Exchange Rate Quotations

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Exchange Rate Quotations


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Dept. of Management Science, MESCE 2

Exchange Rate Quotations Exchange rate quotation is the price of a currency

stated in terms of another

Two way quotes are possible 3 letter codes for all the currencies using the name of

the country & currency (USD, AUD, INR, EUR, JPY, CAD)

Due to different ways of expression one comes across

a variety of terms in foreign exchange quotations


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Carbaugh, Chap. 12Dept. of ManagementScience, MESCE

3

Foreign exchange

One countrys currency has depreciated when

more of it is needed to buy a unit of a foreign

currency (is worth less relative to the other

currency)

A currency has appreciated when less of it is

needed to buy a foreign currency (is worth

more relative to the other currency)


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Exchange Rate Quotations Depending on the time elapsed between the transaction date &

settlement date forex transactions can be classified into

1. Spot transactions settlement date (value date) =transaction date + 2 days

2. Forward transactions - settlement date = value date forspot transaction date +number of days

3. Swap transactions combination of spot & forwardtransactions in opposite directions

Spot forward swap & Forward-forward swap


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European Vs American Quote

- when one of the currency is USD

European Quote expressed as number of

units of a currency per USD

American Quote expressed as number of

USD per unit of foreign currency


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Exchange Rate Quotations Direct Vs Indirect quotes

Direct quotes that which gives units of

the currency of that country per unit offoreign currency

Indirect quotes are stated as number ofunits of a foreign currency per unit of the

home currency


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Inter-bank Vs Merchant quote

Merchant quote given by banks to retail

customers

Inter-bank quote given by one bank to

another


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There are some conventions used whilequoting

Currency is denoted by 3 letter SWIFT code

The numerator is the base currency anddenominator is the quoted currency

The exchange rate quotation is give as number ofunits of the quoted currency per unit of the base

currency

Contd..


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A quotation consist of 2 prices bid & ask separated

by / or

- Bid rate applies to market maker buying one

unit of base currency against quoted currency.- Ask or offer rate applies to rate at which

market maker is willing to sell one unit of base

currency against quoted currency.


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Bid/Ask rate

Rate quoted by market makers:

USD/INR : 45.5700/45.6800

ie, the bank is ready to buy 1 USD for

Rs.45.57/USD [Bid rate] and sell 1 USD for Rs.

45.68/USD [Ask rate]


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The difference in bid/ask rates represents

- the cost incurred for the transaction

- a small return on capital employed

- the compensation for the risk it takes


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The spread depends on the volatility and

volume of trade

% spread = Ask price Bid price x 100Ask price

pip last two decimals, amount to hundredth of ahundredth also called points


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Cross Rates:

The rate between various currencies other than

dollar

Yen/USD = 135.62/$

S.Korean Won/USD = W 763.89/$

Then yen/Won = 0.17754/W


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Inter-bank trading mechanism

Arbitrage opportunities

Exchange arbitrage involves taking advantage of

exchange rate differences in different markets to

make a profit

Helps equalize exchange rates globally


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Arbitrage opportunities in

1.spot market

2.Inverse quotes

3.Cross rates


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Arbitrage opportunities in

Inverse quotes

Implied ($/)bid = 1/(/$)ask

Implied ($/)ask = 1/(/$)bid


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Forward contract

- contract calls for delivery at a fixed future date of

specified amount of one currency against another.

- for hedging a future payment/receipt.


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Forward quotations outright rate quoted for commercial customers

Forward discount forward rate in dollars is below spot rate

Forward premium forward rate in dollars is above spot rate

Forward prem./disc.

= forward rate spot rate x 360spot rate forward contract no. of days


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Forward quotations In inter-bank transactions only the rate differentials between

spot and forward is given Swap rate

Here- Add premium and subtract discount from spot to get forward rate

No +/- sign in swap rate

Forward bid point smaller than ask rate - premium

Forward bid point bigger than ask rate - discount


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Forward quotations

Shorter date contracts

Cash / ready contracts value on the same day

Tom / tomorrow value next day

Broken date contracts


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Exchange rate calculations

T T Telegraphic transfer

Bills bills of exchange drawn by

exporter/importers


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Spot T T buying rate

= A base rate exchange margin

Spot T T selling rate

= A base rate + exchange margin


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Spot bill buying rate

=inter-bank forward rate for a period equal to bill

payment period exchange margin

Spot bill selling rate

= T T selling rate + exchange margin


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Interest Rate Parity Theory (IRP) -forward premium/discount is closely related to the interest

differential between the two countries

-in an efficient market with no transaction costs, the interest

differential should be (approx.)equal to the forward

differential

-when this condition is met, the forward rate is said to be atinterest rate parity and equilibrium prevails in the money

markets.


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Interest Rate Parity Theory (IRP)

An investor has with him $1,000,000, which he can invest for

90 days.

If he invests in USD he will get an interest @ 8% p.a., annd in

DEM he will get 6% p.a. Spot DEM is 1.5311/$ and 90 days

forward DEM is 1.5236/$

What can he do?


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Interest Rate Parity Theory (IRP)

Ifcovered interest differential the difference

between the domestic interest rate and the hedged

foreign rate is zero there will be no arbitrage.

If it is not zero there will be covered interest

arbitrage movement of money from one market to

another.


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covered interest arbitrage

Suppose the interest rate on pound is 12% in London and

interest rate on $ in New York is 7%.

Pound spot is $1.75/, and 1 year forward is $1.68/.

What can be done?

Exchange Rate Quotations

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