foreign exchange Let's start this session with a short definition of foreign exchange or more specifically with a definition of Foreign Exchange transactions. Each foreign exchange or FX transaction is the agreement between two counterparties to exchange and agreed upon amount in one currency against an agreed-upon amount in another currency at specific date.

The ratio between the two currency amounts is given by the agreed upon price in is called the FX rate.

How is this Market structured the FX Market is a global over-the-counter Market, which means it is decentralized and there is no exchange or execution facility on which trading has to take place.

Due to the decentral nature currencies are traded effectively Around the Clock five days a week starting on Monday morning in Asia and finishing on Friday evening in the US granted Market liquidity will generally be higher when Europe and us are trading but the FX Market is a true 24 hours Market.

Speaking of liquidity the FX Market is the largest and most liquid Market there is every three years the bank for international settlement or bis performs a survey among central banks and other authorities in 52 jurisdictions, and according to the April 2016 survey trading in FX markets average the amount of 5.1 trillion US dollars per day such a large number of course raises the question of why the FX Market has grown so much.

Most currencies in the world nowadays are flexible, which means that they are not linked to another currency in any way and prices are primarily driven by supply and demand for the particular currency. And of course when there is a change in supply and demand there is a change in the exchange rate. This chart shows a five-year history of the euro to US Dollar exchange rate over the period the high was just below 140 and the low around 105. So this slide nicely shows how much flexible exchange rates can fluctuate in other words how volatile they can be and this volatility offers possibilities, but also challenges to Market participants and is ultimately the reason why FX is traded so actively Let's have a look at some of the main reasons why investors engage in foreign exchange transactions. The first one is very intuitive. And we all have probably to some extent made these types of transactions very often foreign currencies are bought to make payment in this particular currency for example to pay an invoice received from a foreign supplier, very closely linked to that is the next reason trade FX for risk management purposes in global trade. There are often agreed delays between the order of a good and the actual payment for this order. Of course on first site these payment targets are beneficial for the buyer of the goods as it is generally positive to make payments later. However, in the case of foreign transactions, it introduces foreign currency risk to the transaction, for example, if a European importer agreed to buy some Commodities and pay for them in US dollars in two months from now while the price in US dollar is fixed. The Importer will not know the actual costs for the import in Euros until The purchase of US Dollars has been completed as until then the FX rate can change significantly but several products are available in the FX markets to limit or eliminate this risk and risk management is a significant driver of FX transactions the same products can of course also be used to create exposure to change in foreign exchange rates for speculative purposes. For example, when a macro hedge fund wants to generate a profit from the expected appreciation of one currency versus another one and last but not least many effects flows are generated by Global Investors looking to spread their investment across several countries, and of course across different currencies as well. So that foreign exchange transactions are also driven by diversification efforts.

Let's have a look at how effects rates are quoted in the spot Market before having a look at the actual quote though. There are a few rules. We should be familiar with first. Every currency is referred to by three letters in the FX Market these so called currency ISO codes ISO stands for the International Organization for standardization. And while there is a large number of these codes as you can imagine here are a few codes that you should be familiar with USD stands for US dollar EU R stands. For euros JPY for Japanese Yen GPB for pound sterling CHF for Swiss Francs AUD for Australian dollar CAD for Canadian dollar in nzd for New Zealand dollar as currencies are priced in relation to another currency. They are always quoted in pairs. As for example currency a is worth X units of currency B. The currency mentioned first in the quote is also referred to as the base currency the second.

Currency is also called the quoted currency. The convention is to quote currency X when first referring to the currency pair, so if we have a quote of Euros versus US dollars at 1.1325. This means that one euro is worth 1.1325 US dollars.

And here are a few of the most popular pairs that are traded in the FX markets Euros versus US dollars US Dollars versus Japanese Yen pound sterling versus US Dollars. This pair is often referred to as Cable in reference to the Transatlantic cable between the two countries US Dollars versus Swiss, Francs and Australian dollars versus US dollars as we can see in all these pairs. The US dollars is one of the involved currencies. However, in some pairs US dollars is the base currency in other pairs. It is the quoted currency as a rule of thumb we can say that as US dollar is the most important currency. It is generally the base currency in a currency pair. So the quote is the value of one US dollar in units of the foreign currency. However, Euros British pound sterling Australian New Zealand dollars are an exception when quoted against US Dollars. These currencies are the base currencies.

Although US dollar is the dominating currency in FX markets Market participants also regularly transact in currency pairs that do not include US Dollars, like for example Euros to Japanese Yen or British pound sterling to Japanese Yen Etc in these cases. The pairs are generally referred to as cross rates or crosses for cross quotes the overall quotation conventions apply. The first currency in the pair is the base currency the second one the quoted currency and the rate is quoted as number of units of quoted currency per one unit of the base currency.

However for many crosses there are no general rules, which currency should be the base in which one should be the quoted currency. So the actual quotation might depend on the individual local market and in this context, we can generally distinguish direct quotes from indirect quotes.

In case of a direct quote the domestic currency is the quoted currency. So it is expressed how many units of the local currency have to be paid per unit of the foreign currency? And in the case of an indirect quote it is just the other way around and the domestic currency is the base currency. In other words the quote shows the number of units of the foreign currency that have to be sold for one unit and the domestic currency.