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Foreign exchange is by far the largest financial market in the world. In April 2007, the estimated daily average global turnover was $3,210 billion for traditional markets(spot transactions, outright forwards, and foreign exchange swaps) markets and $2,090 billion for over-the-counter derivatives (bissurvey2007). London remains the global centre accounting for more than a third of all foreign exchange transactions.

Further Reading

Every three years the Bank for International Settlements (BIS) coordinates a global bank survey of foreign exchange markets. At the time of writing, the most recent published survey was (bissurvey2007). It provides a good account of the current state of affairs in global currency markets backed by a wealth of statistical data. The most recent survey is accessible online at

Mechanics of Currency Markets


Foreign exchange practitioners use a large number of technical terms and buzzwords. Many of them are introduced in this chapter. Wherever possible, we strive to give formal definitions; however, sometimes it is more practical to "define" the terms by means of examples. In these cases, the meaning of the terms should be obvious from the context.

Methods of Quotation

Consider a typical foreign exchange rate quote:

EUR/CHF 1.6652

"EUR/CHF" denotes a currency pair. Here "EUR" and "CHF" are the three-letter ISO currency codes for the euro and Swiss frank. The first (left-hand) currency is known as the foreign currency. The second (right-hand) currency is known as the domestic currency. (Note: The foreign currency is sometimes referred to as the base currency or simply base. The domestic currency is sometimes referred to as the variable currency, counter currency or simply counter, quote or quoted currency, or terms currency.)

The foreign currency can be thought of as a "commodity" that is being purchased or sold for "cash", the domestic currency. The quote expresses the value of a single unit of the foreign currency in terms of units of the domestic currency. In our case, the quote is saying that one euro is worth 1.6652 Swiss franks. The number 1.6652 is the exchange rate, or the spot price of EUR in terms of CHF.

When we buy foreign currency for domestic currency we go long or establish a long position. When we sell foreign currency for domestic currency we go short or establish a short position. In each case we enter a trade, which results in an open position. It remains open until it is closed out by entering into an equal and opposite trade. For example, if we are long 300 euros (we have bought them for 300 × 1.6652 Swiss franks), we close the position by selling 300 euros. (Note: Presumably also for 300 × 1.6652 Swiss franks; although FX rates don't tend to stay constant over time.) Thus we no longer have an open position (it is now closed), nor are we long EUR (we are flat).

When we say that we are long EUR/CHF, we mean that we are long EUR (the foreign currency), short CHF (the domestic currency); i.e. we have bought euros for Swiss franks. Similarly, when we say that we are short EUR/CHF, we mean that we are short EUR, long CHF; i.e. we have sold euros for Swiss franks. Thus "long" or "short" is always referring to the foreign currency, our "commodity".

It is, however, uncommon for a broker or market maker to quote the same exchange rate for buying and selling. The quote will usually include two rates. Hence the name, a two-way quote:

EUR/CHF 1.6652/1.6655

The first number, which is almost always smaller, is the bid (pbid); this is the rate at which the quoting broker or market maker is prepared to buy the foreign currency for the domestic currency. The second number, which is almost always larger, is the ask or offer (pask); this is the rate at which the quoting broker or market maker is prepared to sell the foreign currency for the domestic currency. The difference,

s = paskpbid,

is known as the bid-ask spread (sometimes simply spread). In our example, the bid-ask spread is

s = 1.6655 − 1.6652 = 0.0003,

or 3 pips. A point or pip (Note: Pip is an acronym for "percentage-in-point".) is the smallest incremental price movement for a given currency pair in the interbank market. For EUR/CHF it is 0.0001, or exactly one basis point ( \frac{1}{10,000}^\text{th} ).

Although one pip is often equal to one basis point, this is not always the case. For USD/JPY one pip equals 0.01 Japanese yen, not 0.0001.

As in our example, foreign exchange rates are usually quoted to the nearest pip. Sometimes the quote is abbreviated as follows:

EUR/CHF 1.6652/55

Alternatively, since the first few digits are unlikely to change over a short period of time, only the last two digits are given:

EUR/CHF 52/55

This is known as the small figure. The big figure is given by the two digits preceding the last two:

EUR/CHF 66/66



Group of Ten (G10) Currencies

ISO Currency Code Currency Name Country/Entity Symbol HTML Old ISO Currency Code Nickname
AUD Australian dollar Australia       Aussie
CAD Canadian dollar Canada       Loonie, Cad, Canada
CHF Swiss franc Switzerland       Swissy, Swiss
EUR Euro European Union €   Euro
GBP British pound sterling United Kingdom £ £   Sterling
JPY Japanese yen Japan ¥ ¥   Gopher, Yen; GBP/JPY = Geppy
NOK Norwegian krone Norway       Nokee
NZD New Zealand dollar New Zealand       Kiwi
SEK Swedish krona Sweden       Stockee
USD US dollar United states $ $   Dollar; greenback

Emerging Markets (EM) Currencies

ISO Currency Code Currency Name Country/Entity Symbol HTML Old ISO Currency Code Nickname
ARS Argentine peso Argentine        
BRL Brazilian real Brazil        
CLP Chilean peso Chile        
CNY Chinese yuan renminbi China        
CZK Czech koruna Czech Republic     CSK Czech
HKD Hong Kong dollar Hong Kong        
HUF Hungarian forint Hungary        
IDR Indonesian rupiah Indonesia        
ILS Israeli shekel Israel ₪   Shekel
INR Indian rupee India Rp      
ISK Iceland krona Iceland        
KRW South Korean won South Korea ₩    
MXN Mexican peso Mexico     MXP  
MYR Malaysian ringgit Malaysia        
PHP Philippine peso Philippines        
PLN Polish zloty Poland       Poland
RON Romanian new leu Romania     ROL  
RUB Russian ruble Russian Federation        
SGD Singapore dollar Singapore        
SKK Slovak koruna Slovakia        
THB Thai baht Thailand ฿ ฿    
TRY Turkish new lira Turkey     TRL Turkey
TWD Taiwan new dollar Taiwan        
ZAR South African rand South Africa     ZAL  


TODO: Add ISO 4217 to the bibliography.

A standard way to identify the currencies is by their three-letter ISO currency codes (Note: The three-letter ISO currency codes were established by the International Organization for Standardization (ISO) in its international standard ISO 4217. In general, the first two letters of the code are the two letters of ISO 3166-1 alpha-2 country codes and the third is the initial of the currency name. As usual, there are exceptions.}. A full list of ISO currency codes is given in the appendix.

TODO: In which order should we list the currencies?

The currencies are often classified into two groups based on their liquidity. The most liquid currencies are those of the Group of Ten (G10). These currencies, known as the G10 currencies, are United States dollar (USD), euro (EUR), Japanese yen (JPY), pound sterling (GBP), Swiss franc (CHF), Australian dollar (AUD), Canadian dollar (CAD), Swedish krona (SEK), Norwegian krone (NOK), and New Zealand dollar (NZD) (Note: The currencies are listed in the order of the distribution of reported foreign exchange market turnover (bissurvey2007, page 11).) The remaining currencies are known as the EM currencies, where EM stands for "emerging markets". For example, the Hungarian forint (HUF), Turkish lira (TRY), and Chinese yuan (CNY) are EM currencies. There are many more.

The commodity-sensitive currencies are positively correlated with commodity prices. They include the Norwegian krone (oil), Australian dollar (copper), and New Zealand dollar (milk). These currencies are closely linked to growth cycles.

TODO: Pro-cyclical and counter-cyclical currencies

We shall now take a closer look at individual currencies. First the G10, since they are the most liquid, then the EM.

G10 Currencies

United States Dollar (USD)



Japanese Yen (JPY)



The Japanese yen is a low-yielding currency, and as such it is frequently used for carry trades. Investors can borrow the Japanese yen cheaply to fund the purchase of higher-yielding assets, usually currencies such as the Australian dollar or New Zealand dollar. They sell the yen, thus driving it down.

Risk aversion boosts the Japanese yen. When investors are worried about the slowing global economy or equity market sell-offs, they tend to buy the yen acting as a safe haven. Many of these investors are Japanese nationals who historically tend to repatriate their large overseas holdings in times of market distress. Carry trades are usually unwound; yen is bought rather than sold.

For example, following the credit crunch of 2007, yen rallied in the early 2008 despite its relatively weak economic fundamentals. A similar yen rally was observed during the major credit shock of the late 1990s.

Pound Sterling (GBP)



Sterling has historically been the currency most positively correlated to global growth. Global economic slowdowns tend to have a negative effect on its exchange rate. It is a counter-cyclical currency.

Swiss Franc (CHF)



The Swiss franc is negatively correlated with \textit{global growth}. It is generally seen by investors as a safe haven, so in times of global economic slowdowns the franc tends to strengthen. It is a pro-cyclical currency.

Australian Dollar (AUD)



Australia is the world's fourth largest producer of copper after Chile, the United States, and Peru, with mine production estimated to reach 950 million ton per year in 2006 (Source: U.S. Geological Survey, The Australian dollar tends to be positively correlated with copper prices.

Canadian Dollar (CAD)



Swedish Krona (SEK)



Norwegian Krone (NOK)



Norway is one of the world's top oil producers (ranking 10th in 2006 with 2,785 thousand barrels per day) and oil net exporters (ranking 3rd in 2006 with 2,542 thousand barrels per day after Saudi Arabia and Russia) (Source: Energy Information Administration (US), Therefore oil prices exert a major influence on the krone.

New Zealand Dollar (NZD)



New Zealand dollar tends to be correlated with milk prices.

EM Currencies











G10 Trades















Factors Affecting Currency Exchange Rates

Oil Prices

Gold Prices



A foreign currency option is an agreement between two parties, the buyer or holder of the option and the seller or writer of the option, that gives the buyer of the option the right, but not the obligation, to exchange a specified amount (the notional amount or face value) of one currency for another currency on a nominated future date.

A call on currency XXX gives the buyer the right to buy currency XXX (the seller of the option is obliged to sell currency XXX to the buyer if the option is exercised). A put on currency YYY gives the buyer the right to sell currency YYY (the seller of the option is obliged to buy currency YYY from the buyer if the option is exercised).

Of course, a foreign exchange option is written on a currency pair, rather than a single currency, say XXXYYY, where XXX is the foreign currency and YYY is the domestic currency, as usual. Thus each currency option is simultaneously a call and a put: a call on the foreign currency is a put on the domestic currency and vice versa, a put on the foreign currency is a call on the domestic currency.

If we simply say that an option is a call, we mean that it is a call on the foreign currency (Note: Always assume the foreign currency: it is our "commodity", whereas the domestic currency is "cash".) (and a put on the domestic currency). If we say that an option is a put, we mean that is is a put on the foreign currency (and a call on the domestic currency). Thus a USDJPY call is a USD call, JPY put. A USDJPY put is a USD put, JPY call. Yet we prefer to specify explicitly, to avoid confusion: "USD call/JPY put" or "USD put/JPY call", as the case might be.

The premium or option price is the price payable by the buyer to the seller for entering into the option contract. It is set by the seller of the option and is a function of the expiry date, delivery date, strike exchange rate, spot exchange rate, forward exchange rate and the style of the option.

The parties enter an option contract on a trade date (dealing date). The premium is payable by the buyer to the seller on the spot date, which is usually two clear business days after the trade date, although there are exceptions.

The expiry date is the date on which the buyer's right to exercise the option expires. The time of expiry is the time of day that the option expires on the expiry date.

There are two common styles of options. The American style options can be exercised by the buyer at any time on any day up to the expiry time on the expiry date. The European style options can only be exercised on the expiry date and before the expiry time. The date on which the option is exercised is known as the exercise date. For European style options, the exercise date is always the expiry date.

There are other, less common option styles, usually classified as exotic. Asian style options have an exercise price equal to the average price of the underlying asset over a given period. Therefore they do not have a pre-determined strike. Bermudan style options (Note: The island of Bermuda lies between America and Europe. Bermudan style options "lie between" the American and European style options, in the sense that they have the features of both. Hence the name.) can be exercised before the expiry date, like American style options. However, their early exercise is restricted to certain pre-determined dates during the lifetime of the option (usually between a pre-determined early exercise date and the expiry date).

The delivery date is the date on which the exchange of currencies takes place, if the buyer exercises the option. It is usually two clear business days after the expiry date.

Thus for option contracts, there are four dates of importance: trade date, spot date, expiry date and delivery date.

The current spot exchange rate is the exchange rate at the time and on the day the option contract is entered into. The current forward exchange rate is the exchange rate at the time and on the...

To be continued...

Appendix: ISO Currency Codes

Code Num E Currency Locations using this currency
AED 784 2 United Arab Emirates Dirham United Arab Emirates
AFN 971 2 Afghan Afghani Afghanistan
ALL 008 2 Albanian Lek Albania
AMD 051 2 Armenian Dram Armenia
ANG 532 2 Netherlands Antillian Guilder Netherlands Antilles
AOA 973 2 Kwanza Angola
ARS 032 2 Argentine Peso Argentina
AUD 036 2 Australian Dollar Australia, Australian Antarctic Territory, Christmas Island, Cocos (Keeling) Islands, Heard and McDonald Islands, Kiribati, Nauru, Norfolk Island, Tuvalu
AWG 533 2 Aruban Guilder Aruba
AZN 944 2 Azerbaijanian Manat Azerbaijan
BAM 977 2 Convertible Marks Bosnia and Herzegovina
BBD 052 2 Barbados Dollar Barbados
BDT 050 2 Bangladeshi Taka Bangladesh
BGN 975 2 Bulgarian Lev Bulgaria
BHD 048 3 Bahraini Dinar Bahrain
BIF 108 0 Burundian Franc Burundi
BMD 060 2 Bermudian Dollar (customarily known as Bermuda Dollar) Bermuda
BND 096 2 Brunei Dollar Brunei
BOB 068 2 Boliviano Bolivia
BOV 984 2 Bolivian Mvdol (Funds code) Bolivia
BRL 986 2 Brazilian Real Brazil
BSD 044 2 Bahamian Dollar Bahamas
BTN 064 2 Ngultrum Bhutan
BWP 072 2 Botswana Pula Botswana
BYR 974 0 Belarussian Ruble Belarus
BZD 084 2 Belize Dollar Belize
CAD 124 2 Canadian Dollar Canada
CDF 976 2 Franc Congolais Democratic Republic of Congo
CHE 947 2 WIR Euro (complementary currency) Switzerland
CHF 756 2 Swiss Franc Switzerland, Liechtenstein
CHW 948 2 WIR Franc (complementary currency) Switzerland
CLF 990 0 Unidades de formento (Funds code) Chile
CLP 152 0 Chilean Peso Chile
CNY 156 2 Yuan Renminbi Mainland China
COP 170 2 Colombian Peso Colombia
COU 970 2 Unidad de Valor Real Colombia
CRC 188 2 Costa Rican Colon Costa Rica
CUP 192 2 Cuban Peso Cuba
CVE 132 2 Cape Verde Escudo Cape Verde
CYP 196 2 Cyprus Pound Cyprus
CZK 203 2 Czech Koruna Czech Republic
DJF 262 0 Djibouti Franc Djibouti
DKK 208 2 Danish Krone Denmark, Faroe Islands, Greenland
DOP 214 2 Dominican Peso Dominican Republic
DZD 012 2 Algerian Dinar Algeria
EEK 233 2 Kroon Estonia
EGP 818 2 Egyptian Pound Egypt
ERN 232 2 Eritrean Nakfa Eritrea
ETB 230 2 Ethiopian Birr Ethiopia
EUR 978 2 Euro European Union
FJD 242 2 Fiji Dollar Fiji
FKP 238 2 Falkland Islands Pound Falkland Islands
GBP 826 2 Pound Sterling United Kingdom
GEL 981 2 Georgian Lari Georgia
GHS 288 2 Cedi Ghana
GIP 292 2 Gibraltar pound Gibraltar
GMD 270 2 Dalasi Gambia
GNF 324 0 Guinea Franc Guinea
GTQ 320 2 Guatemalan Quetzal Guatemala
GYD 328 2 Guyana Dollar Guyana
HKD 344 2 Hong Kong Dollar Hong Kong Special Administrative Region (People's Republic of China)
HNL 340 2 Honduran Lempira Honduras
HRK 191 2 Croatian Kuna Croatia
HTG 332 2 Haiti Gourde Haiti
HUF 348 2 Forint Hungary
IDR 360 2 Rupiah Indonesia
ILS 376 2 New Israeli Shekel Israel
INR 356 2 Indian Rupee Bhutan, India
IQD 368 3 Iraqi Dinar Iraq
IRR 364 2 Iranian Rial Iran
ISK 352 2 Iceland Krona Iceland
JMD 388 2 Jamaican Dollar Jamaica
JOD 400 3 Jordanian Dinar Jordan
JPY 392 0 Japanese yen Japan
KES 404 2 Kenyan Shilling Kenya
KGS 417 2 Kyrgyzstani Som Kyrgyzstan
KHR 116 2 Riel Cambodia
KMF 174 0 Comoro Franc Comoros
KPW 408 2 North Korean Won North Korea
KRW 410 0 South Korean Won South Korea
KWD 414 3 Kuwaiti Dinar Kuwait
KYD 136 2 Cayman Islands Dollar Cayman Islands
KZT 398 2 Tenge Kazakhstan
LAK 418 2 Lao Kip Laos
LBP 422 2 Lebanese Pound Lebanon
LKR 144 2 Sri Lanka Rupee Sri Lanka
LRD 430 2 Liberian Dollar Liberia
LSL 426 2 Loti Lesotho
LTL 440 2 Lithuanian Litas Lithuania
LVL 428 2 Latvian Lats Latvia
LYD 434 3 Libyan Dinar Libya
MAD 504 2 Moroccan Dirham Morocco, Western Sahara
MDL 498 2 Moldovan Leu Moldova
MGA 969 0 Malagasy Ariary Madagascar
MKD 807 2 Denar Former Yugoslav Republic of Macedonia
MMK 104 2 Kyat Myanmar
MNT 496 2 Tugrik Mongolia
MOP 446 2 Macanese pataca Macau Special Administrative Region (People's Republic of China)
MRO 478 2 Ouguiya Mauritania
MTL 470 2 Maltese Lira Malta
MUR 480 2 Mauritius Rupee Mauritius
MVR 462 2 Rufiyaa Maldives
MWK 454 2 Malawian Kwacha Malawi
MXN 484 2 Mexican Peso Mexico
MXV 979 2 Mexican Unidad de Inversion (UDI) (Funds code) Mexico
MYR 458 2 Malaysian Ringgit Malaysia
MZN 943 2 Mozambican Metical Mozambique
NAD 516 2 Namibian Dollar Namibia
NGN 566 2 Naira Nigeria
NIO 558 2 Cordoba Oro Nicaragua
NOK 578 2 Norwegian Krone Norway
NPR 524 2 Nepalese Rupee Nepal
NZD 554 2 New Zealand Dollar Cook Islands, New Zealand, Niue, Pitcairn, Tokelau
OMR 512 3 Rial Omani Oman
PAB 590 2 Panamanian Balboa Panama
PEN 604 2 Peruvian Nuevo Sol Peru
PGK 598 2 Papua New Guinean Kina Papua New Guinea
PHP 608 2 Philippine Peso Philippines
PKR 586 2 Pakistan Rupee Pakistan
PLN 985 2 Zloty Poland
PYG 600 0 Paraguayan Guarani Paraguay
QAR 634 2 Qatari Rial Qatar
RON 946 2 Romanian New Leu Romania
RSD 941 2 Serbian Dinar Serbia
RUB 643 2 Russian Ruble Russia, Abkhazia, South Ossetia
RWF 646 0 Rwanda Franc Rwanda
SAR 682 2 Saudi Riyal Saudi Arabia
SBD 090 2 Solomon Islands Dollar Solomon Islands
SCR 690 2 Seychelles Rupee Seychelles
SDG 938 2 Sudanese Pound Sudan
SEK 752 2 Swedish Krona Sweden
SGD 702 2 Singapore Dollar Singapore
SHP 654 2 Saint Helena Pound Saint Helena
SKK 703 2 Slovak Koruna Slovakia
SLL 694 2 Leone Sierra Leone
SOS 706 2 Somali Shilling Somalia
SRD 968 2 Surinam Dollar Suriname
STD 678 2 São Tomé and Príncipe Dobra São Tomé and Príncipe
SYP 760 2 Syrian Pound Syria
SZL 748 2 Lilangeni Swaziland
THB 764 2 Baht Thailand
TJS 972 2 Somoni Tajikistan
TMM 795 2 Turkmenistani Manat Turkmenistan
TND 788 3 Tunisian Dinar Tunisia
TOP 776 2 Pa'anga Tonga
TRY 949 2 New Turkish Lira Turkey
TTD 780 2 Trinidad and Tobago Dollar Trinidad and Tobago
TWD 901 2 New Taiwan Dollar Taiwan and other islands that are under the effective control of the Republic of China (ROC)
TZS 834 2 Tanzanian Shilling Tanzania
UAH 980 2 Hryvnia Ukraine
UGX 800 2 Uganda Shilling Uganda
USD 840 2 United States Dollar American Samoa, British Indian Ocean Territory, Ecuador, El Salvador, Guam, Haiti, Marshall Islands, Micronesia, Northern Mariana Islands, Palau, Panama, Puerto Rico, East Timor, Turks and Caicos Islands, United States, Virgin Islands
USN 997 2 United States Dollar (Next day) (Funds code) United States
USS 998 2 United States dollar (Same day) (Funds code) (one source claims it is no longer used, but it is still on the ISO 4217-MA list) United States
UYU 858 2 Peso Uruguayo Uruguay
UZS 860 2 Uzbekistan Som Uzbekistan
VEB 862 2 Venezuelan bolívar Venezuela
VND 704 2 Vietnamese dong Vietnam
VUV 548 0 Vatu Vanuatu
WST 882 2 Samoan Tala Samoa
XAF 950 0 CFA Franc BEAC Cameroon, Central African Republic, Republic of the Congo, Chad, Equatorial Guinea, Gabon
XAG 961 . Silver (one Troy ounce)  
XAU 959 . Gold (one Troy ounce)  
XBA 955 . European Composite Unit (EURCO) (Bonds market unit)  
XBB 956 . European Monetary Unit (E.M.U.-6) (Bonds market unit)  
XBC 957 . European Unit of Account 9 (E.U.A.-9) (Bonds market unit)  
XBD 958 . European Unit of Account 17 (E.U.A.-17) (Bonds market unit)  
XCD 951 2 East Caribbean Dollar Anguilla, Antigua and Barbuda, Dominica, Grenada, Montserrat, Saint Kitts and Nevis, Saint Lucia, Saint Vincent and the Grenadines
XDR 960 . Special Drawing Rights International Monetary Fund
XFO Nil . Gold franc (special settlement currency) Bank for International Settlements
XFU Nil . UIC franc (special settlement currency) International Union of Railways
XOF 952 0 CFA Franc BCEAO Benin, Burkina Faso, Côte d'Ivoire, Guinea-Bissau, Mali, Niger, Senegal, Togo
XPD 964 . Palladium (one Troy ounce)  
XPF 953 0 CFP franc French Polynesia, New Caledonia, Wallis and Futuna
XPT 962 . Platinum (one Troy ounce)  
XTS 963 . Code reserved for testing purposes  
XXX 999 . No currency  
YER 886 2 Yemeni Rial Yemen
ZAR 710 2 South African Rand South Africa
ZMK 894 2 Zambian Kwacha Zambia
ZWD 716 2 Zimbabwe Dollar Zimbabwe
  • E = Number of digits after the decimal point.
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