Good morning, good afternoon, good evening, everyone, and, uh, very, very well welcome to this, uh, Felix live session called Introduction to FX or Foreign Exchange Products. My name is Thomas k Crower, and I have the honor to guide you through this introductory session here today.

Uh, and let's just start with having a quick look, um, at the agenda.

So what are we actually gonna talk about here? We're gonna start with a brief overview of the FX markets in general.

We're gonna talk about what an FX transaction actually is, how big the market is, uh, and we also have a look at the different products that are traded.

Um, following that we will go through, uh, the way that foreign exchange prices are quoted, or FX rates are quoted, and how actually to interpret them and the terminology, uh, around these quotes.

And then we're gonna have an intuitive look at the fx, um, forwards.

And then at the end, if there's a time, we will also have a quick look at FX swaps and what those instruments, um, can actually be used for.

Before we start, as always, a couple of, uh, general reminders.

First one, yes, of course, you can access the course materials that I'm gonna share here on the screen with you.

You can download the PDF uh, file, and you have several ways of accessing those.

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Scroll down quite a bit until you find today's topic.

Introduction to FX products, click on the tile new website opens up, and there you'll find the PDF document waiting for you to, um, download it.

The second point, um, is that you can ask questions in the session.

Important to remember though, so please listen carefully.

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Reason for that is that in many cases, as I said, zoom chat has been disabled for viewers, so we're using the q and a function to make sure that your questions will find their way to me and I will just, uh, answer them as we go through the session.

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Now, from a markets perspective, the, uh, first six months of this year have been mapped out in terms of agenda, but there's a couple of open slots for the second half of the year.

So make your dreams come true, uh, and let your voices heard and tell us what we should cover, uh, in the second half of the year in this, um, format.

But that's it from an introductory point of view. Without further ado, let's get started with today's session.

And as I said, we're gonna begin right at the foundational level with the question, what actually is a foreign exchange transaction? And I'm sure I'm not telling you anything new here, and there wouldn't be any surprising element on the slide here at all.

Um, if foreign exchange transaction is generally just the agreement between two counterparties to purchase one currency against another, that's a pretty straightforward, uh, deal.

I'm buying heroes, I'm selling dollars.

Uh, that would be an example of an FX transaction.

Uh, in this transaction, we not just agree on the time in which the exchange of these two currency amounts will actually take place.

So that's obviously the settlement date.

Uh, we can talk about spot transactions here that are for immediate settlement. We can have four transactions, um, which happens at a where settle at a later state. But both cases, the settlement date will be determined at the inception of the trade.

In addition to the settlement date.

We will also agree upon the actual FX price.

So the exchange rate between those two currencies, which we generally just refer to as the FX rate.

So on the face of it, a very, very simple, um, transaction here.

Um, but because in foreign exchange we are always basically trading one currency against another one, this FX rate that is mentioned here in the bottom right corner, that's actually a source or great source of potential confusion. So if you start looking at foreign exchange quotes, um, it often isn't immediately or at least intuitively clear as to how to read, how to interpret, uh, the price that you have been given because, um, of the way the currencies are quoted in pair terms.

Now, if you hear a price for any other asset, like for example, stock or you, um, see in the supermarket shelf, uh, a price tag, um, it's very, very intuitive to interpret this the right way.

So if somebody tells you Microsoft trades at 400, then it's immediately clear to all of us.

I believe that this means that one Microsoft stock at the moment will cost you $400.

It is very unlikely that somebody interprets this as for $1.

You get 400 Microsoft share, right? Uh, because this is a way we think about prices.

As I said, from day-to-day life prices are usually given as the price for one unit in the good or asset that you are thinking of buying.

Now, when it comes to currencies, this is a little bit less clear because if someone quotes you Euro dollars at let's say one 18 and a half, this is roughly where I think we're trading right now. Well, 1870, but you know, fair enough.

So one 18 and a half, um, that could of course mean one euro gives you $1 18 and a half US cents.

It could also mean that $1 gives you one Euro 18 and a half Euro cents.

Now the good news is there is a hard and fast rule on how to interpret this, but this rule, you just have to know and you have to memorize, and you have to go through this a couple of times until this becomes sort of like almost natural way of thinking.

The rule is that this currency that's named first, that's basically, uh, seen as the good you're buying, the asset that you're buying and the price.

The one 18 and a half is effectively the price in the second currency, which we call the quoted currency, by the way, um, that you need to pay for one unit in the first currency, which is the base currency.

We come back to that later.

Um, but you know, I wanted to sort of lift that secret right at the start here so that everybody has a good idea about how to interpret FX rate.

So Euro dollar one 18 and a half basically means per euro, you get one 18, well, one US dollar and 18 and a half US cents, or you have to pay whichever way you are gonna, um, trade this currency.

Pair one euro equals X dollars, okay? That's the way to interpret and always the currency that's on the left is the one we're looking at as a good purchase point of view.

And the other one is the price or the, the price is given in the second currency.

So that's the one thing, uh, to remember right from the start.

But as I said, we come back to this, um, later.

Now, this slide, um, tells us something about the market structure in the FX space in general.

Uh, and I think, you know, you might have heard that FX markets are generally considered to be one of the largest and also most liquid, um, over the counter markets, over the counter, obviously, meaning that the transactions here happen, uh, in a bilaterally negotiated way often.

So it's not a lot of FX business happening on organized exchanges.

Yes, there are of course, uh, a growing number, um, of FX sutures, which also I think, uh, become more liquid.

But generally speaking, a vast majority of FX transactions still happens outside of organized exchanges, which of course does not mean that we're not using electronic trading platforms, but these are not electronic exchanges, it's just sort of, you know, um, all those electronic trading systems that we have available, um, nowadays.

Now, the FX market then in addition, is really truly global.

And also in addition, we trade 24 hours a day, meaning you can trade, for example, euro dollar starting very early on Monday morning in in Asia, and then the trading books follow, uh, the sun basically we're passing them over to London, and then we're passing them later over to New York and so on and so forth.

So that we basically finish trading Euro dollars, um, very late on Friday evening in the Western hemisphere.

And, um, that is basically then a 24 hour coverage for at least a quite significant numbers of days during the week.

Um, but that of course doesn't mean that liquidity is always equally high, right? So I would suggest that four Euro dollars, just to pick that as an example here, you would naturally expect that liquidity should be highest at the time when both London and New York are open, because this is where, you know, the most natural counterparts for those transactions, um, will be based geographically.

We can trade them, um, in at, at other, uh, trading hours.

But of course, you would expect liquidity to be maybe, uh, a little bit less, uh, significant.

So before then, uh, making a large transaction in any currency pair, you might want to think a little bit about the liquidity distribution, uh, during the day, think about a transaction cost analysis, et cetera, et cetera.

So, um, regarding the market size, was that considered to be one of the most largest markets? And the data that you can see here comes from the bank for international settlement. They do this training or central bank survey every three years, uh, and then, um, you know, obviously measure the average daily turnover in for an exchange products.

And the months that they're using here as a reference is April.

And so then the daily average of the April, uh, months of April every three years is then calculated and published.

And, uh, we see here the data from 2001 to 2022 in 2025.

The report is out since I think, you know, September, October last year.

So, um, in 2025, the daily average was around 9.6 trillion, if I'm not mistaken, uh, in dollar terms.

So quite a significant growth.

Once again, the one caveat that I would throw in there though is that obviously last, uh, April IE April, 2025 was, uh, maybe, uh, a little bit of a special months in the sense that we had obviously a little bit of a heightened market volatility, which might, might have contributed to somewhat higher reading than otherwise.

But, uh, definitely, uh, a solid growth in the foreign exchange, uh, turnover.

So $9.6 trillion a day, uh, certainly, you know, quite an impressive market size indicating, um, you know, pretty good liquidity.

But of course liquidity isn't equally distributed across all currency payers. When we see here on the right, uh, where we're looking at, um, you know, to what extent different currencies are actually involved in this FX transactions, no surprises here, uh, to see that the dollar by far is the, uh, dominating, well, the US dollar we should say, is by far the, uh, dominating currency here.

Second largest, uh, is then the Euro.

And so that indicates that euro dollar, it might be the most actively traded, uh, currency pair.

And for those, uh, eagle eyes, that kind of spot that, obviously the green bars, if you would add them all up, are exceeding quite significantly the seven point, you know, 6 trillion or whatever, a number in 2022.

That's because here we're kind of deliberately double counting.

So if there's a 1 billion transaction happening in Euro dollar, that counts as 1 billion in dollars, and this counts also as 1 billion for euro.

So the green bars should basically be twice as much as the number shown on the left.

So just in case anybody, uh, wonders where these numbers, uh, come from and, and how this adds up.

So bottom line, very, very significant trading volumes.

Um, and obviously also a great coverage of many different currencies.

The question sometimes is why is this market traded so actively? Why is this asset class, if you wish, uh, traded so actively? And I think the answer to that is because there are so many, um, potential use cases, right? And, uh, here are just a couple, um, that I think are worse knowing.

And the first one is probably the most intuitive one. It's all about payment facilitation, the world of global trade that, you know, we, we live in.

Um, you know, it's a simple fact that when you buy a good abroad or a service abroad, and you have to pay for it in foreign currency, if you want to pay your invoice, you will need to buy this currency first, right? And it might not be you directly, this might be done through your credit card company or through your bank or whatever, but at some point, somebody will have to translate.

If you are based in Europe, for example, the euros into US dollars, if that's the currency you have to pay your invoice in, or if you travel abroad and you just kind of go and, and and exchange, um, some of your home currency for another currency at the airport, that would also basically be, uh, n fx, uh, transaction, right? So that's just a simple facilitation, um, of, uh, payments.

Um, closely attached to that is then the risk management element here.

So again, we're thinking about global trade here.

So we have an importer and we have an exporter, and the importer has agreed to buy a certain piece of machinery from the exporter paid in the home currency of the exporter.

So let's, um, put this down as US dollars here, for example.

Um, and because this machinery takes a couple of months to be put together and then to be shipped, so let's say it takes, you know, roughly around three months, uh, for this piece to turn up at our doorstep, we then get a payment target of three months, right? So we being the importer now have to pay and let's say a round amount of a hundred billion dollars in three months time.

And let's say we're based in Europe, so our currency is euros.

So it's great to have this payment target because that sort of, you know, obviously means we can keep this liquidity, uh, for a little while longer on our accounts. But then on the down, or the downside of this is, and obviously that we are now exposed to for an exchange risk, because all we know is that we have to pay a hundred million dollars in three months time, but what we do not know yet is at which FX rate will I be able to do that? Because we know Euro dollar trades at 1 18 80 right now, but we don't know where this currency pair is gonna trade three months from now. So that introduces for an exchange exposure, um, to us.

And if we do not feel comfortable taking this, then we might want to think about hedging it.

And one way, you know, probably the, the classical hedge, uh, for scenarios like this would be to enter into a forward contract.

IE agree on the price at which we're gonna exchange our Euros $4, um, today, but the settlement is agreed upon to happen three months from now because this is when we actually have to make, uh, the payment.

So these are real world, real industry examples here, uh, that I think are fairly intuitive.

Um, then, uh, there's of course also a certain amount of speculation that's happening, as you will have heard by now, um, and new before anyway, um, FX rates do change and they are, you know, there's some decent volatility, um, obviously dependent on the environment and the time and so on and so forth, but there's some decent movement in for an exchange.

Also, what we can see when we look at a long-term charts, there is a sort of like trending behavior, um, for certain periods at least.

Uh, and all that makes FX quite an attractive asset class, I believe for many to, um, you know, basically take speculative positions.

Say if you believe that the recent dollar weakening, uh, has come to an end and you now expect dollar to strengthen against Euro, for example, of the next couple of weeks, then what you would do right now is buy a dollar, sell euros, uh, and then hopefully when your view turns out to be correct, whatever, at a profitable, um, level.

So that would obviously, um, be the date, generally directional trade.

And then, um, that's more a financial obviously, um, element here.

Uh, and very similar, uh, idea here behind the, uh, column, um, to the right here, the diversification one, some FX flows were, you know, probably quite a decent amount of FX flows will be just triggered by investors diversifying their portfolios geographically.

So if you are a, an Asian investor and you're looking to, uh, invest part of your portfolio abroad, so let's say in Europe or in in, in, in the United States or Americas, um, then you will obviously find a lot of securities to invest in those areas, but you would normally have to pay for them in, uh, the local currency.

So if you want to buy stocks on the New York Stock Exchange, then you will have to pay dollars for them.

So when you are looking to shift your portfolio partially into US equities, for example, then you would need to buy, uh, dollars and sell whichever domestic currency you have available.

And therefore that would trigger, uh, again, a, uh, an FX transaction.

It's not necessarily, um, because you, we have a view on the currency, um, but we just need to basically, once again, facilitate a payment, right? And we can then think about, obviously if there should be a risk management, uh, attached to this if we are feeling comfortable with the FX risk, uh, and on our investments or not, but that's an entirely different store.

Okay, so now, um, we have a little of use cases here, and of course there's more, uh, than the ones that are on the screen here, but, uh, at least gives us a good idea as to why the market trades, uh, so actively.

And now, uh, we start looking at the product.

So we're gonna do this in, in, in, you know, two steps. First, we're just gonna have a general look at each of the products that you, uh, can see here and just sort of talk briefly about what the main characteristics are, uh, and, and how they, you know, uh, how we can distinguish them from each other.

And then we're gonna go through spot outrights and FX swaps if there's time, a little bit more in that, um, and leave cross currency swaps in certainly options for another day.

So, um, FX spot transactions, nothing really, um, surprising here.

These are just the transactions for immediate settlement and immediate obviously being inverted commas here, because in financial markets, immediate doesn't really mean right now, it means T plus one, T plus two, T plus three, dependent on, uh, the currency pair we are looking at.

That's just a normal regular spot transaction. Like you would buy a stock or a bond in the spot market for delivery two days or one business day after the trade has been, uh, made.

So that's spot market, and those are the rates that you would typically see.

And if you hear me saying Euro dollar trading at 1 18 80, that's the current spot price.

Okay? So that is, uh, obviously the spot market.

Then we have the next column here which says outrights and outrights is sort of, I think a pretty FX specific term, uh, standing or short form for outright forwards.

Uh, and um, it's basically just the FX way to describe a regular forward trade.

IE we agree on the price today.

We also agree on the settlement date today, but the settlement is not spot, it's a date after that predefined. So it might be three months after that, six months after that might be, um, you know, a less round, uh, uh, number here.

But we know that settlement date, we know the price and the settlement date is in the future.

That's a classic forward, uh, definition.

And, um, so the question then is why do we call it outrights? Well, as we will see in a minute from now, there's a, um, product in FX that is actually the combination between an FX spot and an FX forward trade.

And we call it outright forward, just to make crystal clear that this is a standalone for transaction, not this combination of the two.

So that's at least my, uh, theory as to why this term outright is, is being used.

And the instrument I've just been referring to there, combination between an FX spot and an FX four transaction.

That's what we generally, uh, call an FX swap.

And here word of, uh, caution, you need to be really careful with terminology because there are FX swaps and then there are cross currency swaps.

And while they both share some, uh, element of, you know, some common elements, they're also, uh, fairly distinct in a mechanic.

So don't mix these two up, right? So what is an FX swap? As I said, it's a combination between an FX spot and an FX forward trade.

Um, and that could be something like, or you might hear someone saying, I, um, buy and sell a hundred million euros versus dollars on a, um, six months swap, right? Or six months euro dollar swap. What does that now mean? It means that we have basically agreed to two transactions.

The first one is that we buy a hundred million euros versus dollar at spot, and we would then agree on the spot price.

And we have simultaneously agreed on a transaction where we buy, uh, sorry, we sell, uh, a hundred million euros versus US dollars, and we do that at six months, uh, forward basis as the agreed upon six months forward price.

So that would be the, the classic FX swap transaction.

And now what's interesting when you, when you look at this is that we have basically four cash flows here in this transaction, right? Two of them happening at spot.

That is, we get a hundred million euros and we deliver whatever amount of dollars is required as per the spot rate that we have agreed at the time of trading.

And then six months later we deliver a hundred million euros and we get back whatever amount of dollars is, um, required for our counterpart to pay us through the agreed upon forward rate. And both of these rates, the spot rate and the forward rate will be agreed at inception of the trade IE today, if, you know, we're doing this transaction, uh, today, and that means that we have four cash flows here happening in the future, but none of these cash flows is actually variable.

We know all these cash flows in advance.

This is absolutely free from FX exposure, right? I know exactly how many dollars I have to pay on Tuesday or Wednesday or whenever it is, the settlement for the spot.

And then I know also how many dollars I will get in six months for the a hundred million euros I'm delivering.

And that's regardless of whether Euro dollar, uh, rate will go over time.

And that's interesting, right? Because if you think about both transactions individually, I buy a hundred million euros at spot, that gives me a long position in Euros, right? I'm exposed to Euro losing value against US dollars if I just would sell a hundred million Euros versus dollars on a forward basis.

I'm short euros, right? Because that will give me, um, a short position on euros.

I sold Euros, and it doesn't really matter if I've delivered the Euros already or will do that in six months time.

We've locked in the price.

So both transactions individually have FX exposure, but because the FX directional exposure is, um, you know, the opposite in the first case, were long euros. In the second case, were short euros that almost cancel out, canceled out the entire FX exposure for this combined transaction.

So we have two lags of a trade here, uh, and both are FX products, but the combination is basically a set of cash flows that is, you know, if we're leaving counterparty exposure aside here entirely free, well, not entirely, there's a bit of residual, but you know, virtually no FX exposure left.

And so that then often leads people to believe, well, I don't immediately understand what, why someone would do this.

Um, I'm sure there is a good reason if this product exists, but I am not really, um, perfectly getting it right now.

So my assumption would be this is a bit of a niche product, right? Because we totally get spot transactions, we get for and all that kind of stuff.

FX swaps feels a bit like, yeah, there must be a reason, but probably not.

So, um, frequently used.

That's perfectly fine if you think like this, because that was certainly my expectation when I started thinking about this many, many decades, well, some decades ago.

Um, but when you actually then go into the, uh, data from the bank for international salmon again, and you just break down the trading volume in for an exchange across the different instruments, what you do see is that, yes, okay, spot and outrights are both having reasonably, uh, sizable, um, volumes here.

But the interesting piece is that the light green bar here over the years, right? So consistently from 2001 to 2022, and if we, um, update this for 2025, it won't look different.

The FX swap, the green bar is gonna be the highest contributor to that, uh, daily turnover.

So that's a surprise, right? When you think this is, um, you know, this is something that you say is more niche, maybe, um, but then you actually realize, no, this is niche.

This is probably, you know, this is the dominating, uh, contributor, and that feels kind of strange.

So what we definitely want understand is what's the use case for these products? It is not FX speculation clearly, because there's no a exposure. It can't be really that much hedging either, because for a hedge you need directional exposure.

So it's kind of an interesting one to think about.

I leave you on a cliffhanger though, because we are gonna, um, you know, come up with, or we, we are gonna keep that to the, uh, and anyway, so that's the, um, fact about, uh, the, the product distribution. And then you see that the other two here, the cross currency swaps and the FX options are relatively small in comparison to the others, but of course, it doesn't mean that they are not important and attractive instruments. So let's just quickly talk, uh, through those ones, and in particular the cross currency swap where I already said there are some, uh, common elements between FX swaps and cross currency swaps, but there's also, uh, a different, so FX swap, remember was the exchange of one currency for another at spot, and then the reversal of that exchange basically at the forward, um, points or six months, 12 months after a cross currency swap, uh, is similar in the way that it involves an exchange of currency amounts at spots.

So if we would enter into a cross currency swap, then for example, I would give you, uh, a certain amount of dollars and you would give me a certain amount of euros, right? Uh, and we would have the agreement that I can keep your euros and you can keep my dollars for let's say a period of five years.

And in five years we're gonna reverse, uh, this initial exchange.

So you get your euros back, I get my dollars back.

So it does look a little bit similar to an FX wall where the key difference is, uh, is that over the next five years, we are also gonna exchange interest rate payments.

So because in a way what you could interpret the f uh, the cross currency swap as is, you've given me euros.

That means you lend euros to me, I've given you dollars, which means I lend dollars to you.

And then what you should do is you should me, you should pay me a dollar interest rate on the dollars that I lent you, and I'm gonna pay in return your interest rates on the euros that you lent me over the next five years.

So it is a bit like exchanging a loan in one currency for a loan in another currency, whereas in an FX swap, there is no interest exchange. There's just exchange of one currency, for instance, another at spot.

And then at forward, what is then obviously raising the question, what drives forward rates anyway, and we're gonna come to that, uh, in a minute.

And then of course, just to, uh, complete this product overview, there are FX options and there's quite a range, obviously starting with, uh, plain vanilla puts and calls. And then we have also more exotic pale profiles like barriers and, uh, you know, the whole knockin knockout, um, stuff, and then digitals and, and, and, you know, many, many more variations there in the foreign exchange space.

And that, uh, concludes then the, um, um, first half of our session here, and what we're now gonna do is we're going into, um, the different products and kind of get a little bit more in depth understanding about terminology and, and, uh, you know, some of the jargon, some of the, uh, practicalities.

And so the first thing we're gonna talk about again, is the FX spot quotation.

We know already, um, how this works, but it's, uh, doesn't hurt to go through it one more time.

And also we want to now, um, include bid office spreads, which we haven't done before.

So general rule, ladies and gentlemen, left hand currency.

So the currency that comes first in the quote is commonly for to ask base.

And the second I, on the right hand is a quoted currency.

And the golden rule is quote is given as a number of units in quoted currency per one unit of base.

So a Euro dollar 1 18 80 means one euro equals $1 18 a US cents 80.

Okay? Um, and here you have the example, Euro dollar euro is a base dollar being the quoted currency.

We then have given you here an appropriate quote IE bid and ask.

And, um, now we need to think about, okay, how do I interpret bid and ask then? So as I told you before, the rule is that the first currency is the asset you are buying.

And then the FX rate gives you the price at which you are buying expressed in the quoted currency.

So Euro dollar gives you the price per one euro in dollars, and then we have a bid and we have an ask.

So when you think about stock prices as a market taker, where do you buy this stock? You buy it at the offer, right? And if you're selling the stock, you're selling it at the bid, at least if you use market orders.

And the exact same principle applies in fx, of course.

So if you are looking to buy euros, you're looking to buy the asset.

You, if you are using a market order, would buy at the ask or offer that is 1 9 0 9 53 in this particular quote.

If you're selling euros and you do that with a market order, you're selling on the bid, and that means you will only per Euro sold get 1 0 9 50.

That's exactly how bid ask work in any other instrument.

It just is a little bit more complex in effects to get your head around because of the way, uh, that these numbers are quoted.

And also, you know, the communication is not always done on the Euro basis.

You might have hear someone saying, I wanna sell dollars, and then you have to make, you know, maybe you don't, maybe your brain is different wire differently than mine, but what I would have to do is I had to translate, okay, selling dollars means buying euros.

Where do I buy euros on the, you know, and so on and so forth.

So that is something obviously that you need to go through couple of times and make sure that you can sort of think through this, uh, almost instantly.

Um, but this is, uh, nothing to worry about.

You just kind of will get there automatically once you've done this a couple of times.

So that's certainly, um, no big issue, but it's something that one should expect, will cause a few, um, a few, uh, well will take a few, um, times of, of training or a bit of training.

Okay? So, uh, the next thing is just the terminology.

How do we actually refer to parts of the quote? And, um, as you see here on our slide, the, you know, many cases FX quotes are to five digits.

Uh, and then the general rule is that the last digit is, or the last two digits are basically the points, uh, or pips.

Uh, and then the first three are referred to as a big figure or the handle, or, you know, um, any, any other, uh, term that's appropriate there.

And, um, so that is, you know, to some degree, maybe only really market terminology.

Uh, and it raises the question as to why this is important.

But, you know, once, uh, we get to, to another, uh, product here, you will see that these terms actually matter because they help us to understand exactly what we need to do.

So leave that for now, but the point I'm like to raise is also that we need to understand what one point in an FX pair actually is. And if we're using the euro dollar example, you see we're talking about the forced decimal point here, and that means we need to divide one over 10,000 to get into this measure, measure.

So rule is then for euro dollar one pip or one point equals one over 10,000.

That is not universally applicable because you have other currency pairs like Dian for example, here, uh, that are quoted differently because you know, simply of the weakness of one of the involved currencies. So dollar y at the time we took this example was trading at 1 49 0.0 4, 2 0 5.

And then if you follow the rule that we have, um, seen on the, on the euro dollar example, then these are still the points, right? But now, uh, you can see that because, um, the way the currency pair is quoted a point is not one over 10,000, but it's one over 100.

And, uh, so far this is just a, you know, nice to know technical, uh, piece.

But generally, as I said earlier, we get to a point where this becomes relevant. So just bear with me, um, for a while.

Also, um, you know, when you look at electronic trading platforms, what you realize is that nowadays we have six digits, uh, very often.

Uh, so there's another one edit, uh, and that is almost constantly changing anyway, so you'd hardly ever see this, but that's the Pippa or PT or, you know, like I, I'm not entirely sure, um, how this is called, but uh, generally, um, that is not changing the terminology of points and, um, big figure all that much good.

Um, then quickly on, how do we communicate about moves in currencies? Uh, obviously, um, because we're looking at a pair, we always need to describe how one currency has changed relatively to the other one.

So we Briefly, briefly changed, Uh, here, uh, and, uh, that's all there is to it.

So let's have a look at this concrete example here.

So we have a history of euro dollar over, what is that, three years starting on the 19th of April, 2021.

And, um, you know, it's almost, uh, like we complete a round trip almost, right? Because as I said, we're 1 18 80 at the moment.

So, uh, pretty close to where we started the observation here.

So at the beginning, right at the 19th of April, 2024, we had a quote of, let's say one 20, meaning one euro equals $1 20 US cents, and then, um, couple of months go by.

And then 14 months, 15 months later, um, we, or 16 months, you know, some, something like that.

Uh, we go to 0.9, let's call it nine six, right? Meaning one euro is now only worth, uh, 96 US cents, which then means that relatively to the dollar, the Euro has weakened, or the other way around relatively to Euro, euro, uh, dollar has strengthened, right? Um, and if you really wanna know whether this is Euro weakening or dollar strengthening, what you would have to do, you had to, uh, look at other currency pairs. And if Euro has not just weakened against dollars, but against any other currency, then it's likely a euro weakening.

If dollar has, uh, however, uh, strengthened against everything else as well, then it's probably a dollar strengthening move. It might be combination of those two.

So it's not always a hundred percent crystal clear, but remember we're talking about weakening strengthening and it's always one currency relatively, uh, to the other.

And then when these, um, move was partially reversed there over the next couple of months, that was then in, in time of euro strengthening, uh, and dollar weakening.

But, you know, just take a look at this chart and you, you sort of realize that there are some long term, uh, trends here that one can definitely identify.

And that sort of brings us back to the use case of speculative um, engagement there in the foreign exchange market.

So we have this final and fast rule how to read and interpret, uh, the, the foreign exchange quote.

Now, the big question then is of course, how do we know which currency is named first in the pair and which should be, uh, second? And there are a couple of rules here that will help you with this, although, um, you know, this doesn't explain all the, um, potential FX pairs here that, that you could come across.

So the rule first rule is euro is always base currency.

So euro against any other currency stands on the left, right? Then comes pounds, Aussie dollars, New Zealand dollars, they are always base currency, IE on the left, the first currency in the pair except against euros because it's Euro pounds, Euro, Aussie, dollar euro, New Zealand, right? And then we have the US dollar, uh, is then the base against any currency except Euro pounds, Aussie, and New Zealand dollars.

So these rules I think are universally applicable, but of course the problem starts when you are looking at a currency pair where none of the two currencies is either US dollar, euro pounds or the, or New Zealand dollars.

Then it's not that clear.

And, uh, the general rule of thumb, um, that applies to my knowledge is that the stronger currency tends to be the base currency, and the reason is that we prefer, um, you know, lar or larger numbers as quotes to an FX quote of 0.00001, right? So the stronger currency tends to be the base currency, but I would not blindly rely on this.

Uh, I would just, you know, in case you have any doubt and you haven't been able to validate this, always check with the subject matter experts that have a definite answer to that, uh, question.

Okay, good.

Um, and then the last thing that's, uh, that I wanted to um, briefly mention here in connection with the spot markets is the Carr. And the Carr obviously, you know, is nothing that is a hundred percent specific to foreign exchange.

Um, but it's a pretty, um, often used and often heard term.

Um, and so let's shed some light on what the Kerr means in the FX space.

Generally, the idea here is that you borrow a low yield or in a low yielding currency.

Um, so in the past historically, uh, yen would've been, um, a, a funding currency.

Also the Euro, especially when, uh, interest rates were negative here.

Um, so you know, you borrow in a low yielding currency, you then, um, go into the FX market and exchange this lower yielding currency for a higher yielding currency.

And then you have the money and you invest it in a high yielding interest, uh, in instance bearing instrument.

And then the idea of course is that you have funding costs of relatively close to zero, um, but your investment pays your return of five, 6%, um, you know, dependent obviously, uh, where, and, um, and at which point you have invested this.

Um, and this is of course important to note that this is not a risk-free investment simply because, um, you are exposed to translation risk, IE at some point you have to pay back your borrows in the lower yielding currency, and for that you will have to sell your investment and the currency that you've bought, the higher yielding one.

And of course that means you are exposed to a weakening of this currency in which you have invested your money in. So if you, for example, decided to fund in yen and invest in US dollars, if dollar then subsequently weakens against, uh, Japanese yen, I, the Japanese yen strengthens, that would obviously, um, be eating into your return.

So on a care trade, you are earning the interest rate differential, but as soon as the currency you are invested in, um, weakens, that eats right into your profits, then of course, and can very quickly, um, you know, basically eat off all your profits.

That's therefore, uh, an important thing to be aware of.

So there's more on the reward and risk characteristics here.

I leave this, um, to you to read in your own time, but generally that is the, uh, principle idea.

And with that, we're now going to talk a little bit more about FX forwards.

Um, we have already sort of defined what it is, prices agreed settlement data is agreed.

Uh, so on this slide, all I really want to note is that the forward period, uh, starts actually at the spot date, not at the trade date.

So if we trade, um, you know, six months forward today and today, so the trade date being the 13th of February, this forward transaction will not settle on the 13th of August, 2026, but it will actually settle six months after the spot date, which I believe is Wednesday next week, given that there might be a holiday.

Um, and so that brings us to, what is it, the eighteenths, I believe.

So the 18th of August, 2026 would be the settlement date for our six months forward, assuming that's a weekend.

Um, is that, that's no weekend or no bank holiday.

And then, you know, all the other stuff we have talked about, it's fairly liquid, especially in those round, uh, forward dates one months, 2, 3, 6, 9, 12.

Um, and uh, you know, you have a couple of numbers there that confirm, uh, all this.

Um, but what we're now coming to is, I'm going back to something that we talked about before.

And so that's the relevance of how to interpret points Because you're looking at the Way that FX forwards are, Uh, terminal, get something that three, that's our, Um, spot quotes that we are already familiar with.

And then you go down and you see here six months, and that's relatively intuitive to think that this would be a six months forward.

And then you see something like 89.1.

Now it's the spot rate one, it's hopefully fair to everyone that 89 point ones not the forward price, right? Um, because that would be really, um, bizarre if in the stock model, if you could Get for one, or you could buy one For one euro, you would have to, uh, pay 1 0 9 53, um, but Then on a 6.4 For the same euro would have to pay $59.60.

That, you know, that, Um, doesn't really make a lot of sense.

So it is not the Actual forward price.

Uh, but what is it that, Well, it's what we call forward points and what forward points are just, um, they are just reflecting the number of points by which we have to adjust the spot rate to actually get to the forward price.

Okay? So what this means is if we want to know the six months, um, forward price here in price terms, what we would have to do is take the current spot, which is 1 0 9 50, that's the example we're talking about here now, then adjust it by the six months forward points.

That's 89.1 if we're staying on the bid here for simplicity.

And we would have to divide this because we cannot simply add the points to the FX spot code because we know that a point is actually one over 10,000.

So what we would have to do first is we have to divide 89.1 by 10,000, and then the result we add to our spot rate of 1 0 9 50 and the result is 1 10 39 1.

You can do the same thing on the ask, and we have the bid and ask for, uh, the, uh, six months Forward.

Uh, it gets fairly obvious as to why we should understand how we actually have to read a point. Because if we're now doing the same for dollar in here on the, uh, right hand side and we're seeing 426, um, we shouldn't use 426 26 and divide by 10,000 because that would dramatically underestimate the change because a point in dollar yen is not one over 10,000, it's one over 100.

So we have to divide those points by a hundred, and if we make a mistake there, then obviously we get a dramatically different, um, effect rate and we will price ourselves far out the market, um, because of that mistake.

So that's the adjustment first points divided by the, um, you know, relevant number there.

And then, you know, of course, what we also want to know is, okay, we need to adjust the, the, uh, the, the spot, but do we always add, do we always subtract bullet points? How does it work? Well, now example, your dollar we have added, um, and um, but if you go again to dollar, again, what you see here, there's a negative sign, uh, on the bullet points, which I think is a good indicator that, um, you know, um, that, that we should subtract here.

And there might be some legacy, uh, systems where there are no signs, so there's no plus, no minus, so then you might not be 100% sure.

And in those cases, there's a pretty, um, easy, uh, quick check, and that is if the absolute amount here of the, um, forward points on the left is smaller than on the right, so 89, 10 89 60 left and smaller than right hand, that means we have to add, if the absolute number, uh, on the left is larger than on the right here, the dollar year example, 4 26 to 425, then we have to subtract.

So that's sort of like a quick, um, sense check there that you can apply to just be on safes.

And Nelson might say, okay, cool, we get all this, um, you know, text spot just by forward points and so on and so forth.

Why do we not just quote in, in, uh, forward prices, uh, straight away, right? Well, I, I think, you know, in many systems you just have to toggle, right? You can, you can switch on, uh, whether you wanna see forward points, you wanna see the actual forward prices or both at the same time.

So it's not really, you know, that we only agree or only quote forward points, but I think it's, it's, it's still, uh, something that's very often done in practice. And that's because forward points are relatively sticky in comparison to the spot rate.

So, and, and, and that's something that we need to maybe, uh, shed some light on and that becomes a bit clearer once we understand where the forward, uh, rates are actually coming from.

So let's talk a little bit about that and uh, right, and the starting point, um, for thinking about the fair value of a derivative in many cases actually is the no arbitrage principle, right? Where you then say, or basically use a principle where you say, well, if I have two or more alternatives to achieve the exact same outcome, the price of these two alternatives must be identical because if not, then I buy the cheaper alternative and I sell the more expensive alternative, meaning I have zero position, but I have some risk free profits in my pocket and that should not be possible in efficient markets. That's the starting point, and that is obviously an idealized principle.

It doesn't work in in reality to a hundred percent, but it's a good starting point, right? Um, and so we can use that to conceptually derive where FX forward prices will come from.

So here we're using an example of an investor that's looking to, uh, lock in the purchase price for a hundred million euros versus dollars, uh, on a six months forward basis.

So they want to have a hundred million euros in six months time, they want to deliver dollars in six months time, and they want to know the price today.

And of course, the first alternative that comes to mind is just ask a market maker for their six months euro dollar forward alternative one.

The other alternative is that we can, instead of using a derivative, we could basically just go into the market and buy the a hundred million euros that we need in six months, um, in the spot market because that's the now is the only point in time where we know with absolute certainty where the fx, uh, spot market or where we can trade euros versus dollars in the spot market, and that's at 1 18 80, right? So, or any other currency, uh, any other exchange rate than whatever is applicable at the time.

Um, however, if we do the spot transaction, then t plus two we're gonna get a hundred million euros and we also have to deliver the equivalent amount of dollars, uh, and then we have to do something, right? Because we now have euros that we just need in six months from now. So what are we going to do as euros? We're gonna invest them, we're gonna earn interest on those a hundred million euros and the US dollars we probably do not have, uh, right? So we need to borrow them for the six months period, and that means we have to pay interest on our dollar borrows.

But all these transactions, these borrow dollars for six months, then sell them in the market, buy euros and invest the euros.

That should effectively according to no arbitrage lead to the exact same net result. And that is we have a hundred million euros in six months time at a certain amount of US dollars.

And this should be the exact same then through the, uh, six months forward rate, because if not, there would be arbitrage opportunities.

That of course, ignores transaction costs, but offer and all this sort of things.

But conceptually, this is a good starting point, right? So that leads us to the simple equation that the Euro dollar six months forward should be the same than the future value of our US dollar borrow divided by the future value of our Euro investment.

IE how many euros do we get in six months time and how many dollars do we have to pay in six months time that put in relationship that should be equal to the forward rate.

Sometimes people ask, how do we know we have to divide dollars by euros and not the other way around? Well, that's just because euro dollar is dollars per Euro.

And if you look at it like that, then you need to divide the dollars by euros and not the other way around.

Okay? So then the only thing that's left for us is to think, okay, how do we calculate the future values? And that's relatively easy because we're have a six months, uh, example here.

So, um, you know, we said, okay, we, uh, give you some market data here.

Spot was 1 0 9 50.

We recognize that we have two interest rates, one in dollars, one in Euros, and we know that the six months period here was 182 days.

So then we calculate the future value of the dollar borrow simply by, uh, you know, taking $109.5 million. Where does that come from? Well, it's just a hundred, uh, times 1 0 9 50, um, spot rate, right? Uh, so these 109, um, 109 and a half million dollars we have to borrow, we borrow that at a rate of 5.3 9 5 482 days, and that gives us a certain, uh, future value.

And then we have a hundred million euros invested at 3.7 five four nine four, a hundred eighty two days.

And then we have the two future values.

We put this in relation to each other, and you can see we get the exact same number here then on the, um, previous slide.

Um, and I have to be honest with you though, in the, you know, uh, interest of, of full transparency, we made a couple of tweaks here. We simplified this, uh, obviously a bit.

In reality we would have to include other factors, FX basis, et cetera.

But, uh, that's for another day.

So here we just kind of wanted to show that the general idea of what we call the interest parity, uh, principle, because that's basically the formula we're coming to now.

Um, you know, does a pretty good job in, in, in, in, uh, showing conceptually, uh, how FX forwards, um, should behave.

So basically, you know, what we've said on the previous slide can then be condensed to this, uh, formula.

The FX forward rate is equal to the FX spot rate adjusted by, you know, basically the interest rate differential between the two currencies.

Why do I say that? Well, because imagine we had same interest rates in both currencies. So let's say dollar interest rate was 5%, your interest rate was 5%, then this term would basically equal one.

And then FX forward rate is equal to FX spot rate multiplied with one that means FX forward and the FX spot rate would be the same.

So the explanation as to why FX spot and FX forward rates differ, uh, according to this formula is that there is a differential in interest rates, and we can take more from this.

Uh, we know that, um, you know, here the currency that's lower yielding, um, should appreciate or appreciates on a forward basis.

So let's say here, put the example that was around 5%, right? That was around 3.75%. Well, let's say 5.39%, uh, that was three seven.

So this base currency euro is the lower yielding currency.

And what we can see here now, because the interest rates are different, this term here is larger than one meaning that the FX forward rate equals spot rate multiplied with something larger than one, meaning a higher result.

And that means one 10, uh, rather than 1 0 9.

And that means that on a forward basis, the dollar has actually lost value against euros. That has nothing to do with the expectation the market. That dollar is gonna lose value over the next six months. It's just a result of the six months, uh, interest rate differential that we can see here.

And if you think about it, it's necessary that the dollar depreciates on a forward basis because if it wasn't, then there would be at, in fact, risk-free profits to make. Because what you could do is borrow money in euros at 3 75, then invest in dollars at 5 39, uh, and then hedge the remaining FX rate or the, the FX risk that you normally have to take in a carry trade away by using a forward transaction.

And so if the forward then doesn't correct for this interest rate differential, then of course there would be risk-free profits.

So that conceptually is very sound. It makes a lot of sense.

Practical reality, sometimes there are some sort of like disturbing elements there.

Um, but, uh, generally the direction should be, um, well, the, the, the general conceptual point is, is very, very sound.

Okay. Um, that is the interest rate parity.

Uh, and with that, we now have reached a point where we just want to solve, uh, this big mystery around FX swabs.

What are they used for, right? Because it's that they are not necessarily speculative instruments because certainly you can't speculate on, on fx, uh, all that much.

Um, then, so not really hedging tools.

So what are they used for? And there are many, many use cases as well for those.

But I think the most intuitive one that I want to share with you is that they're used in cash management.

And, um, here we just kind of put ourselves in the shoes of a corporate treasure here.

Um, we're in a globally, um, active company.

So we have, you know, obviously cash accounts in, in many different currencies.

And, and let's say we're looking at our cash forecasts, um, today.

And what we realize is that for the next three months, we have quite a significant, um, surplus on our Euro account and we have a quite significant shortfall on our US dollar account.

And of course, you know, both are not ideal because obviously we need to be able to pay the bills and dollars.

And we also don't really want billions on our Euro accounts sitting out there idle because it doesn't generate any returns.

So we need to think about what to do about this.

And the most natural response, uh, would be, okay, I have euros that I don't need, so I put them in a deposit and earn interest and the dollars I need for six months or three months or whatever.

Um, it's relatively short. So I might use my, um, revolving credit facility to just finance that gap.

There's nothing fundamentally wrong with this.

I would just say it's maybe not the most efficient way of addressing this because think about, you know, your own experience.

Compare the rate at which you are borrow at with a rate you get paid when you're investing money at their bank account.

These are often significantly different.

I'm not saying corporates will have the same rates and you and I have, they might have better conditions, but still they will have a difference between rates they can invest at and rates they can borrow it. And that's natural because when they borrow money from a bank, the bet takes credit risk on them and that needs to be paid.

So that is, uh, obviously the reason why borrow rates are higher than investment rates for all of us, right? So, um, how could we then, um, address this problem a little bit more efficiently? Well, of course we have not just the shortfall in USD, we also have a surplus in euros. And what we could simply do is take the surplus in euros, go to the FX market, sell euros, buy dollars, and with this dollars, we're plugging our dollar funding gap.

If we do nothing else though, um, what we've done is we've introduced FX risk, uh, to ourselves because as we have learned this, um, surplus in euros and the shortfall in dollars is only temporarily three or six months, whatever I said.

Um, so at some point we would have to reverse these transactions, uh, and that then, um, you know, will happen at some unknown, um, spot rate at some point in the future.

So that's not ideal. What do we do then? What's the solution? Well, not only do we exchange our Euros in the spot market for dollars, at the same time, we also agree on reversing that exchange IE giving back the dollars we no longer need as a three or six month point and getting back our Euros that we then, uh, need, um, at the same point at a rate that is already agreed upon today.

So rather than investing euros at a deposit and borrowing dollars through a revolving credit facility, what we're effectively doing here is we're temporarily exchanging our Euro surplus for dollars, plugging our dollar funding hall, uh, and then we have automatically agreed, or not automatically, but we have agreed also on the reversal of the transaction later on.

And then when you think, how is this possible that this leads to a better outcome? Well, conceptually what you can think about it is as this is collateralized boring, right? So if I would just go to a bank and ask for US dollar loan, the bank would take credit risk on me, um, simply because there's no guarantee that I will be able to pay the dollars back in, in, in three or six months time.

But if we're trading an FX swap, not only do I get the dollars from the bank, but I give them euros, right? Meaning even if I don't pay the dollars back at three or six months, they have some euros that's not guaranteed to cover all their losses, but at least, uh, their losses to a certain degree.

So in a way, um, I think a a a nice practical way to think about FX swaps is just a collateralized, uh, borrow transaction, which then should reduce the credit risk for your counterpart and therefore lead to lower funding costs in the currency that you're actually boring.

And that, ladies and gentlemen, was all I wanted to share with you here today, and I hope you found this, uh, beneficial.

Thank you so much for participating.

Uh, thanks also for the questions that you sent in via the q and a, um, function.

I answered them as I went along.

Uh, have a great rest of your Friday, uh, fantastic weekend, and I really hope to have you back on board here in one of our future sessions.

And, uh, remember the feedback form.

Remember, follow up questions, uh, connect, stay in touch.

Um, always happy to, uh, discuss this further.

Thank you so much once again.

Um, bye bye for now and take care.