Bangladesh Association of Banks

FX Workshop
Tarique Islam Khan
Head of Global Markets Nov 2009
Contents

Agenda

Basics FX Rates Forward SWAPS Quiz

Spot FX Determination of Outright Forward FX SWAPs
Exchange Rate Retail Exchange Pricing a FWD Interest Rate SWP ?
Conventions Rate

2
The FX Market and Spot
A SPOT FX Transaction is
• an agreement between two
parties
• to exchange a specified amount
of one currency
• for a specified amount of
another currency
• on the second business day (CAD
is the exception)
FX rate is the second currency
exchanged per unit of the first
currency
If the FX transaction is to be
settled beyond SPOT date then it
is a FWD FX transaction
European Terms

A few examples:
• $1 = CHF1.1655/60
• $1 = JPY98.30/35
• $1 = SGD1.5145/55
• $1 = BDT69.00/05
• $1 = AED3.6700/50

These are called “Direct Quotes”, because these

currencies are quoted per dollar. In other words,
dollar is the “unit currency” [also known as BASE
ccy] while the other currency is the “variable
currency” [also known as PRICING ccy]
American Terms

A few examples:
• GBP1 = USD1.4590/95
• EUR1 = USD1.3445/50
• AUD1 = USD0.7010/15
• NZD1 = USD0.6555/65

These are called “Indirect Quotes”, because

these currencies are not quoted per dollar. Here
the dollar is the “variable currency” [BASE ccy]
while the other currency is the “unit currency”
[PRICING ccy]
Cross currency

A few examples:
• GBP1 = JPY136.90/95
• EUR1 = GBP0.8845/48
• AUD1 = BDT48.37/44
• GBP1 = BDT100.67/78

• These are called “Cross currencies”.

• The dollar has been calculated “out” of these
rates.
• The “variable currency” and the “unit
currency” in cross-ccy quotations are determined
by convention.
Two Way Quote

Big Figure: Shows the approximate amount of the pricing currency required to
purchase one UNIT of the Base currency. In the above example, it is 1.59

Small figure or PIPS: The smaller numbers that contain the spread
(difference between the bid and the offer). In the above e.g., the small figure is
60-65, which is 100th of one US cent. Dealers generally multiply this small
figure with 10 thousand and call that PIPs and quote in pips.
Different currencies use different number for pips (a.k.a. points), such as in
Bangladesh we use the number just after the decimal and call that pips. For
e.g. if USD/BDT is quoted 69.00-69.05, then we call the 69 taka as the BIG
Figure and the 0.00-0.05 the SMALL figure and 00-05 becomes the pips.
Quoting/Dealing conventions

• The entity quoting the rate or price is the “Market Maker”

• The entity asking for the price is the “Market Taker”
• Market Maker decides on the spread between the Bid and
Ask/Offer
• Market Taker is subjected to the spread, i.e. Mkt Taker has
to buy at Mkt Maker’s Offer and sell at Mkt Maker’s Bid.
• Mkt Maker takes the risk of quoting 2-way price not
knowing which side the Mkt Taker will “hit”
• Mkt Taker may or may not deal or hit on the rate quoted by
the Mkt Maker
Retail Exchange Rate Set up

Latest Interbank Bid – Offer for Taka against Dollar

Add Spread on Both sides

Latest interbank rates of the other currencies

Build in volatility and market competitiveness

Setting the Board Rate

Interbank BID and Offer

69.00 69.05

-0.52 +0.43

68.48 69.48

Mkt Bid minus spread Market Offer plus spread

Spread depends on following factors :

1. Market volatility. This is a subjective measure based on history.
2. Market competitiveness (are we too far off from competition?)
3. Any relevant regulatory guidelines (i.e. As for the dollar,
regulation states that the spread cannot be more than BDT1.00)
Life of an FX Transaction

Customer calls
Dealer asks for quotes The best quote dealer gets is
dealer and wishes
from several banks and 69.00-69.05 from ABC bank to
to buy $1m
takes the best quote cover this $1 mln

Customer agrees. Dealer adds BDT0.25 to the

What is the profit
Deal Done with offer price of 69.05 and
from this transaction
customer at 69.30 quotes 69.30 to customer
Volatility! (EUR/$ 5-min chart)

If Client calls a few hours

later, client should not
expect original price. Market
has already moved
Client calls to buy EUR0.5m
agst BDT

We quote 1.3270*69.35 =
92.03
Market Average USDBDT Chart [6 months]

6 9 .7 0 0 0

6 9 .2 0 0 0

6 8 .7 0 0 0

6 8 .2 0 0 0

Mar-09
Mar-09
Nov-08
Nov-08
Oct-08
Oct-08

Jan-09
Jan-09
Feb-09
Feb-09
Sep-08
Sep-08
Sep-08

Dec-08
Dec-08

B u yin g R a te S e llin g R a te
Outright Forward
A contract where :
two parties agree to buy/sell a
currency against another at an
agreed exchange rate at an agreed
future date.
date Forwards are generally
used by both Exporters and
Importers to hedge against future
exchange rate volatility.
Main Advantages are:
•Hedge Exchange risk exposure and reduce
exchange losses.
•Advance knowledge of transaction price
helps in forecasting balance sheet.
Main Disadvantages are:
•Contract must be closed out at or before
maturity date.
•Market rate may be against forward rate
at maturity of the forward.
 Example

A 6-months USDBDT flexi forward contract

Deal date : 25 Mar 2009
Option Start dates : 01 Sep 2009
Option End date : 30 Sep 2009
Forward rate : 72.90
Customer to sell : $100,000
Settlement Date : Any date between 01-Sep-09 and 30-Sep-
09
Customer to buy : BDT7,290,000
Customer will be able to
encash required amount
any time during the option
period

01Sep09 30Sep09
Deal Date
Month One Month Two Month Three Month Four Month Five
25Mar09 USD 100,000
Pricing a Forward
Using the previous example of 6-mnth $/BDT outright FWD

Spot rate on 25/mar : 69.35

BDT int rate for 6 months : 11.75%
USD int rate for 6 months : 1.45%
Future value of BDT : 69.35+69.35*11.75%*180/360 =
73.4243
Future value of USD : 1+1*1.45%*180/360 = 1.00725
Future exchange rate : 73.4243/1.00725 = 72.8958
Forward rate : 72.8958
Shorthand estimation : 69.35+69.35*(11.75-1.45)%*180/360
= 72.9215
FX Swaps

• FX swaps are really money market instruments

• It uses the FX to mitigate counterparty credit risk

• Works because FX funds viewed as collateral against LCY

• There are two legs of the transaction

• First leg is the SPOT deal

• Far leg (or the maturity leg) is the FWD deal

• Pricing is exactly as calculating FWD

• Key driver of SWAP points is the interest rate of the two

currencies, whereas the key driver of FWD rate also includes the
SPOT rate
FX Swaps & FWD

Both i/r of Base

Base Ccy i/r is Base Ccy i/r is
SPOT rate ccy and pricing
HIGHER than LOWER than
increases ccy increases by
pricing ccy i/r pricing ccy i/r
same amount

FWD rate Moves

FWD rate is FWD rate is
increases by marginally
Forwards lower than SPOT higher than
same closer to the
rate SPOT rate
amount SPOT rate

SWAP points
Minor
SWAP Points Negative Positive decreases
change
marginally
Interest Rate Swap (IRS)
Contract between two parties to exchange interest flows in order to
hedge against interest rate movements
Generally, a fixed interest rate is exchanged for a floating rate based
on market benchmark such as LIBOR
E.g. Client borrows USD10m from ADB at LIBOR6m+2.50% for 7yrs
Libor changes every six months, so does client’s int payments
US interest is low & bottoming out; exposure to rising Libor rates in future
Client willing to pay a bit more than current Libor throughout the loan tenor

Libor+2.5%
Client ADB

Libor 5.85%
The client and the bank
only swaps interest
Bank amounts on the NPA
($10m)
Interest Rate Swaps (IRS)

Question: How does the BANK hedge itself?

Answer: One way :–
Libor 6m + 2.5%
Client ADB

Libor 6m 5.85%

Issues a $10m 7yr Bond with

Bank 5.85% semi-annual coupon @5.85%

Libor 6m

Buys a 7 yr FRN of $10m yielding Although the client and the

Libor 6m with the money raised
from issuing the Bond
bank only swaps interest
amounts on the NPA ($10m),
hedging this way the bank
needs to buy and sell
bonds/FRNs for the full
amount ($10).
Quiz Time
Deal Date is 16Jun09
Spot Settlement date for
a. EURUSD
b. USDCAD
c. USDBDT
Direct or Indirect Quote
1. USD 1 = BDT69.05
2. GBP 1 = USD1.6500
3. EUR 1 = GBP0.8449
American Term is
Indirect Quote/Direct Quote?
Who is the market maker below?
Can you
1.6500- quote me
1.6505 100 cable?
 Market Rate is 69.00
To make a profit of 10 paisa what will be
your rate for an exporter?
Difference between BID and
OFFER is called
A. PIPS
B. Spread
C. IRS
Calculate the Cross-rate

USDBDT 69.05
EURUSD 1.4000
EURBDT=?
Calculate the Cross-rate

USDBDT 69.05
USDJPY 98.50
JPYBDT=?
USDBDT FWD for Importer is

At Discount or Premium ?
USDBDT forward for exporter is

At Discount or Premium ?
THANK YOU !