Foreign Exchange —
The world's biggest market.

A spot FX trade is an agreement between two parties to exchange a specified amount of one currency for another at the prevailing spot rate, with settlement in two business days (T+2 for most pairs; USD/CAD settles T+1).

The FX rate is quoted as the amount of the pricing currency per one unit of the base currency. EUR/USD at 1.0850 means one euro buys 1.0850 US dollars.

Settlement flows through CLS (Continuous Linked Settlement), a multilateral system that simultaneously settles both legs of a trade — eliminating the bilateral settlement risk that existed historically when one party would pay out before receiving. CLS clears roughly $6 trillion of trades daily across 18 currencies and has largely eliminated principal risk from FX settlement.

Roughly 30% of FX volume is spot. FX swaps (~45%) and forwards (~15%) make up the bulk of the remainder — spot is the most visible segment but not the largest.

An FX quote shows the amount of the pricing currency per one unit of the base currency. The base currency is always listed first. EUR/USD = 1.0850 means one euro buys 1.0850 US dollars.

In dealer quoting, the rate splits into two components: the big figure (e.g. 1.08 — both sides know this, usually not spoken aloud) and the pips, the last two decimal places that form the bid-ask spread. A dealer quoting "50–55" on EUR/USD means they buy euros at 1.0850 and sell euros at 1.0855. The 5-pip spread is their compensation for providing liquidity.

A pip is the smallest conventional price increment — $0.0001 for most USD pairs, 0.01 for USD/JPY (since yen trade in smaller fractions). A 10-pip move on a €1 million position is $1,000.

The bid is always the lower number (dealer buys the base cheaply); the ask is higher (dealer sells the base expensively). This holds regardless of direction.

The three main categories are spot, forward, and FX swap:

• Spot (~30%): Exchange of currencies at the current rate, settling T+2. The price reference for all other FX instruments.
• Forward (~15%): An agreement to exchange currencies at a fixed rate on a future date. The forward rate is mechanically derived from the interest rate differential between the two currencies — it is not a market forecast of where spot will be. Forward maturities from a few days to several years.
• FX swap (~45%): A simultaneous spot purchase and forward sale (or vice versa) of the same notional. The client effectively lends one currency and borrows another for a defined period. FX swaps are the largest segment by volume because banks and corporates use them constantly to manage short-term currency funding — rolling positions from one date to another without taking outright FX risk.

FX options account for approximately 5–10% of volume. The right but not the obligation to exchange currencies at a set rate — used for hedging tail risk or expressing directional views with defined downside.

The most important framing: FX is always relative. A currency does not strengthen in isolation — it moves against something else. So every FX move reflects the relative balance of forces between two economies:

• Interest rate differentials: Higher rates attract capital inflows, increasing demand for the currency. This is the dominant short-to-medium term driver. The Fed hiking rates sharply relative to the ECB drove the dollar significantly higher in 2022. In 2025–26, the pace of ECB easing versus a cautious Fed is the main EUR/USD driver.
• Inflation differentials: Higher inflation erodes purchasing power and depreciates a currency over time. Purchasing Power Parity (PPP) predicts long-run exchange rate levels based on price differentials — it works over decades, not months.
• Growth differentials: Stronger GDP growth attracts investment inflows. Risk-on environments strengthen higher-yielding currencies (AUD, EM) and weaken safe havens (JPY, CHF, USD).
• Political and geopolitical risk: Political instability or sanctions risk drives capital flight. The pound fell sharply in September 2022 when the Truss government's mini-budget raised fiscal credibility concerns.
• Current account dynamics: Large trade deficits create structural selling pressure on a currency over time — the US dollar's resilience despite persistent deficits is partly explained by its reserve currency status.

No single factor dominates all the time — the regime shifts. That is why FX is difficult and why so many experienced FX traders end up at global macro funds.

A cross rate is any FX rate that does not involve USD on either side. EUR/GBP and EUR/JPY are crosses; EUR/USD and GBP/USD are majors. Most global FX pairs are priced through USD as an intermediate currency, so crosses are calculated rather than quoted directly in many cases.

The calculation uses the two USD-based rates:

• EUR/USD = 1.0850 (one euro buys 1.0850 dollars)
• GBP/USD = 1.2700 (one pound buys 1.2700 dollars)
• EUR/GBP = EUR/USD ÷ GBP/USD = 1.0850 ÷ 1.2700 = 0.8543

So one euro buys 0.8543 pounds. If the EUR/GBP market rate diverges from this cross-implied rate, an arbitrage opportunity exists — though in liquid pairs this closes in milliseconds. In less liquid EM crosses, the arbitrage window can be wider and represents genuine opportunity.

In practice, London dealers make direct markets in EUR/GBP without going through USD — the volume is large enough to support direct market-making. But the USD cross remains the theoretical reference for fair value.

FX markets are decentralised — no central exchange. Trading happens across a network of dealers, platforms, and bilateral relationships. Main participants:

• Banks: The dominant market makers. The top five banks (JPMorgan, Deutsche Bank, Barclays, UBS, Citi) typically control 35–50% of volume in any given year per Euromoney league tables. They trade on behalf of clients and run proprietary positions within regulatory limits.
• Central banks: Intervene to manage currency levels or stability. The Bank of Japan is the most active G10 central bank in FX intervention, having spent over $60bn defending the yen in 2022. Some central banks hold large FX reserves to maintain currency pegs (Saudi Arabia, China's managed float).
• Corporates: Hedge transactional FX exposure from international operations. A UK exporter receiving USD revenue buys GBP/USD forwards to lock in the exchange rate. This is core client flow on an FX sales desk.
• Asset managers and hedge funds: Take directional and hedging positions. Global macro funds are the most active — they take large currency views based on macro analysis and are often on the other side of central bank intervention attempts.

London dominates geographically at 35–40% of global volume. New York is second at roughly 20%, followed by Singapore, Hong Kong, and Tokyo.

The forward FX rate is derived from covered interest rate parity — the principle that you cannot earn a risk-free profit by borrowing in a low-rate currency, converting to a high-rate currency, investing, and hedging the FX exposure back. If you could, arbitrageurs would eliminate it immediately.

The formula: Forward = Spot × (1 + base currency rate) / (1 + pricing currency rate)

Example: EUR/USD spot = 1.0850. EUR 1-year rate = 3.5%. USD 1-year rate = 5.0%.

Forward = 1.0850 × (1.035 / 1.05) = 1.0850 × 0.9857 ≈ 1.0695

The forward EUR/USD is lower than spot — the dollar trades at a forward premium because USD rates are higher. This is not a prediction that EUR/USD will fall to 1.0695. It is an arbitrage-enforced mathematical relationship.

In practice, the difference between spot and forward is quoted as forward points (pips). In this example roughly -155 pips, added to or subtracted from spot to get the outright forward rate.

An FX swap combines a spot transaction with a forward transaction in the opposite direction, for the same notional amount and currency pair. Example: buy €10m against USD today at spot (1.0850), simultaneously agree to sell €10m against USD in three months at the forward rate (say 1.0810). The two legs net out the FX exposure — the client ends up where they started in currency terms — but has effectively borrowed USD and lent EUR for three months.

FX swaps are fundamentally a short-term funding and liquidity management tool, not a directional currency trade. Banks use them daily to fund their currency positions. Corporates use them to temporarily convert cash held in one currency into another for operational needs, with a known return date and price. Central banks use swap lines to provide dollar liquidity to foreign banking systems in stress.

Key differences from a forward:

• A forward is a single transaction settling on a future date — it creates outright FX risk.
• An FX swap is two transactions (spot + forward) that net to zero FX exposure but create a funding relationship. No directional FX risk is taken.

FX swaps account for roughly 45% of total FX volume — more than spot — because the global financial system constantly needs to roll currency positions and manage short-term funding across currencies.

Corporate FX clients trade to manage genuine business exposures, not to speculate. Main use cases:

• Hedging transactional exposure: A UK exporter invoicing US customers in USD receives dollars quarterly. To eliminate the risk that GBP/USD moves before conversion, they sell USD/buy GBP forward, locking in a known exchange rate. This is the bread-and-butter flow on an FX sales desk.
• Repatriation of overseas earnings: A FTSE 100 company with US revenues converts dollars to sterling for accounts and dividend payments. This creates regular, predictable USD selling flow.
• Issuing debt in a foreign currency: A European corporate can sometimes borrow more cheaply in USD than EUR if US investors accept a tighter spread. They swap the dollar proceeds back to euros using a cross-currency swap — total cost may be lower than issuing in euros directly.
• Locking in CapEx costs abroad: A company building a factory in Japan needs JPY at a future date. They buy JPY forward today to eliminate the FX risk over the construction period, allowing accurate budgeting.
• Balance sheet hedging: Companies with foreign assets or liabilities hedge the FX exposure to prevent accounting volatility from affecting reported financials each quarter.

Covered interest rate parity says the FX swap should reflect the interest rate differential exactly. In practice, it often does not. The deviation is called the cross-currency basis.

A negative EUR/USD basis (persistent for years) means EUR investors must pay an additional premium — above what interest rate parity would imply — to borrow dollars through the FX swap market. This arises when there is excess demand for dollar funding relative to willing dollar lenders.

The basis widens sharply in stress. During the 2008 financial crisis, the 2020 COVID shock, and various episodes of dollar funding pressure, the EUR/USD basis reached -100 to -200 basis points. This signals structural dollar scarcity — European banks desperately need dollars but cannot get them at the parity-implied price. The Fed's dollar swap lines with the ECB, Bank of England, and Bank of Japan were specifically designed to alleviate this by providing a direct source of dollar liquidity to foreign central banks, who on-lend to domestic banks.

For corporate issuers, the basis determines whether it is cheaper to issue in USD and swap to EUR, or issue directly in EUR. When basis is very negative, the swap cost erodes the advantage of issuing in dollars. For hedge funds and prop desks, a persistently wide basis creates relative value opportunities.

An FX call gives the buyer the right, not the obligation, to buy the base currency at the strike on or before expiry. An FX put gives the right to sell. The buyer pays a premium to the seller for this optionality.

Example: a UK importer must pay €5m in three months. They buy a EUR call/GBP put struck at 0.8600 (EUR/GBP) — the right to buy euros at that rate. If EUR has strengthened to 0.9000 by expiry, they exercise and save on the exchange. If EUR has weakened, they let the option lapse and buy euros in spot cheaper, losing only the premium.

Key differences from equity options:

• OTC bilateral: Primarily traded bilaterally between counterparties, not on exchanges. No standardised contract sizes or expiry dates.
• Vol-quoting convention: FX options are typically quoted in implied volatility, not dollar premium. Both sides agree on the vol; the dollar premium is computed from the pricing model.
• Two interest rates: Both domestic and foreign interest rates affect option pricing — unlike equity options where only one risk-free rate applies.
• Longer maturities available: FX options trade out to 10 years in major pairs, far longer than typical equity options. Corporate hedging demand for multi-year FX exposure drives this.

USD is by far the most common base currency, involved in over 90% of FX option volume. EUR/USD, USD/JPY, GBP/USD, USD/CHF, and AUD/USD are the most liquid pairs for options.

The most active maturities are one week to three months, where most corporate hedging and speculative activity concentrates. However, FX options trade out to ten years or more in major currency pairs — a significantly longer horizon than typical equity option markets. This reflects genuine corporate and project finance demand for long-dated hedges: a company building infrastructure abroad over five years needs FX protection for the full duration.

Beyond two to three years, liquidity thins and bid-ask spreads widen. At these maturities, the vol assumption dominates all pricing — getting long-dated implied vol right matters far more than spot moves. These markets are primarily institutional.

FX options are predominantly OTC through dealers, though some standardised short-dated contracts trade on the CME and ICE for the most liquid pairs.

The global FX market turns over approximately $7–8 trillion per day (BIS Triennial Survey) — far larger than equities (~$500bn/day) or bond markets (~$1tn/day). The size reflects three structural drivers:

• Globalisation: Multi-national companies constantly hedge and convert currency as they operate across borders. As global trade has expanded over the past 30 years, transactional FX demand has grown with it.
• Currency liberalisation: Most major economies moved from pegged to free-floating currencies over the past 40 years. Free-floating means prices change continuously, creating constant hedging and speculative demand. Britain's forced exit from the ERM in 1992 — George Soros's famous trade — is a landmark example of a semi-peg collapsing under speculative pressure.
• Technology: Electronic trading platforms have made FX accessible 24 hours a day to a far broader range of participants — corporates, asset managers, retail — not just interbank flows.

Volume breakdown: roughly 30% spot, 45% FX swaps (the dominant segment, driven by bank funding), 15% forwards, 5% options, 5% other.

A carry trade involves borrowing in a low-interest-rate currency and investing in a high-interest-rate currency to earn the differential — the "carry." Classic example: borrow JPY at near-zero rates, convert to USD, invest in US Treasuries at 4–5%. The gross carry is 4–5% per year as long as exchange rates stay roughly stable.

The risks:

• Sudden reversal / crash risk: Carry trades are crowded — many funds run the same trade. When they unwind, they all sell the high-yielding currency simultaneously, causing sharp moves that exceed the carry earned. The August 2024 yen carry unwind was dramatic: USD/JPY fell from 157 to 142 in days as BoJ rate hike expectations forced mass deleveraging across the trade.
• Risk-off environments: In market stress, investors flee to safe havens — JPY and CHF — exactly the currencies being borrowed. Carry trades lose money precisely when the rest of the portfolio is also stressed, amplifying overall losses.
• Uncovered interest parity failure: Theory says higher-rate currencies should depreciate to offset the carry advantage. In practice they often do not — UIP is one of the most documented failures in international finance. But when it does hold, it holds violently: carry trades earn slowly and lose fast.

Central banks intervene when their currency moves to levels deemed disorderly or inconsistent with economic stability. Methods range from symbolic to substantial:

• Verbal intervention: Officials signal concern through speeches or press conferences, hoping market expectation alone moves rates. Less costly but less credible if not backed by action.
• Direct market intervention: The central bank buys or sells its own currency outright. Japan has been the most active G10 central bank in this respect — the Bank of Japan spent over $60bn defending the yen in 2022 when USD/JPY approached 152, and intervened again in 2024 near 160. The effectiveness depends on whether the intervention goes with or against the underlying trend.
• Coordinated intervention: Multiple central banks act together. This is far more credible — the G7 coordinated yen intervention in 2011 after the Tohoku earthquake is a recent example.
• Policy rate adjustment: The most powerful tool. Higher rates attract capital inflows and strengthen a currency. Switzerland's SNB went sharply negative on rates partly to suppress CHF appreciation against EUR.

Intervention against fundamental trend moves rarely succeeds for long. Against disorderly, thin-market volatility it can stabilise conditions. The consensus view is that intervention buys time but cannot reverse structural currency moves driven by macroeconomic fundamentals.

Purchasing Power Parity (PPP) is a theory of long-run exchange rate determination: in equilibrium, exchange rates should adjust so that identical goods cost the same across countries in a common currency. If a basket of goods costs $100 in the US and £80 in the UK, PPP implies GBP/USD should be 1.25. If it trades at 1.40, sterling is overvalued against PPP.

The Economist's Big Mac Index is a famous popularisation — it tracks Big Mac prices globally as a light-hearted PPP measure and has run since 1986.

In practice, PPP works poorly in the short run and reasonably well over decades. The reasons for short-run failure:

• Many goods and services (haircuts, real estate, restaurants) are not internationally tradeable, so their prices can diverge indefinitely without creating arbitrage pressure.
• Transaction costs, tariffs, and trade barriers prevent price equalisation even for tradeable goods.
• Capital flows — driven by interest rate differentials, risk appetite, and geopolitics — dominate short-run FX far more than trade flows or price levels.

The honest assessment: PPP is a useful long-run valuation framework but useless for trading on a one-year or shorter horizon. It tells you roughly where a currency should eventually end up, not when or from where.

A flexible (floating) exchange rate is determined by supply and demand. The central bank does not target a specific level. Most major economies operate floating rates: USD, EUR, GBP, JPY, AUD all float freely. The Bank of Japan may intervene occasionally but does not commit to maintaining a specific USD/JPY level.

A fixed (pegged) exchange rate requires the central bank to maintain the currency at a specific rate against a reference, using FX reserves to absorb pressure:

• Saudi Arabia (SAR/USD): The riyal has been pegged to the dollar at 3.75 since 1986. Saudi Arabia's large USD oil revenues fund the reserves needed to defend the peg.
• Hong Kong (HKD/USD): A currency board system since 1983 — the monetary base is fully backed by USD reserves, making this one of the most credible pegs in the world.
• China (RMB): A managed float — the RMB moves within a daily band set by the PBOC, which adjusts the central rate each morning. Not a hard peg but not a free float either.

The fundamental tension: pegged currencies sacrifice monetary policy independence (you must mirror your anchor currency's policy) but gain exchange rate certainty. Britain's forced exit from the ERM in September 1992 — when sterling could not sustain its Deutschmark peg under speculative attack — is the textbook example of peg failure.

As interest rates in a currency fall relative to the other currency in the pair, the forward rate for that currency goes up (the currency trades at a forward premium).

Working through the logic: recall the forward formula — Forward = Spot × (1 + base rate) / (1 + pricing rate). If the base currency's interest rate falls, the numerator shrinks. The forward rate falls (the base currency weakens in forward terms).

Equivalently: if the pricing currency's interest rate falls, the denominator shrinks, and the forward rate rises (the base currency strengthens in forward terms).

Practical example: if the ECB cuts rates aggressively while the Fed holds, USD rates are relatively higher than EUR rates. Forward USD trades at a premium — the EUR/USD forward rate is lower than spot. A European investor locking in a forward EUR/USD sale (selling dollars forward) does so at a worse rate than spot, because the market compensates them for holding higher-yielding USD now.

This is the core mechanism by which interest rate differentials express themselves in FX forward markets — and why watching central bank divergence is so important for FX trading and sales.

Always know the current EUR/USD rate before walking into any FX interview. This question tests whether you actually follow the market. A strong answer structure:

State the level: "EUR/USD is currently around [X], having moved from [Y] since [key event/time period] driven primarily by [dominant factor]."

Give the framework: "The dominant driver right now is the rate differential between the Fed and ECB. The ECB has been more aggressive in its easing cycle relative to the Fed's cautious approach — this keeps the dollar relatively well supported."

State a view: "I'd expect EUR/USD to remain range-bound near-term. The key upside risk to EUR would be US growth disappointing — pushing rate expectations lower and weakening the dollar. The key downside risk to EUR is further ECB cutting or a deterioration in European growth, particularly if tariff escalation hits German manufacturing exports."

Hedge appropriately without retreating: "There is a lot of political uncertainty — trade policy in particular could drive sharp moves. But given the current rate differential, I lean slightly dollar-supportive on a 3-month view."

Interviewers are not expecting you to be right. They want to see you form and communicate a coherent market view with conviction, while acknowledging the key risks to that view.

GBP/USD (cable) is one of the most closely watched rates in London markets and is often tested in UK desk interviews. Key drivers to know:

Bank of England policy relative to the Fed: The dominant near-term driver. If the BoE cuts faster than the Fed, GBP weakens against USD. The UK's services inflation trajectory — whether it falls enough to give the MPC cover to cut — is the critical domestic variable to track.

UK growth and fiscal credibility: UK real GDP growth has been sluggish relative to the US. The Truss mini-budget episode in September 2022 — where a £45bn unfunded tax cut triggered a gilt crisis and forced sterling sharply lower — showed that UK fiscal credibility can become a GBP-negative factor almost overnight. Gilt yields and currency stability are linked.

Broad dollar dynamics: Much of cable's movement reflects USD broadly. When dollar strength is the dominant global theme, cable falls regardless of UK-specific news.

UK-US trade relationship: Post-Brexit trade dynamics with both the US and EU remain relevant. Any material tariff or trade agreement development between the UK and US would move sterling.

State where cable is, give a view based on the dominant driver, and name one or two specific near-term catalysts (upcoming BoE or Fed decisions, UK employment/inflation data).

QE involves a central bank purchasing government bonds to inject reserves and push down long-term interest rates. FX effects flow through several channels:

• Interest rate channel: QE lowers long-end yields, reducing the interest rate differential with other currencies and making the currency less attractive to foreign capital — pushing it weaker. When the Fed launched QE in 2020, the dollar initially fell as US yields dropped relative to peers.
• Portfolio rebalancing: QE forces domestic investors out of government bonds (which are being purchased) into higher-yielding assets, some of which are foreign. Capital outflows weaken the currency.
• Inflation expectations: QE raises inflation expectations, eroding real yields and weakening the currency on a purchasing power basis over time.
• Risk-on effect: QE supports risk assets broadly. Risk-on sentiment strengthens higher-yielding currencies (AUD, EM) and weakens safe havens (JPY, CHF, USD) — which can paradoxically weaken the USD even when the Fed is running QE.

In practice, what matters is relative QE. The 2020–2021 period saw the Fed run the largest QE programme in history, yet the dollar strengthened significantly against EM currencies — because US growth outperformed and the Fed tightened first. Absolute scale of QE is less important than how it compares to what other central banks are doing simultaneously.

This tests whether you think like a salesperson rather than a product manual. Strong answer structure:

Start with the client, not the product: "Before recommending anything, I'd want to understand the exposure — what is the size, exactly when is the receivable due, and does the client have any existing hedges or natural USD offsets from USD costs? Also, what is their functional reporting currency?"

Understand risk appetite: "Are they comfortable with some FX exposure if it means potentially benefiting from a favourable USD move? Or do they need certainty — for example, if the USD proceeds are funding a specific GBP commitment?"

Present options clearly:

• Forward: Sell USD/buy GBP forward at the six-month forward rate. Complete certainty, zero flexibility. Most appropriate for clients who need to budget precisely.
• USD put/GBP call option: Protection if GBP strengthens (USD buys fewer pounds), while retaining upside if GBP weakens. The cost is the premium — typically 0.5–2% of notional for a six-month ATM option.
• Participating forward: A structured product giving partial participation in a favourable move while still providing downside protection. Zero premium but more complex to explain.

Give a recommendation: "For most corporate clients wanting clarity, the forward is the simplest and most transparent solution. If they want to retain some upside and can absorb a premium cost, a vanilla option is a clean alternative."

London handles 35–40% of global FX volume — more than the next four centres combined. The reasons are structural and mutually reinforcing:

• Time zone: London's hours overlap with both Asia (morning) and the US (afternoon). The 1–5pm London / 8am–noon New York overlap is when the most liquid FX trading globally occurs. No other major centre occupies this bridging position.
• Historical depth: London has been the pre-eminent financial centre for over a century, building expertise, talent, legal infrastructure, and client relationships that compound over time.
• Legal infrastructure: English law governs the vast majority of global FX contracts — the ISDA master agreement is most commonly English law. This creates a legal infrastructure advantage that is genuinely hard to replicate.
• Network effects: FX desks want to be where other FX desks are. Once a market reaches critical mass in a geography, displacing it requires enormous incentive.

Post-Brexit, there was significant concern about euro-denominated derivatives clearing shifting to the EU. The shift has been smaller than predicted — London's structural advantages have proven resilient. The EU continues to push for euro clearing to be mandated onshore, creating medium-term uncertainty for London's share of that specific market. But for spot and forward FX more broadly, London's position remains dominant.

Yes — a forward-starting FX swap has both legs starting in the future. For example, a company enters into a 3-months-into-3-months swap: sell USD/buy EUR starting in three months, maturing in six months. This hedges a currency need that arises at a future date rather than immediately.

The additional risk is straightforward: in a standard spot-start swap, the near leg (spot) and far leg (forward) perfectly offset each other from day one — no net FX exposure. A forward-starting swap does not have this feature. The bank is effectively carrying an outstanding forward position from today until the start date of the swap, which must be separately hedged using a matching forward in the market.

This creates added complexity in pricing: the dealer must hedge the stub period FX risk in addition to applying the standard interest rate differential pricing for the swap legs. Bid-offer spreads on forward-starting swaps are typically wider than spot-start equivalents to reflect this additional management cost.

The main advantage of an FX swap over a forward is the risk profile. A forward creates outright FX exposure — the client is locked into buying or selling a currency at a future date, and if the spot rate moves against them in the meantime, the mark-to-market loss on the forward grows. While this is offset by the gain on the underlying exposure being hedged, the accounting and collateral implications can be significant for some clients.

An FX swap, by contrast, leaves the client with only interest rate risk. The spot purchase and forward sale net to zero FX exposure. The client has effectively lent one currency and borrowed another — the residual risk is the interest rate differential changing over the life of the swap, not the exchange rate itself.

For clients wanting to fund short-term currency needs without taking FX risk — for example, a bank funding its EUR loan book using USD deposits — the FX swap is the natural instrument. The forward is more appropriate when the client actually wants a directional FX position or needs to lock in a specific exchange rate for a known future transaction.

Additionally, forward starting swaps can be used (with slightly wider spreads) when the FX need arises at a future date rather than today.