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Unit 14: Currency/Forex Market

unit of the base currency for in relation to the quote currency). The bid price is always Notes
smaller than the ask price.

 Unlike conventional equity and debt markets, forex investors have access to large amounts
of leverage, which allows substantial positions to be taken without making a large initial
investment.

 The adoption and elimination of several global currency systems over time led to the
formation of the present currency exchange system, in which most countries use some
measure of floating exchange rates.
 Governments, central banks, banks and other financial institutions, hedgers, and speculators
are the main players in the forex market.

 The main economic theories found in the foreign exchange deal with parity conditions
such as those involving interest rates and inflation.

 Overall, a country’s qualitative and quantitative factors are seen as large influences on its
currency in the forex market.

14.6 Keywords

Ask Price: It refers to the amount of quoted currency that has to be paid in order to buy one unit
of the base currency.
Direct Quote: It is simply a currency pair in which the domestic currency is the base currency.
Forwards Market: In this market contracts are bought and sold OTC between two parties, who
determine the terms of the agreement between themselves.
Indirect Quote: It is a currency pair where the domestic currency is the quoted currency.
Pegging: It occurs when one country directly fixes its exchange rate to a foreign currency so that
the country will have somewhat more stability than a normal float.
Pip: It is the smallest amount a price can move in any currency quote.
Spot Market: This is where currencies are bought and sold according to the current price.

Spread: The difference between the bid price and the ask price is called a spread.
14.7 Review Questions

1. Define currency pair.
2. Distinguish between Forex and Equities.
3. Elaborate the benefits and risks associated with the forex market.
4. Explain the theory of Purchasing Power Parity with relevant example.

5. How are Forwards markets different from Futures markets?
6. What are the main players of the forex market?
7. What do you mean by interest rates?

8. What do you mean by Spreads and Pips? Explain giving suitable examples.
9. What is the effect of Inflation on interest rates?

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