KRC

Foreign Exchange

Presented to Coronation Merchant Bank

– Training School

2020
Outlin
e1 Introduction
2 Key Players in the FOREX market

3 Foreign Exchange rates and quotes

4 Currency Derivatives

5 Case Study: Fraud

6 Q&A
The Foreign
Exchange Market
The Foreign Exchange Market
• The foreign exchange market is the biggest financial market in the
world. Every day, transactions worth about 5.6 trillion dollars are
carried out within the market. The major aim of introducing the
foreign exchange market is to facilitate international trade by
enabling businesses to perform transactions outside their local
currency. The market operates round the clock from Monday through
Friday.

• Foreign exchange means the money of a foreign country; that is,

foreign currency bank balances, banknotes, checks and drafts.

• A foreign exchange transaction is an agreement between a buyer

and a seller that a fixed amount of one currency will be delivered for
some other currency at a specified date.

3
• Foreign Exchange : Any currency other than the local currency which is
used in settling international transactions. It is the process by which
people in different countries pay each other by exchanging different types
of money

• Foreign Exchange Market: This is a global market where convertible

currencies are traded and their conversion rates are determined.

• Nominal Exchange Rate: This is the rate at which the currencies of two
countries can be exchanged

• Real Exchange Rate is the ratio of what a specified amount of money will
buy in one country compared with what it can buy in another country

4
Market Participants
• The foreign exchange market consists of two tiers:
– The interbank or wholesale market (multiples of $1MM US or
equivalent in transaction size)
– The client or retail market (specific, smaller amounts)

• Five broad categories of participants operate within

these two tiers; bank and nonbank foreign exchange
dealers, individuals and firms, speculators and
arbitragers, central banks and treasuries, and foreign
exchange brokers.

5
 Central Banks and Treasuries
• Central banks and treasuries use the market to acquire or spend
their country’s foreign exchange reserves as well as to influence
the price at which their own currency is traded.
• They may act to support the value of their own currency because of
policies adopted at the national level or because of commitments
entered into through membership in joint agreements such as the
European Monetary System.
• The motive is not to earn a profit as such, but rather to influence
the foreign exchange value of their currency in a manner that will
benefit the interests of their citizens.
• As willing loss takers, central banks and treasuries differ in motive
from all other market participants.

6
Major trading currencies & 2-way quote
system
DOMESTIC MARKET • 2-WAY QUOTE DEALING SYSTEM
• BID/ASK is the pricing methodology in both
• Naira is the major trading currency.
the Money and FX market.

FOREIGN CURRENCY MARKET • BID: The binding price at which you (the
dearer) are willing to buy

• USD is the major currency. • OFFER: The binding price at which you (the
dealer) are willing to sell
• GBP, EURO, JPY & RMB are also traded.
• Market level $/N154.25 : 154.35 . This is a
2- way quote/price
• However, for settlement purposes, most
currencies are converted to USD through • BID (Left) - $/N154.25
cross rates.
• OFFER (Right) - $/N154.35

• Other currencies – ZAR, CHF, AUD, etc • Trading platform in Nigeria is OTC-
Reuters & Exchange Traded

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 Foreign Exchange Rates and
•Quotations
Interbank quotations are given as a bid and ask (also referred to
as offer).
• A bid is the price (i.e. exchange rate) in one currency at which
a dealer will buy another currency.
• An ask is the price (i.e. exchange rate) at which a dealer will
sell the other currency.
• Dealers bid (buy) at one price and ask (sell) at a slightly higher
price, making their profit from the spread between the buying and
selling prices.
• A bid for one currency is also the offer for the opposite currency.
• Market level $/N154.25 : 154.35 . This is a 2-way quote/price
• BID (Left) - $/N154.25
• OFFER (Right) - $/N154.35
• Trading platform in Nigeria is OTC-Reuters & Exchange
Traded 8
Foreign Exchange Rates and Quotes

• Citibank quote - $/€ $0.9045/€

• Barclays quote - $/£ $1.4443/£
• Dresdner quote - €/£ €1.6200/
• Cross rate £
calculation: =
$1.4443/£
$0.9045/ 1.5968/£
=€
€

9
 Apex Bank

Licensed Key Oil

Banks
Players Companies

Importers
and
Exporters

10
SPOT
Contracts
• A spot transaction is an agreement between two parties where an
exchange of currency happens at an agreed rate, at a pre-
determined time
• The effective date of exchange of currency will be two business
days after trade date

Party A sells USD to Party B

Party B buys NGNfrom Party A

SPOT
• Market makers must show a two-way price in a currency.
Rates
• Simply put a rate where they would buy and a rate where they would
sell.
• This rate is usually quoted in terms of the Base Currency
• Currency pairs trade in terms of one unit of base currency
in exchange for variable units of quoted currency.
• This simplifies the quoting process amongst banks so that traders
don’t always have to wonder which currency is referenced.
• Therefore, in a USD/NGN quote, the USD is the base currency
• 1 unit of USD is equal to a variable number of units of Naira
• In a EUR/USD quote, the EUR is the base currency, quoted in a
variable number of units of USD.

USD 1 = NGN 165.00

Base Currency Quoted Currency
Questio
n
If EUR/USD is quoted to you as 1.3050-53, does this price
represent?

a. The number of EUR per USD

b. The number of USD per EUR
c.Depends on whether the price is being quoted in Europe or
the US
e. Depends on whether the price is being quoted interbank or
to a customer
Answe
rIf EUR/USD is quoted to you as 1.3050-53, does this price
represent?

a. The number of EUR per USD

b. The number of USD per EUR
c.Depends on whether the price is being quoted in Europe or
the US
e. Depends on whether the price is being quoted interbank or
to a customer
Questio
n
In GBP/CHF, you are quoted the following prices by four
different banks. You are a buyer of CHF.
Which is the best quote for you?

a. 1.4340
b. 1.4343
c. 1.4337
d. 1.4335
Answe
rIn GBP/CHF, you are quoted the following prices by four
different banks. You are a buyer of CHF.
Which is the best quote for you?

a. 1.4340
b. 1.4343
c. 1.4337
d. 1.4335
 FX
A Derivatives
derivative is a financial contract, or a contingent claim, whose
value depends on the value of one or more underlying assets
or indices of assets
• Derivatives “derive” their value from the underlying “cash”
or “spot” markets
• Pay-off or outcome of derivative transaction can always be
replicated by a combination of cash market transactions
• Quicker to complete than the combination of individual
transactions
• Cheaper to transact – save on transaction costs
• Easier to transact – one contract as opposed to combination of
contracts
 Currency
• Derivatives
Forwards
• Swaps
• Futures
Outright
Forward
 Buy or sell foreign currency at predetermined rates to be delivered some time in the future
(more than seven business days). In Nigeria, the maximum tenor approved for forwards by the
Central Bank is three years (3 yrs.)

• At the agreed future date & rate:

Party A sells Currency to Party B

Party B buys Currency from Party A

Features include:
 Price agreed today for delivery in future.
 Payment and delivery are not required until the maturity of the forward contract.
 Requires additional documentation such the FX Master Agreement or the ISDA Master Agreements
 Effective to hedge foreign exchange exposure during times high exchange rate volatility.
Swaps
Simultaneous purchase and sale of identical amounts
of one currency for another with two different value
dates usually spot to forwards.
Foreign Exchange Swap allows sums of a certain
currency to be used to fund obligations/charges
designated in another currency without acquiring
Transfers USD/NGN
foreign exchange risk. It permits companies that have

Near Leg
funds in different currencies to manage them
efficiently.
Transfers NGN/USD

Features
• Both the Spot and Forward prices are agreed on
the same day. Transfers NGN/USD

Far Leg
• Cash flows are exchanged both on the spot and
forward dates.
• Completely eliminates price risks. Transfers USD/NGN

• Provides temporary funding in other currencies.

• Requires additional documentation such the FX
Master Agreement or the ISDA
Agreements Master
• Effective in hedging foreign exchange exposures
during times high exchange rate volatility.
Cross Currency
Swaps
A Cross Currency Swap is a foreign
exchange derivative between two Customer transfers Naira principal

Beginning
institutions to exchange the principal and/or
interest payments of a loan in one currency
Access Bank transfers USD principal
for equivalent amounts, in net present value
terms, in another currency.

Interest Payments
Access Bank makes NGN interest
payments

Features
• Requires additional documentation such Customer makes USD interest
payments
the ISDA Master Agreement
• Used to secure cheaper debt (by Access Bank transfers Naira principal
borrowing at the best rate Maturity
regardless available of
swapping for debt currency
in desired and then
currency
Customer transfers USD principal
using a back-to-back-loan)
• Effective in hedging foreign exchange
exposures during times of high
exchange rate volatility.
Non-Deliverable
A Non-deliverable OTC FX Futures (NDF)
Futures
contract is an agreement between parties in
which counterparties settle the difference
Executes NDF contract with the Bank
between the contracted forward price or rate and

Beginning
the prevailing spot price or rate on an agreed
notional amount.
Customer post initial contract margin
Naira-settled over-the-counter (OTC) Foreign
Exchange (FX) Futures are essentially
local- currency non-deliverable forwards (NDFs).

Contract Period
Features: Variation Margin

• Actual of the notional

delivery amount not maturity, as
required even at the contracts are
cash flows
• Cash settled.
include initial and variation margins,
and the difference between the agreed forward Access Bank sells Currency to Customer
Maturity

price and spot fixing at maturity.

• Requires additional documentation such the FX
Master Agreement or the ISDA Master
Agreements.
• Effective in hedging foreign exchange
exposures during times high exchange rate
volatility.
Fraud in the FX
Market

CASE
STUDY

23