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In: Finance

Explain how banks/foreign exchange dealers make money off the bid-ask spread, and why you can have...

Explain how banks/foreign exchange dealers make money off the bid-ask spread, and why you can have two rate quotes on any currency. (Please answer all parts!!!!!!!!!)

Solutions

Expert Solution

Banks and foreign exchange dealers make profit from the spreads between bid and ask rate.

Bid ask spread is the difference between the selling price which is the ask price and the purchasing price which is the bid price of the security. Ask price is a price at which seller is ready to sell and bid price is the price at which buyer is ready to buy, bid ask spread trades can be done in all kinds of securities such as forex, commodity and intrest rate yields. The bid is always lower than the ask price and the spread is the difference between them, in case of the normal market. Dealers make money in every situation of the market. It can make profit in any situation. He earn profit mainly from volatility and spread management. Dealers has to set the bid and ask price:

Dealers mqkes money by looking at the the demand versus supply.

Dealers has to consider quotes from other dealers to set the price in line with the market.

Dealers consider a tight spread, if the spread is too wide, then there will be case of losing orders.

Dealer can build up losses easily in the case of narrow spread.

In case of risky situation, dealer take a higher spread which makes trading expensive for price takers.

Dealer increase the spread to offset the risk.

For money trading, dealers considers fundamental as well as technical indicators that give signals when to buy or sell and also allows to make profit in times of high risky situation.

Two rate quotes on any currency

There are direct and indirect quotes and these are used in exchange rate quotes. In Direct quotes, variable units of home currency equal to a fixed unit of foreign cuurency are quoted. In indirect quotes, the variable units of foreign currency equal to home currency are quoted.


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