Bid-offer spread

CFA Level II Economics
#1

In the curriculum it says as an answer to a question that While the credit ratings can affect spreads(for currency exchange), the trade (descirbed in the question) involves spot settlement i.e two business days after the trade date, so the spread quoted to this highly rated firm is not likely to be much tighter than the spread that would be quopted to a somewhat lower rate (but still high quality) firm.

I dont understand how credit ratings can affect bid-offer spread in any circumstances for a currency exchange. Perhaps for a forward, the quote might be different due to extra credit risk but for a spot rate I just dont get how the credit ratings of the company buying the currency can influence the spread? Anything I am missing here?

#2

What question is this?

#3

Higher credit risk increases the risk to the party originally holding the currency (i.e. Broker/Dealer). Therefore, they charge a higher spread.

#4

If its a spot settlement, then how is the broker ‘holding’ the currency? If it was a forward, then yes but in a spot settlement, any holding risk is negligible from what I know.

#5

If it is a principal trade they are selling it form they’re own inventory, and hence would carry a larger spread.

#6

this what is referred to as Settlement Risk (that a bank or other financial institution faces)-

So say a client/company bought $100 million from a US bank and in turn will wire the bank say Euros 75million (there is a time lag associated here, albeit a couple of days, but in these two days there is an outside chance that the counterparty could default or delay in its Euros wire payments to bank.

That is why sometimes if the counterparty is of poor credit quality the bank wants to compensate itself for taking this operational risk.