How are Foreign Currencies Priced?
Now let's take a look at how foreign currencies are quoted and priced. Currencies are designated by three-letter symbols. The standard symbols for some of the most commonly traded currencies are shown below.
|USD||United States dollar|
Currency pairs are often quoted as bid-ask spreads. The first part of the quote is the amount of the quote currency you will receive in exchange for one unit of the base currency (the bid price). The second part of the quote is the amount of the quote currency you must spend for one unit of the base currency (the ask or offer price). For example, a EUR/USD spread of 1.2170/1.2178 means that you can sell one Euro for $1.2170 and buy one Euro for $1.2178. This spread could also be quoted as 1.2170/78.
At first glance, the bid and ask prices may seem backwards to you. That is because they are listed from the dealer's point of view, not from your point of view. The first part of the spread, or the bid, is what the dealer is willing to pay to buy the base currency. So this is the price you will get if you SELL the base currency. In the same way, the second part of the spread, or the ask, is what the dealer is willing to sell the base currency at, so this is the price you will get if you BUY the base currency.
Let's look at another example.
If the USD/CHF spread is listed as 1.2440/1.2443, you can sell one US dollar for 1.2440 Swiss francs and buy one US dollar for 1.2443 Swiss francs.
Remember that the forex market has no central marketplace. The forex dealer determines the execution price, so you are relying on the dealer's integrity for a fair price. There are many interactive brokers of forex, so make sure you research the one you choose to use.
In this currency pair, which is the base currency?
The correct answer is the Canadian dollar, or CAD. Remember, the first currency in a currency pair is the base currency and the second currency is the quote currency
Using this USD/JPY spread (110.45/55), how many Japanese yen would it take to buy one US dollar?
It would take 110.55 yen to purchase one US dollar.
Who determines the execution price—the trader, the dealer or the exchange?
The correct answer is the dealer. Remember that the forex markets we are discussing have no central exchange on which the contracts are traded, and you as the trader have no control over the execution price.