User FAQs

1) What is the term EuroDollar ?
This term refers to US dollar deposits at foreign banks or foreign branches of American banks.
These are basically just regular dollars outside of the US banking system.
The US dollar is the global reserve currency which means this market is the largest (and probably the most important) in the world.
This market influences the price of every type of financial instrument globally.
The EuroDollar market can be thought of as a deposit and loan market for offshore dollars.
This market is practically cashless and is made up of balance sheets.
The reason for the name is because at the beginning most of the dollar denominated deposits were held in European banks.

2) What is the term EuroSterling ?
Also known as europound.
This term refers to UK pound deposits at foreign banks or foreign branches of UK banks.

3) What is the term EuroCurrency ?
This refers to any currency deposited in a bank that is not in the home country where the currency was issued.
For example Japanese yen deposited at a bank in China would be called eurocurrency.

4) Can you describe the different types of Foreign Exchange Derivatives ?
FX Future
FX Swap (different currencies, removes exchange rate risk)
FX Option

5) What exchanges are Foreign Exchange Derivatives traded on ?

6) Can you describe the Foreign Exchange market ?
Largest market, round the clock trading 24 hours a day.

7) What is a Foreign Exchange Future ?
This is a forward contract that locks in an exchange rate.

8) What is a Foreign Exchange Option ?

9) What is a Foreign Exchange Swap (FX Swap) ?
This lets you remove exchange rate risk.
The two cash flows are in different currencies
This is a type of foreign exchange derivative.
There are two legs, a spot transaction and a forward transaction which are entered at the same time for the same Quantity.

A swap that exchanges the principal and interest in one currency for the principal and interest in another currency.

10) Why would you buy an FX Swap ?
This is used to hedge against the fluctuations in exchange rates.

11) Do FX Swaps have any interest rate risk ?
Not really.

12) How long does it take for a Spot FX transaction to settle ?
T + 2 (although some currency pairs are T + 1)

13) Can you give some examples of different types of FX Swaps ?
Spot to Forward -
Forward to Forward -

14) Can you describe the two different cash flows in a FX Swap ?
Lets imagine that we have an amount in Euros and we need to change it into US dollars in 3 months time.
Spot Transaction - The equivalent amount of dollars is bought (using Euros at the current exchange rate).
Forward Transaction - At the end of the contract the same amount of Euros is bought (using Dollars at the agreed forward rate).

15) What is the difference between an FX Swap and an Interest Rate Swap ?
FX swaps are used to hedge exchange rate risk. Both legs are in different currencies. Only swap principal,
Interest rate swaps are used to hedge interest rate risk. Both legs are in the same currency. Only swap interest,

16) What is the difference between an FX Swap and a Cross-Currency Swap ?
FX swaps are used to hedge exchange rate risk. Both legs are in different currencies. Only swap principal,
Cross currency swaps are used to hedge against exchange rate risk AND interest rate risk. Both legs are in different currencies. Swap both interest and principal.

17) Are Exchange Rates mean reverting ?

18) If the Yen/Dollar exchange rate is 110 y/d today and the 1 year forward is 115 y/d, what does that imply ?

19) Can you describe a EuroDollar Future ?
Unless otherwise specified this has a 3 month maturity.

20) How is the price of a EuroDollar Future calculated ?
The prices are determined by the markets forecast of the 3 month USD LIBOR interest rate.
The prices are determined by subtracting the forecasted interest rate from 100.
For example, if on a particular day an investor buys a single three-month contract at 95.00 (implied settlement LIBOR of 5.00%):
if at the close of business on that day, the contract price has risen to 95.01 (implying a LIBOR decrease to 4.99%), US$25 will be paid into the investor's margin account; or
if at the close of business on that day, the contract price has fallen to 94.99 (implying a LIBOR increase to 5.01%), US$25 will be deducted from the investor's margin account.
On the settlement date, the settlement price is determined by the actual LIBOR fixing for that day rather than a market-determined contract price.