82 CHAPTER 3. SPOT MARKETS FOR FOREIGN CURRENCY
Example 3.7
Suppose that you read the following quote on the Reuters screen:usd/cad1.000-
1.005.
Q1. What is the bank’s buying and selling rate forcad?
A1. The bank’s buying rate forcadisusd1.000 and its selling rate isusd1.005;
that is,yousellcadatusd1.000 and buy at 1.005.
Q2. What, therefore, are the bank’s buying and selling rates forusd(incad)?
A2. The bank’s buying rate or bid forusdis 1/1.005 =cad/usd0.995025 (probably
rounded to 0.9950) and the selling rate or ask is 1/1.000 = 1.000; that is, wearing
your Canadian hat,yousellusdatcad0.9950 and buy at 1.000.
One corollary is that in countries like theuk, where the reverse or indirect quote
is used, the rate relevant when you buy is the lower of the two, while the higher
quote is the relevant rate when you sell. Thus, it is important to be aware of what
the foreign currency is, and what convention is being used for quoting the exchange
rate. Again, it is always easier and more convenient to have the foreign currency in
the denominator. That way the usual logic will work: banks buy low and sell high.
3.2 Major Markets for Foreign Exchange
In this section, we describe the size and structure of the exchange market and the
type of transactions one can make in this market.
3.2.1 How Exchange Markets Work
The foreign exchange market is not an organized market. Stock markets or futures
markets are: they have fixed opening hours, a more or less centralized mechanism to
match supply and demand, standardized contracts, an official publication channel
for data on volumes and prices, and a specific location or one designated group of
computers running everything. In contrast, the exchange market consists of a whole-
sale tier, which is an informal network of about 500 banks and currency brokerages
that deal with each other and with large corporations, and a retail tier, where you
and I buy and sell foreign exchange. At any point in time, wholesale exchange mar-
kets on at least one continent are active, so that the world-wide exchange market is
open twenty-four hours a day (see Figure 3.4). Until the mid-90s, most interbank
dealing was done over the telephone; most conversations were taperecorded, and
later confirmed by mail, telex, or fax. Reuters—which was already omnipresent
with its information screens—andEBS^6 have now built computer networks which
(^6) EBS(Electronic Broking Services) was created by a partnership of the world’s largest foreign
exchange market-making banks. Approximatelyusd125 billion in spot foreign exchange transac-