Handbook of Multi-Commodity Markets and Products: Structuring, Trading and Risk Management

CHAPTER 10 Foreign Exchange Markets and Products

Antonio Castagna

10.1 THE FX MARKET

The foreign exchange (FX) market is an over-the-counter (OTC) market where each participant trades directly with others; there is no exchange, though we can identify some major geographic trading centres: London (the primary centre, where majors market makers are located; its importance increased in the last few years), New York, Tokyo, Singapore, Sidney. This means that trading activity is 24 hours a day, though in practice during London working hours the market has the greatest level of liquidity. Needless to say, the FX market experiences fierce competition amongst participants.

10.1.1 FX Rates and Spot Contracts

Definition 10.1.1 FX rate. An exchange (FX) rate is the price of one currency in terms of another currency; the two currencies make a pair. The pair is named by a label comprising two tags of three characters: each currency is identified by its tag. The first tag in the exchange rate is the base currency, the second is the numeraire currency. So the FX is the price of the base currency in terms of the numeraire currency.

The numeraire currency can be considered as domestic: actually, in what follows we will refer to it as that. The base currency can be regarded as an asset whose trading generates profits and/or losses in terms of the domestic currency. In what follows, the base currency will also be referred to as the foreign currency. We would like to stress that these denominations ...