Foreign Exchange
The Foreign Exchange domain tests quoting conventions, settlement dates, cross-rate construction, forward pricing and the distinction between FX swaps, currency swaps and non-deliverable forwards. Precision with bid and offer matters more than general commentary.
Quoting conventions
FX is quoted in base/quote terms. EUR/USD 1.0850/52 means the dealer buys EUR at 1.0850 and sells EUR at 1.0852. The first number is the bid for the base currency; the second is the offer. Most pairs use four decimals; JPY pairs use two.
Value dates and forwards
Spot is normally T+2, except USD/CAD, which is T+1. If the spot date is a holiday in either currency's centre, it rolls to the next valid joint business day. Forwards are priced off spot plus forward points, which reflect the interest-rate differential. Points quoted as a discount are subtracted; points quoted as a premium are added.
Cross rates and swaps
Cross rates are derived through USD. An FX swap is a spot purchase and forward sale, or vice versa, in one transaction; it is a funding instrument, not a currency conversion. A cross-currency swap exchanges interest payments and is a different product. An NDF is cash-settled and does not deliver the restricted currency.
Worked example
Given EUR/USD 1.0850/52 and USD/JPY 148.10/12:
- EUR/JPY bid = 1.0850 × 148.10 = 160.6885
- EUR/JPY offer = 1.0852 × 148.12 = 160.7402 Quoted as 160.69/160.74. Reasoning: the client sells EUR to the bank; the bank sells USD against EUR at its EUR/USD bid, then sells JPY against USD at its USD/JPY bid. Both legs use the bank's bid, so multiply the two bids.
Traps that cost marks
- Multiplying a bid by an ask in a cross, which produces an arbitrageable rate.
- Applying forward points in the wrong direction or reversing their bid/offer order.
- Confusing an FX swap with a cross-currency swap.
- Forgetting that an NDF is cash-settled.