Forex: How do banks determine the price?
 

Bank dealers will determine their prices based upon a variety of factors including, the current market rate, how much volume is available at the current price level, their views on where the currency pair is headed and their inventory positions. If they think that the euro is headed higher, they may be willing to offer a more competitive rate for clients who want to sell euros because they believe that once they are given the euros, they can hold onto them for a few pips and offset at a better price. On the flip side, if they think that the euro is headed lower and the client is giving them euros, they may offer a lower price because they are not sure if they can sell the euro back to the market at the same level at which it was given to them. This is something that is unique to market makers that do not offer a fixed spread.

How does a bank offset risk?
 

Similar to the way we see prices on an electronic forex broker's platform, there are two primary platforms that interbank traders use: one is offered by Reuters Dealing and the other is offered by the Electronic Brokerage Service (EBS). The interbank market is a credit-approved system in which banks trade based solely on the credit relationships they have established with one another. All of the banks can see the best market rates currently available; however, each bank must have a specific credit relationship with another bank in order to trade at the rates being offered. The bigger the banks, the more credit relationships they can have and the better pricing they will be able access. The same is true for clients such as retail forex brokers. The larger the retail forex broker in terms of capital available, the more favorable pricing it can get from the interbank market. If a client or even a bank is small, it is restricted to dealing with only a select number of larger banks and tends to get less favorable pricing.

`Both the EBS and Reuters Dealing systems offer trading in the major currency pairs, but certain currency pairs are more liquid and are traded more frequently over either EBS or Reuters Dealing. These two companies are continually trying to capture each other's market shares, but as a guide, the following is the breakdown where each currency pair is primarily traded:

EBS	Reuters
EUR/USD	GBP/USD
USD/JPY	EUR/GBP
EUR/JPY	USD/CAD
EUR/CHF	AUD/USD
USD/CHF	NZD/USD

Cross currency pairs are generally not quoted on either platform.