and ask rate of a currency? Give an example of bid/ask spread.
Why do you think London is the centre of largest currency trading?
What is cross rate? If US$1 is equivalent to 85 BDT and 1200 Korean won respectively, then
how much Korean Won one BDT can buy?
7. What is interbank and TT rate in Forex market?
8. What is an arbitrage? What are the three types of arbitrage in the foreign exchange market?
9. Write down the process of a triangular arbitrage please.
10. What is the spot and forward market in Forex?
11. HSBC Mumbai quotes Rs.46.45/65 for Australia Dollar. Compute Bid, Ask and spread. Also
show what they would quote if it were in indirect quote.
12. The $: exchange rate is 1 = $0.85, and the :SFr exchange rate is SFr 1 = 0.71. What is
the $: SFr exchange rate?
13. If the following exchange rates are prevailing: /$=1.3378 and $/=0.6426. What will be the
cross rate between /?
14. HSBC in Dhaka quotes BDT 82.30/95 against USD. Please compute Bid-Ask, spread.
15. If one Taka was 1.2 Japanese Yen last year and today it is 0.8 Yen then how much BDT has
depreciated/appreciated against Yen?
16. If the Mexican peso is worth $.0752, and the Canadian dollar is worth $0.94, the value of the
peso in Canadian dollars will be how much?
17. If you have been offered 600 for your $1000 which you need for touring UK, given
1=$1.60 will you accept the offer? Explain please.
18. Suppose the quote on British pounds is $1.624-31. If you converted $10,000 to British
pounds and then back to dollars, how many dollars would you end up with?
LONG ANSWER QUESTIONS:
1. In the interbank Bangladesh Currency Market, the USD is quoting BDT 83.50. If HSBC
charges 1.5% commission for TT selling and 1.75% for TT buying, what TT rate HSBC
should quote?
2. If 1 USD is quoting 83.5 BDT and 129 BDT is exchanged for one GBP in the forex market.
You have 150,000 BDT in your pocket. How much USD and GPB can you purchase with this
amount of BDT?
3. Write down in short the major historical events that took place in Bangladesh Foreign
Exchange Market since 1972.

4. What are the reasons behind forming Asian Clearing Union? Did it attain the desired
outcome?
5. What is BAFEDA? What are the objectives of this association?
6. If the U.S dollar is currently trading at 82.5 taka and BDT is expected to depreciate 8% next
year, what will be the BDT spot rate then? How about if dollar appreciates 8% next year
against BDT what will be the USD spot rate then? Is 8% depreciation of BDT and 8%
appreciation of USD the same?
7. Please write down the major changes in the valuation of taka against British Pound and USD
since the independence of Bangladesh.
8. If one USD equals to 82 BDT and 12000 IRR (Iranian Rial) respectively, but someone
offered you to exchange one BDT for 130 IRR. If you can borrow one million BDT how
much profit would you make by conducting one arbitrage? Diagram please.
9. If one USD equals to 55 INR and 82.5 BDT respectively, but you have found an offer of 1
INR = 1.75 BDT. If you have access to borrow from any money market (i.e. from USA, India
or Bangladesh) then how would you conduct an arbitrage? Show a diagram please.