Forex – Settlement and Quotation
In big figure
Mar 3rd, 2012
We have already gone through the basics of Forex.So we know that there are three types of FX deals, namely spot, forward andswap. The other important point that we had mentioned in the above link is thatif we are able to comprehend the base currency as some commodity, FXtransactions will no longer remain complex. And we also know that actualexchange of currency takes place on the second business day after the FX dealis struck.
Here we discuss the procedure followedduring these two days, from dealing to the actual exchange or the settlement.
The important point to note before in an FX deal is that delivery of the currency happens in the country of that currency only.
Let us setup a hypothetical example tounderstand the procedure. Suppose there is an investment bank A in UK and a bank B in Singapore. Let’ssay A wants to buy USD 1mn in return of INR. On the other hand B wants to sellUSD in return of INR. If the FX rate USD/INR is 49, A buys USD 1mn by paying INR49mn while B sells USD 1mn by receiving INR 49mn.
DealDate: A deal is struck between A, UK and B,Singapore. A buys USD 1mn by paying INR 49mn to B and B sells USD 1mn by receivingINR 49mn. A, UK sends the confirmation to B, Singapore along with theinstructions asking B, Singapore to pay US dollars into A, UK account with A, US.Similarly B, Singapore sends confirmation to A, UK along with instructionsasking A, UK to deposit INR into B, Singapore account with B, India.
Along with the confirmations andinstructions A, UK will send an advice to A, US to expect USD 1mn from B,Singapore in 2 days time. B, Singapore will send a similar advice to B, India.
DealDate + 1: After receiving the confirmations A,UK will send a payment instruction to A, India to debit its INR account andcredit B, India a sum of INR 49mn to the account of B, Singapore. Similarly B,Singapore will send a payment instruction to B, US to debit its USD account andcredit A, US to the account of A, UK.
DealDate + 2: The actual transfer happens on thisdate. After which A, US and B, India will send a confirmation to A, UK and B,Singapore respectively that they have received the expected amount in USD andINR.
In a spot FX deal the settlement(currency delivery) is alwaysdone on the second business day. The provision for 2 days before the finalsettlement is there because the FX market as you may recall is open for almost24 Hrs a day. Hence the 2 days time frame gives the parties on both sides ofthe FX deal which might actually be present in different time zones sufficienttime to fulfill their obligations.
Next we see how an FX rate is quoted. Tillnow we have seen a simple quotation of USD/INR as 49. Now we will see how inthe actual market the FX rate is quoted.
FX Rate Quotation
A typical FX rate quote would be somethinglike this. $1=INR 48.2516-18
From our introductory post on FX we know that $ is the base currency and INR (IndianNational Rupee) is the second currency.
- Bigfigure: 48.25, the big figure here i.e. the mostsignificant digits.
- Pip: 16-18 is the pip i.e. the least significant digits in the quote.
The quote is so divided into the big figureand the pip as the FX market is very fast paced and quoting the entire 48.2516–18would be very inconvenient for the traders as the price might change during the time the entire quote is stated. Hence only the pips are quoted. Don’tworry we will soon see why the pip is quoted as a range. 🙂
For now we will take $1=INR48.2516 tointerpret the quote.
As we have always said, consider the basecurrency as some commodity which will make our life easier. This makes us readthe above quote as $1 costs INR 48.2516. And as the INR figure rises $, basecurrency in our case rises in worth and becomes more valuable. The basecurrency is always quoted to be 1 unit. Hence we can read the quote of $/INR asunits of INR per unit $. The base currency is always quoted to the left.
Whythe pip is quoted as a range? Well, we can begin our next post by answeringthis basic question. For now we will just summarize what we have in our pockettill now.
1) Understanding FX transaction
2) Basics of types of FX deal
3) Settlement procedure of a spotdeal
4) FX quotations