The value of one country’s currency relative to another’s is constantly changing and is known as the exchange rate. Large commercial banks exchange currencies for their own accounts and for the accounts of large banks and commercial customers in the Interbank market. The Interbank market is a large unregulated marketplace where currencies are traded in spot and forward transactions. A spot transaction is an exchange of currencies that will settle in two business days. A forward transaction is an exchange of currencies that will settle on an agreed upon date that is more than two business days in the future. Most forward transactions will settle in either 1, 3, 6, 9 or 12 months. The exchange rate under which the currencies will be exchanged for both spot and forward transactions is agreed upon on the trade date.

Spot Rates

The term spot rate is used by traders and investors to reference or quote the exchange rate between currencies. The spot rate can be quoted in U.S. or European terms. A U.S. quote states the number of U.S. dollars needed to purchase a unit of the relevant foreign currency. If, for example, the British pound is quoted in U.S. terms at 1.75 it takes $1.75 to purchase one British pound. The corresponding European quote would be the reciprocal of the U.S. quote. To find the European terms use the following formula: 1 / U.S. terms. In this case 1/ 1.75 = .571 British pounds are required to purchase one U.S. dollar. Accordingly, the U.S. quote is the reciprocal of the European quote. If a spot rate is quoted in European terms to find the corresponding U.S. quote use the following formula 1 / European terms.

Foreign Currency Options

The value of one currency relative to another constantly fluctuates. The U.S. dollar is the benchmark against which the value of all other currencies is measured. During any given point, one U.S. dollar may buy more or less of another country’s currency. Businesses engaged in international trade can hedge their currency risks through the use of foreign currency options. Foreign currency options may also be used by investors to speculate on the direction of a currency’s value relative to the U.S. dollar.

Foreign Currency Option Basics

As the value of another country’s currency rises, the value of the U.S. dollar falls. As a result, it would now take more U.S. dollars to purchase one unit of that foreign currency. Conversely, if the value of the foreign currency falls, the value of the U.S. dollar will rise and it would now take fewer U.S. dollars to purchase one unit of the foreign currency. The value of foreign currencies is inversely related to each other. U.S. investors can only trade options on the foreign currency. No options trade domestically on the U.S. dollar. Foreign currency options trade on the Philadelphia Stock Exchange or “PHLX” now part of NASDAQ. The exchange sets the strike prices, expiration cycle and the amount of the foreign currency covered under each contract. Foreign currency options settle in the delivery of the foreign currency. To calculate the total premium for a foreign currency option, use the following table:

































Cents per unit


Cents per unit


Cents per unit


Cents per unit


of Cents per unit


Cents per unit









To calculate the total premium, multiply the quoted premium by .01. If the option is for the Japanese yen, multiply the quoted premium by .0001. Once you have determined the quoted premium, multiply it by the number of foreign currency units covered by the contract.


Related Articles
  1. Trading

    The Effects Of Currency Fluctuations On The Economy

    Currency fluctuations are a natural outcome of the floating exchange rate system that is the norm for most major economies.
  2. Investing

    3 Strategies to Mitigate Currency Risk (EUFX)

    Discover the often overlooked risk known as currency risk, and learn three strategies to mitigate or eliminate it in your portfolio.
  3. Trading

    Top 5 Hardest-Hit Currencies

    The value of a country's currency is dependent on many factors that will cause it to fluctuate, relative to other world currencies.
  4. Trading

    How to Calculate an Exchange Rate

    Struggling to get a grasp on exchange rates? Here's what you need to know.
  5. Trading

    The 6 Most-Traded Currencies And Why They're So Popular

    Regardless of the reason, forex is an integral part of 21st century finance. And the more widely used and reliable the currency, the greater the likelihood of people buying and selling it every ...
  6. Trading

    Profiting From a Weak U.S. Dollar

    Learn how to allocate your investments when the U.S. dollar is down.
  7. Personal Finance

    The Worst Place to Exchange Currency

    Exchanging currency is a necessary part of traveling, but not all currency exchanges are created equal.
  8. Trading

    Play Foreign Currencies Against The U.S. Dollar And Win

    Don't panic when the dollar drops. Learn to exploit the greenback's decline and profit from it.
  9. Trading

    How To Lock In An Exchange Rate

    Currency risk can be effectively hedged by locking in an exchange rate through the use of currency futures, forwards, options, or exchange-traded funds.
Frequently Asked Questions
  1. Can coupon in fixed-income security effect bond yield maturity?

    See how fixed-income security investors can expect to use coupon on semi-annual payments if the bond or debt instrument is ...
  2. How are savings bonds taxed?

    Learn who is responsible for reporting U.S. EE savings bond interest for taxation and when the interest can be reported for ...
  3. What is the difference between inflation and deflation?

    Determine how inflation and deflation affect prices, employment, loans, and the central banks. Economies frequently teeter ...
  4. How does the foreign-exchange market trade 24 hours a day?

    Trading in the forex is not done at one central location, but is conducted by phone and electronic communication networks ...
Trading Center