Foreign Exchange

FOREIGN EXCHANGEForeign Exchange Market Framework

The following are typical exchange rates as reported in The Wall Street Journal for trading among banks in the amount of US$1 million or more, for example, for the GBP

U.S. $ Equivalent GBP per U.S. $(dollars per pound) (pounds per dollar)Monday Friday Monday Friday

Spot Rate 1.5996 1.6084 0.6252 0.62171-month forward 1.5956 1.6048 0.6267 0.62313-month forward 1.5894 1.5982 0.6292 0.62576-month forward 1.5796 1.5884 0.6331 0.6296


Important features of these exchange rates:• Rates are quoted for the previous two trading

days are known as outright quotes• The first two columns are known as rates on

U.S. terms, and the last two columns are called rates on European terms

• For the first two columns the base currency is the British pound (£)

• For the last two columns the base currency is the U.S. dollar ($)


Important features of these exchange rates:• The last two columns are simply the

reciprocal of the first two columns• The first two columns are direct rates for the

British pound (£) and indirect rates for the U.S. dollar ($)

• The last two columns are direct rates for the U.S. dollar ($) and indirect rates for the British pound (£)


Important features of these exchange rates:• The first row depicts the exchange rate in the

spot market• The next three rows are forward rates for one

month, three months and six months• In the spot market, currency either

appreciates or depreciates in daily trading


Spot Market• The following examples show how to calculate currency

appreciation or depreciation in the spot marketUsing direct quotes for the U.S. dollarSpot Monday – Spot Friday (0.6252 – 0.6217)

Spot Friday 0.6217 0.56%

• The U.S. dollar ($) has appreciated by 0.56 percent against the British pound (£) in the previous two trading days, that is, Friday and Monday



appreciation or depreciation in the spot marketUsing indirect quotes for the U.S. dollarSpot Friday – Spot Monday (1.6084 – 1.5996)

Spot Monday 1.5996 0.56%

• The U.S. dollar ($) has appreciated by 0.56 percent against the British pound (£) in the previous two trading days, that is, Friday and Monday



appreciation or depreciation in the spot marketUsing direct quotes for the GBPSpot Monday – Spot Friday (1.5996 –1.6084)

Spot Friday 1.6084 - 0.56%

• The British pound (£) has depreciated by 0.56 percent against the U.S. dollar ($) in the previous two trading days, that is, Friday and Monday



appreciation or depreciation in the spot marketUsing indirect quotes for the GBPSpot Friday – Spot Monday (0.6217 –0.6252)

Spot Monday 0.6252 - 0.56%

• The British pound (£) has depreciated by 0.56 percent against the U.S. dollar ($) in the previous two trading days, that is, Friday and Monday


Forward Market• The following examples show how to calculate currency

premium or discount in the forward market

Using direct quotes for U.S. dollar Forward Rate – Spot Rate 360 (0.6267 –0.6252) 360

Spot Rate n 0.6252 30 3.0%

• where n= number of days in the forward contract.• The U.S. dollar ($) is selling at premium against British pound (£) in a

1-month forward market.




Using indirect quotes for U.S. dollar Spot Rate – Forward Rate 360 (1.5996 –1.5956) 360

Forward Rate n 1.5956 30 3.0%

• where n= number of days in the forward contract.• The U.S. dollar ($) is selling at premium against British pound (£) in a

1-month forward market.




Using direct quotes for GBP Forward Rate – Spot Rate 360 (1.5956 –1.5996) 360

Spot Rate n 1.5996 30 - 3.0%

• where n = number of days in the forward contract• The British pound (£) is selling at a discount against the U.S. dollar ($)

in a 1-month forward market




Using indirect quotes for GBP Spot Rate – Forward Rate 360 (0.6252 – 0.6267) 360

Forward Rate n 0.6267 30 - 3.0%

• where n = number of days in the forward contract• The British pound (£) is selling at a discount against the U.S. dollar ($)

in a 1-month forward market


Bid-Ask Rates• The bid rate is a currency broker's buying rate for the U.S.

dollar ($) and the selling rate for the British pound (£)• The ask rate is the currency broker's selling rate for the U.S.

dollar ($) and the buying rate for the British pound• Bid rates are always lower than ask rates

• The bid-ask spread represents the broker's cost and the profit on the transaction

Bid Ask Spread =

Bid Rates Ask RatesSpot £0.6275/$ £0.6281/$1-month Forward £0.6280/$ £0.6290/$3-month Forward £0.6300/$ £0.6328/$

Ask Rate – Bid Rate

Ask Rate


Bid-Ask Rates• Point quotes are reported as 0.6275 – 81, 5 – 9, 25 – 47,

where 0.6275 is the spot bid rate• 81 represents the last two digits of the spot ask rate• 5 is the difference between the spot bid rate and the 1-

month forward bid rate• 9 is the difference between the spot ask rate and the 1-

month forward ask rate• 25 is the difference between the spot bid rate and the 3-

month forward bid rate• 47 is the difference between the spot ask rate and the 3-

month forward ask rate


Cross Rate• A cross rate is the exchange rate between two

nondollar-denominated currencies• The following examples show the equations used to

determine the cross rates in different situations• Currency A in $ / Currency B in $ = Value of 1 unit of

currency in A in units of currency B• Exchange rates as quoted are ¥117.53/$ and and you

wish to determine the rate between ¥/€¥117.53/$ €0.8624/$

• Mathematically, the dollar amounts will cancel out

= ¥136.30 / €

Foreign Exchange

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