Unit 2.2 Exchange Rate Quotations & Forex Markets

 Exchange rate quotations,
 Common currency symbols,
 Direct and indirect quotes,
 American terms, European terms, cross rates,
 Bid and Ask rates, Mid rate, Spread and its
determinants,
 Spot markets, Forward Markets, Premium and
Discounts,
 Various practices of writing quotations,
 Calculating broken period forward rates,
 Speculation and arbitrage,
 Forex futures and Currency Options
 Practice Numericals
2Mrs. Charu Rastogi, Asst.Professor

 Currency pairs and the rate of exchange
Every foreign exchange transaction is an exchange
between a pair of currencies.
 Each currency is denoted by a unique three-character
International Standardization Organization (ISO) code
(e.g. GBP represents sterling and USD the US dollar).
 Currency pairings are expressed as two ISO codes
separated by a division symbol (e.g. GBP/USD), the first
representing the "base currency" and the other the
"secondary currency“ or “quoted currency”
 The rate of exchange is simply the price of one currency
in terms of another.
 Base currency is the one you are buying or selling

 For example GBP/USD = 1.5545 denotes that one unit
of sterling (the base currency) can be exchanged for
1.5545 US dollars (the secondary currency).
 Exchange rates are usually written to four decimal
places, with the exception of Japanese yen which is
written to two decimal places.
 The rate to two (out of four) decimal places is known as
the "big figure" while the third and fourth decimal
places together measure the "points" or "pips".
 For instance, in GBP/USD = 1.5545 the "big figure" is
1.55 while the 45 (i.e. the third and fourth decimal
places) represents the points

USD : US Dollar
HKD : Hong Kong Dollar
EUR : Euro
JPY : Japanese Yen
GBP : British Pound
CHF : Swiss Franc
CAD : Canadian Dollar
SGD : Singapore Dollar
AUD : Australian Dollar
RMB : Chinese Renminbi
INR : Indian Rupee

 Direct Quotes
◦ Gives the units of currency of domestic country per unit of a
foreign currency
◦ Price of foreign currency is quoted in terms of home currency.
◦ In this system variable units of home currency equivalent to a
fixed unit of foreign currency are quoted.
◦ Domestic currency is quoted currency
For Eg – USD/INR = 45.30 Rs. / $
 Indirect Quotes
◦ Gives the units of currency of foreign country per unit of the
domestic currency
◦ Price of home currency is quoted in terms of foreign currency
◦ In this system variable units of foreign currency equivalent to a
fixed unit of home currency are quoted.
◦ Foreign currency is the quoted currency
For Eg – INR/USD = 0.0220 $ / Rs.

 Exchange rate quoted in American Terms
◦ USD becomes the quoted currency.
◦ For Eg – INR/USD = 0.0220 $ / Rs.
 Exchange rate quoted in European Terms
◦ USD becomes the base currency
◦ For Eg – USD/INR = 45.30 Rs. / $
◦ Or USD/CHF = 1.4550 CHF/$
 Cross Rate
◦ Quotation between two non dollar currencies
◦ For Eg – GBP/INR = 90.4587 Rs./pound

 USD is the most widely traded currency and is often
used as the vehicle currency
 This helps in reduction of no. of quotes in the
market, as exchange rate between two currencies
can be determined through their quotes against the
USD.
 Any quote not against the USD is a „Cross Quote‟
 Availability of USD quote for all currencies can help
in determining the exchange rate for any pair of
currencies by using the cross rate
 For eg. Cross quote for EUR-GBP =
 EUR/USD * USD/GBP

 Bid rate
◦ Price at which the forex dealer is willing to buy a
unit of the base currency
◦ As a customer this will be the price at which you
will sell the currency
 Ask rate/offer rate
◦ Price at which the forex dealer is willing to sell a
unit of the base currency
◦ As a customer this will be the price at which the
currency is offered to you or at which you buy.
 Eg – USD/CHF = 1.4550/1.4560
 Video

 When a bank quotes a currency, it simultaneously offers
another currency in lieu; if it buys dollars for rupees, it is
simultaneously offering rupees for dollars.
 For example if a bank quotes bid rate at spot for dollars as
(S) USD/INR bid= Rs. 35.50/$; (it is buying dollars at this
rate; recall that base currency is the one being traded);
 It also sells rupees for dollars simultaneously; this rate is
ask price of rupees in terms of dollars; in indirect quotes.
 (S) USD/INR bid= Rs. 35.50/$ = ask price of rupees in
indirect quotes
 Therefore,
S (USD/INR)ask= 1/ S (INR/USD)bid
S (USD/INR)bid = 1/S (INR/USD)ask

 Spread or dealer‟s margin or cost of transaction is the
difference between bid price and ask price
 If exchange rate quotation is given in “direct quote” form, bid
rate < ask rate, and vice versa as the dealer will want to make
a profit on currency dealing
 Eg – USD/CHF = 1.4550/1.4560 , (the spread is 10 pips). It
may be shortened to 1.4550/60
 In Sweden, USD/SEK = 8.9595/10 means 8.9595/83.9610
 In Japan, USD/JPY = 106.98/05 means 106.98/107.05
 Calculating spread and percentage spread
◦ For Direct quotes, Spread = Ask Price-Bid Price
◦ Percentage Spread = (Ask Price – Bid Price)/ Ask Price * 100
◦ A bank in India quotes, USD/INR = 35.7621/35.8024
◦ (For Indirect quotes reverse ask and bid price)

 Liquidity/trading volume in the market; high volume, lower
spread; as cost of service per unit falls
 Nature of the organization making quotes (bank vs. money
changer or finance company)
 Overall perception of the dealer about the conditions of the
economy and the forex market
 Size of the transaction
 Number of players, time of the day etc
 Currency rate volatility.
 In the United States, spreads tend to be narrowest in the New
York morning-Europe afternoon period, when the biggest
markets are open and activity is heaviest. Bid-ask spread is
widest in the late New York afternoon, when European and most
large Asian markets are closed.
 In India the spread is set by Foreign Exchange Dealers
Association of India

 A term used to describe the average rate agreed
upon when conducting foreign exchange.
 The middle rate is calculated using the median
average of the bid and offer rates.
 The middle rate is the average of bid and ask
rates.
 For direct quotes,
◦ S(bid) = M - c
◦ S(ask) = M + c
◦ Where, M= Mid rate and c = one side average spread or
cost of transaction

 Forex rates can be quoted as spot or, forward
contracts. When buyers and sellers agree to trade at
the current exchange rate for immediate delivery, it is
known as spot transaction or cash transaction. The
word “immediate” has different meaning in this case.
It can go upto maximum of two days.
 In forex market parlance, the trade date is the day on
which both parties agree to buy and sell.
 The settlement date/value date is the day on which
funds are actually transferred between the buyer and
seller.
 Transactions can be
◦ Cash (trade date is the same as the settlement date)
◦ Spot
◦ forward

 A spot rate is the exchange rate which is valid for a transaction
(purchase of currency A and sale of currency B) that must be
concluded within the next two working days.
 Thus the value date (i.e. the day of actual delivery of currencies) of a
transaction performed on a Monday is Wednesday. For Thursday it is
Monday (weekend days are not counted).
 With the advance in communication technology and electronic fund
transfer mechanism, settlement date is narrowing down to trade
date
 In India delivery under spot transaction can be:
Type Description
Ready or cash The transaction to be settled on the same day
Tom The delivery of foreign exchange to be made on the day next
(tomorrow) to the date of transaction.
Spot Delivery of foreign exchange would take place on the 2nd working
day from the trade date.

 In a forward contract both parties enter into a
contract on a given day and lock in a fixed rate
on specific future date.
 In such types of contract, the terms of the
purchase (buy or sell) are agreed up front (trade
execution date) but actual exchange take place
on a date in the future (maturity date).
 Suppose on trade date, the Indian exporter
agrees to sell EURO 1000 and receive INR 72450.
On the maturity date, he delivers EURO 1000 and
receives INR 72450. Such types of forward
contracts are known as outright forward
contracts (OFTs).

 Forward contracts can be many types depending on the rigidness
associated with the maturity date.
 In a Fixed Maturity Contract, the maturity date is fixed. The
payment and receipt happens on the maturity date.
 Partially Optional Contracts provide some flexibility. In such type
of contract, there are three dates, trade execution date, option
start date and maturity date. On the trade execution date, two
parties agree to exchange and the rate of exchange is fixed. In
addition, the parties can settle the transaction any time during
the option start date and on before maturity date. In other
words, in this contract, the maturity date spans across days
rather than a single day.
 In Fully Optional Contract, the contract may end anytime during
the life of the contract i.e, anytime during trade execution date
and maturity date.
 Like the spot contracts, in forward contracts, the actual
settlement happens within two-business day from the maturity
date.

 A foreign currency is said to be selling at a forward discount
when forward price of the foreign currency is lower in terms
of the domestic currency than its spot rate.
 Conversely, a foreign currency is said to be selling at a
forward premium when its forward price in terms of domestic
currency is higher than the spot price
 If, USD/INR (S) = Rs. 31.9812/$ and USD/INR (F) = Rs.
32.1345/$, the foreign currency is at a premium and
domestic currency is at a discount.
 Premium/discount = [F(bid) – S(bid)]/S(bid) *100
 Annualized Premium/discount = [F(bid) – S(bid)]/S(bid) *12/N
*100 when quotes are in months (N = Months)
 Annualized Premium/discount = [F(bid) – S(bid)]/S(bid)
*360/ND *100 when quotes are in days (ND=No of days)

 In terms of discounts and premiums
◦ Brokers may quote currencies in terms of discounts
and premiums on them in the forward market.
◦ Eg: if USD/INR (S) = Rs. 36.3500 and broker says:
dollar is at 3% premium in the three months
forward market. The outright forward rate can be
found by using the formula
◦ If the broker said that dollar is at 3% annualised
premium then the premium would be 3% * (3/12)

 In terms of basis points or swap rates or forward margins
◦ Forward rate may be the same as spot rate, but generally the currency becomes
costlier or cheaper.
◦ The difference is called swap points or forward margin
◦ A basis point is 1/100th of 1 percentage
◦ Suppose a broker at new york quotes for French Francs: FF/USD (S) =
$0.2144/FF, 30 days forward discount 100 basis points and 60 days forward
discount 20 basis points and for German Mark, DM/USD (S) = $ 0.4860/DM, 30
days forward premium120 basis points and 60 days forward premium 160
basis points
◦ For direct rates, premium has to be added to the spot rate and discount has to
be subtracted from the spot rate
◦ For indirect quotes, reverse is true
Spot
exchange rate
30 days swap
rate/forward
margins
60 days swap
rate/forward
margins
30 days
forward rate
60 days
forward rate
$0.2144/FF -100 -20 $0.2044/FF $0.2124/FF
$0.4860/DM 120 160 $ 0.4980/DM $ 0.5020/DM

 In terms of a-b or a/b where a and b are numbers
◦ When forward bid/ask quotes are given in this format;
◦ USD/INR (S) = Rs. 47.8525/9775, one month; 50/150 and 2 months; 200/300 or
◦ USD/INR (S) = Rs. 47.8525, one month; 50-150 and 2 months; 200-300 or
◦ If first figure is smaller than second figure then, base currency is at a premium and
basis points have to be added to spot rate
◦ If first figure is greater than second figure then, base currency is at a discount and
basis points have to be deducted from spot rate
◦ Therefore you can see the forward points and tell if base currency is at discount or
premium
Spot exchange
rate
1 month swap
rate/forward
margins
2 month swap
rate/forward
margins
1 month
forward rate
2 month forward
rate
47.8525/9775 50/150 200/300 47.8575/9925 47.8725/48.0075
Base currency is at a premium in both, so we add.

 Forex dealers normally quote forward rates at regular
intervals like one month or three months.
 For example, dealers normally quote 1-week, 2-week, 1,2,3 6
months forward rate.
 However, depending on customer‟s requirement, these
dealers quote forward rate on a specific future date that is
not an exact multiple of months. Such kinds of forwards
quotes are known as broken period quotes.
 Broken period rates are calculated by method of interpolation.
 Eg: Suppose a corporate customer wants to buy 100,000 USD
on October 21st and the following info is given:
USD/INR Maturity Date Bid Rate Ask Rate
Spot July 14th 47.0725 47.0745
1 Month Aug 14th 135 130
2 Month Sept 14th 140 133
3 Month Oct 14th 160 145
4 Month Nov 14th 175 155 23Mrs. Charu Rastogi, Asst.Professor

The interpolation method is used as follows:
 The forward rate points applicable are (160 to 175) for bid
and (145-155) for ask.
 For 31 days (October 14th to November 14th), the bid
spread is 15 points (175 to 160).
 For 7 days, the spread in bid point =15/31 *7 = 3.89
 So the spread applicable for October 21st is 160 + 3.89 =
163.89
 Similarly, for 31 days (October 14th to November 14th ), the
ask spread is 10 points (155 to 145).
 For 7 days, the spread in bid point = 10/31 * 7 = 2.26
 So the spread applicable for October 21st is 145 + 2.26 =
147.26
 For October 21st the bid/ask spread is 163.89/147.26;
meaning that the base currency; USD is at a discount, so
we deduct.
 Bid rate on Oct 21st will be = 47.0725 - 0.016389 =
47.0561
 And the Ask rate will be = 47.0745-0.014726 = 47.0597

 Speculation exists whenever someone buys a foreign
currency, not because they need to pay for an import
or is investing in a foreign business, but because they
hope to sell the currency at a higher rate in the future
 Speculators buy and sell currencies to profit from
fluctuations in the value of those currencies
 Some level of speculation is good; as it increases
liquidity and provides easier access to foreign
currencies
 However, excessive speculation can disrupt
international trade and economic development
 Speculation is done both in spot markets as well as
forward markets

 Arbitrage occurs when a currency trader takes advantage of different spreads
offered by brokers for a particular currency pair by making trades.
 Different spreads for a currency pair imply disparities between the bid and
ask prices.
 Currency arbitrage involves buying and selling currency pairs from different
brokers to take advantage of this disparity.
 Currency arbitrage involves the exploitation of the differences in quotes
rather than movements in the exchange rates of the currencies in the
currency pair.
 Forex traders typically practice two-currency arbitrage, in which the
differences between the spreads of two currencies are exploited.
 Traders can also practice three-currency arbitrage, also known as triangular
arbitrage, which is a more complex strategy.
 Due to the use of computers and high-speed trading systems, large traders
often catch differences in currency pair quotes and close the gap quickly.

 Refers to a exchange traded contract to exchange one
currency for another at a specified date in the future at a
price (exchange rate) that is fixed on the purchase date
 A exchange traded forward contract is known as futures
contract. Forward contracts are tailor made depending on the
requirement of the contract buyers or sellers.
 However being exchange traded, futures contracts are
standardized – contract size, maturity period etc.
 Being exchange traded, futures contract can be squared off
(settled) easily which may not be possible in case of forward
contract.
 In case of futures contract, the clearing house associated with
exchange takes the counterparty risk – risk that the loss making
party does not deliver during the maturity period.
 Traders also have to pay margins – initial and daily margin as
exchanges require all traders to pay margin

 In finance, a foreign-exchange option (commonly
shortened to just FX option or currency option) is a
derivative financial instrument that gives the owner the
right but not the obligation to exchange money
denominated in one currency into another currency at a
pre-agreed exchange rate on a specified date
 An option that gives the right to buy is known as a „call‟
while one that gives the right to sell is known as a „put‟
 Depending on the contract term, an option may be
exercisable on any date during a specified period or it
may be exercisable only on the final or expiration date
of period covered by the option contract

FOREX QUOTATIONS
Q.1) The following quote is given.
USD 1 = CAD 1.1630/50.
Identify the country in which this is a direct quote.
Find the mid rate, spread and the spread percentage.
Calculate the inverse quote.
Q.2) Cable Rate is GBP USD 1.6000 / 1.6070
In which country this is a direct quote?
Find the midrate, spread and the % spread. Calculate inverse quote.
Q.3) Following are the quotes given by a banker at Mumbai. Identify whether the quote is direct or
indirect quote. Compute the direct quote for indirect quote and vice versa.
1USD = Rs.45.85
Rs. 100 = GBP 1.2312
Rs. 100 = Euro 1.7850
Rs. 100 = USD 2.2002
1 Yen = Rs. 0.4129
Q.4) Consider the following quotes:
Spot (Euro / Pound) = 1.6543 / 1.6557.
Spot (Pound / NZ $) = 0.2786 / 0.2800.
a) Calculate the percentage spread on the Euro / Pound rate.
b) Calculate the percentage spread on the Pound / NZ $ rate.
c) The maximum possible percentage spread on the cross rate between the
euro and the NZ $.
Q.5) You have just graduated from the University of Florida and are leaving on a whirlwind tour to
see some friends. You wish to spend USD 1,000 each in Germany, New Zealand, and Great Britain
(USD 3,000 in total). Your bank offers you the following bid-ask quotes: USD/EUR 1.304-1.305,
USD/NZD 0.67-0.69, and USD/GBP 1.90-1.95.
(a) If you accept these quotes, how many EUR, NZD, and GBP do you have at departure?
(b) If you return with EUR 300, NZD 1,000, and GBP 75, and the exchange rates are
unchanged, how many USD do you have?
(c) Suppose that instead of selling your remaining EUR 300 once you return home, you want
to sell them in Great Britain. At the train station, you are offered GBP/EUR 0.66-0.68,
while a bank three blocks from the station offers GBP/EUR 0.665-0.675. At what rate are
you willing to sell your EUR 300? How many GBP will you receive?
Answers:
(a) EUR 766.28; NZD 1,449.27; GBP 512.82.
(b) 391.2 + 670 + 142.5 = USD 1203.7
(c) You will sell at GBP/EUR 0.665; you will receive GBP 199.5

Unit 2.2 Exchange Rate Quotations & Forex Markets

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Unit 2.2 Exchange Rate Quotations & Forex Markets