Unit-4

Exchange Rate Quotations

In a foreign exchange market where different currencies are bought and sold, it
is essential to know the ratio between different currencies; or how many units
of one currency will equal one unit of another currency. The ratio between two
currencies is known as an exchange rate. Exchange rate quotations can be
quoted in two ways – Direct quotation and Indirect quotation.

Direct and Indirect Quotes

Exchange rates are quoted either directly or indirectly. A direct quote gives the
home currency price of a certain quantity of foreign currency, usually one unit
or 100 units. If India quotes the exchange rate between the rupee and US
dollar directly, the quotation will be written as Rs. 45/US $. On the other hand,
in case of indirect quoting, the value of one unit of home currency is presented
in terms of foreign currency. If India adopts indirect quote, the banks in India
will quote the exchange rate as US $0.022/Rs.

A direct quote can be calculated using the following formula:

DQ = 1/IQ

Where:

 DQ = Direct Quote
 IQ = Indirect Quote

An Indirect quote can be calculated using the following formula:

IQ = 1/DQ

Where:

 DQ = Direct Quote
 IQ = Indirect Quote
Q1 If direct quote is Rs 45/US $, how can this exchange rate be presented
under indirect quote?
Solution:

IQ = 1/DQ
US $ 1 / Rs 45 = US $ 0.0222 /Rs

Q2 If indirect quote is US $ 0.025/Rs., how can this exchange rate be shown

under direct quote?
Solution:

DQ = 1/IQ
Rs 1/ US $ 0.025 = Rs 40/ US $

Q3 If direct quote is Rs 50/US$, how can this exchange rate be presented

under indirect quote?

Answer: $0.02/Rs

Q4 If indirect quote is US $ 0.02/Rs., how can this exchange rate be shown

under direct quote?

Answer: Rs 50/ US $

Buying and Selling Rates

(Rs 74.00/USD - Rs 74.30/USD)

Buying Rate Selling Rate
Bid Rate Ask Rate
(From the point of view of the Bank)

Normally, two rates are published—one being the buying rate and the other
being the selling rate. Buying rate is also known as the bid rate. Selling rate is
known as ask rate or offer rate. Bid rate is always given first, which is followed
by the ask rate quote. Suppose the rupee-US dollar rate is Rs. 45.00 –
45.30/US $, the former is the buying rate and the latter is the selling rate. The
former is the rate at which the banks purchase a foreign currency from the
customer. The selling rate is the rate at which the banks sell any foreign
currency to their customers. Since the banks need some profit in these
transactions, the selling quote is higher than the buying quote. The difference
between these two quotes forms the banks’ profit and it is known as spread.
The bid-ask spread is often stated in percentage terms that can be computed
as follows:

Thus, in the above example,

Spread = (45.30 – 45.00)/ 45.30 x 100 = 0.662%

The size of spread in respect of a currency depends upon many factors, like its
strength, the type of transaction, and its supply and demand position with the
transacting bank. The spread is smaller in a widely traded currency because it is
easy for the banks to transact in such a currency. In a scarcely traded currency,
the banks have to face some difficulty, and hence the spread is large.

Q5 Consider the following bid-ask prices: Rs 40 - 40.50/ US $. Find the bid-ask

spread.

Answer: 1.23%

Q6 Find out the bid rate if ask rate is Rs 40.50/ US $ and the bid ask spread is
1.33%

Answer: Rs 39.96

Q7 consider the following bid ask prices: Rs 50.00 – 50.60/US $. Find out
The bid ask spread.

Answer: 1.185%
 Forward Market Quotation

The quotes for the forward market are also published in the newspaper and
periodicals. There are two ways of quoting forward rates. One is known as an
outright quote, while the other is known as swap quote. The outright quote for
the US dollar in terms of the rupee can be written for different periods of
forward contract, as follows:

Spot One Month Three Months

Rs 40.00 - 40.30 Rs 39.80 – 40.40 Rs 39.60 – 40.50
Spread
0.30 0.60 0.90

Forward Premium and Discount

In the above quotes, it is found that the longer the maturity, the greater the
change in the forward rates. Again, with longer maturity, the spread too gets
wider. This is because of uncertainty in the future, which increases with
lengthening of maturity. The change in forward rates may be upwards or it
may be downwards. With such movements, disparity arises between the spot
and forward rates, which is known as forward rate differential.

If the forward rate is lower than the spot rate, it will be a case of forward
discount. On the contrary, if the forward rate is higher than the spot rate, it
would be known as the forward premium. Forward premium or discount is
expressed as an annualised percentage deviation from the spot rate. It is
computed as follows:

Forward premium (discount)

=(n days forward rate – spot rate)/ spot rate × 360/n x 100

= (n days forward rate – spot rate) × 360 x 100

spot rate n

Where n is the length of forward contract expressed in number of days.

Example:

Spot One Month Three Months

Rs 40.00 - 40.30 Rs 39.80 – 40.40 Rs 39.60 – 40.50

Applying the above example of a one month forward Bid quotation, we get

Forward premium (discount)

=(n days forward rate – spot rate)/ spot rate × 360/n
=(30 days forward Bid rate – spot Bid rate)/ spot Bid rate × 360/30

=(39.80 – 40.00) /40.00 × 360/30 = -.06 or - 6% forward discount.

Applying the above example of a three month forward Bid quotation, we get

Forward premium (discount)

=(n days forward rate – spot rate)/ spot rate × 360/n
=(90 days forward Bid rate – spot Bid rate)/ spot Bid rate × 360/90
=(39.60 – 40)/40*360/90 = -.04 or -4% forward discount

Applying the above example of a one month forward Ask quotation, we get

Forward premium (discount)

=(n days forward Ask rate – spot Ask rate)/ spot Ask rate × 360/n
=(30 days forward Ask rate – spot Ask rate)/ spot Ask rate × 360/30

=(40.40 – 40.30) /40.30 × 360/30 = .0297 or 2.97% forward premium

Applying the above example of a Three month forward Ask quotation, we get
=(n days forward Ask rate – spot Ask rate)/ spot Ask rate × 360/n
=(90 days forward Ask rate – spot Ask rate)/ spot Ask rate × 360/90

=(40.50 – 40.30) /40.30 × 360/90 = .0198 or 1.98% forward premium

Q8 Find out the forward rate differential if spot rate of US $ is Rs 45.00 and
one month forward rate is Rs 45.80.

Solution:
Forward premium (discount)
=(n days forward rate – spot rate)/ spot rate × 360/n

=(45.80 – 45.00) /45.00 × 360/30 = .2133 or 21.33%. (forward premium).

It will be known as a forward premium as the value of US dollar has increased.

Q9 Find the one month forward rate of US dollar if spot rate is Rs 45.00/$ and
the forward premium is 12 percent.

Solution
Answer: Rs 45.45/$

Q10
Spot One Month Three Months
Rs 74.00 - 74.30 Rs 73.80 – 74.50 Rs 73.60 – 74.60
Forward premium (discount)
=(n days forward rate – spot rate)/ spot rate × 360/n

Calculate:
1. 30 days forward bid quotation
2. 30 days forward ask quotation
= (74.50 – 74.30)/74.30 x 360 /30 x 100 = 3.23% (Forward premium)
3. 90 days forward bid quotation
= (73.60 – 74.00) /74.00 x 360/90 x 100 = 2.16% (forward discount)

4. 90 days forward ask quotation

=(74.60 - 74.30)/74.30 x 360/90 x 100 = 1.61% (forward premium)
Answers:
1. - 3.24% forward discount
2. 3.23% forward premium
3. - 2.16% forward discount
4. 1.61% forward premium
Reciprocal Rates/ Reverse Rates
For example:
If I know the exchange rate of currency pair Rs/USD, how do I get the exchange
rate of USD/Rs ?

Bid : Ask
(Rs/USD) = 74.10 - 74.50
(USD/Rs) = ?
(USD/Rs)Bid Rate = 1
(Rs/USD)Ask Rate
= 1
74.50 = .01342
(USD/Rs) Ask Rate = 1
(Rs/USD) Bid Rate
= 1
74.10 = .01349

Bid Rate – Ask Rate

(USD/Rs) = .01342 - .01349

For example:
If I know the exchange rate of currency pair Rs/USD, how do I get the exchange
rate of USD/Rs ?

Bid : Ask
(Rs/USD) = 45.10 - 45.50
(USD/Rs)= ?
(USD/Rs)Bid Rate = 1
(Rs/USD)Ask Rate
1
45.50 = .02197
(USD/Rs)Ask Rate = 1
(Rs/USD)Bid Rate
= 1
45.10 = .02217
(USD/Rs) = 0.02197 - 0.02217
Q
(Rs/Euro) = Rs 80.30/ Euro - Rs 80.80/Euro
(Euro/Rs) = .01237 - .01245
Cross Rates

Sometimes the value of a currency in terms of another is not known

directly. In such cases, one currency is sold for a common currency; and again,
the common currency is exchanged for the desired currency. This is known as
the cross rate trading and the rate established between the two currencies is
known as cross rate.

Question:
Bid : Ask
(Rs/UKf) = 79.00 – 79.70
(Rs/USD)= 44.25 – 44.85

What is the exchange rate between USD:UKf?

Solution:
(USD/UKF) Bid Rate = (USD/ Rs) Bid Rate x (Rs/ UKF) Bid Rate

(USD/UKF) Bid Rate = 1 x 79.00

(Rs/USD)Ask Rate

(USD/UKF) Bid Rate = 1 x 79.00

44.85
(USD/UKF) Bid Rate = 1.7614

(USD/UKF)Ask Rate = (USD/Rs) Ask Rate x (Rs/UKF) Ask Rate

(USD/UKF)Ask Rate = 1 x 79.70

(Rs/USD)Bid Rate

(USD/UKF)Ask Rate = 1 x 79.70

44.25
(USD/UKF)Ask Rate = 1.8011

(USD/UKF) = 1.7614 – 1.8011

Q10
GBP/USD = 1.6545 – 1.6552
IEP/USD = 1.3655 – 1.3665

Calculate GBP/IEP Exchange Rate?

Solution:
(GBP/IEP)Bid = (GBP/USD)Bid × (USD/IEP)Bid

(GBP/IEP)Bid = 1.6545 × 1/(IEP/USD)Ask

(GBP/IEP)Bid = 1.6545 × 1/1.3665 = 1.21075

(GBP/IEP)Ask = (GBP/USD)Ask × (USD/IEP)Ask

(GBP/IEP)Ask = 1.6552 × 1/(IEP/USD)Bid

(GBP/IEP)Ask = 1.6552 × 1/1.3655 = 1.2121

GBP/IEP = 1.21075 – 1.2121

Q11
Bid - Ask
USD/CAD = 1.6505 – 1.6510
GBP/USD = 1.4524 – 1.4530

Calculate GBP/CAD Exchange Rate?

Solution:
GBP/CAD = 2.39718 – 2.3989

Q12
Rs/USD = 43.93 - 43.95
Euro/USD = 0.83 – 0.84

Calculate Rs/Euro Exchange Rate?

Solution:
Rs/EURO = 52.2976 – 52.9518

Q13
Bid - Ask
Rs/ USD = 70.10 - 70.60
Rs/ GBP = 90.20 – 90.80

What will be the exchange rate between USD and GBP?

Solution:
(USD/GBP)Bid Rate = (USD/RS) Bid Rate × (RS/GBP) Bid Rate

(USD/GBP)Bid Rate = 1
(Rs/ USD)Ask Rate × 90.20

(USD/GBP)Bid Rate = 1 × 90.20

70.60
(USD/GBP)Bid Rate = 1.2776

(USD/GBP)Ask Rate` = (USD/RS) Ask Rate × (RS/GBP) Ask Rate

(USD/GBP)Ask Rate` = 1 × 90.80
(Rs/USD)Bid Rate

(USD/GBP)Ask Rate` = 1 × 90.80

70.10

(USD/GBP)Ask Rate` = 1.2952

(USD/GBP)= 1.2776 – 1.2952

Question:
Bid : Ask
(Rs/GBP) = 59.00 – 59.70
(Rs/USD)= 24.25 – 24.85

What is the exchange rate between USD:GBP?