Currency and Foreign Exchanges

This section discusses currency exchange, exchange rates, and how currency exchange rates are determined based on the direct and indirect currency quotes (also known as the US and European terms, respectively). It also discusses spot rates, forward rates, and cross rates. Why might companies use these tools?

What Is the Purpose of the Foreign Exchange Market?

Currency Arbitrage

Arbitrage is the simultaneous and instantaneous purchase and sale of a currency for a profit. Advances in technology have enabled trading systems to capture slight differences in price and execute a transaction, all within seconds. Previously, arbitrage was conducted by a trader sitting in one city, such as New York, monitoring currency prices on the Bloomberg terminal. Noticing that the value of a euro is cheaper in Hong Kong than in New York, the trader could then buy euros in Hong Kong and sell them in New York for a profit. Today, such transactions are almost all handled by sophisticated computer programs. The programs constantly search different exchanges, identify potential differences, and execute transactions, all within seconds.