EXCHANGE RATE

M.K.JHA
 EXCHANGE RATE
• The price of one ccy against another ccy is
known as exchange rate. It is is used to
convert the ccy of one country to ccy of
another country
 Base ccy and Variable ccy
• In exchange rate two ccys are involved
• One remains fixed –known as Base ccy
• Change in rate is reflected in another ccy
• Known as Variable ccy
• Generally USD is the base ccy
• Notable exceptions are
GBP,AUD,NZD,EURO,SDR
• Exp-USD 1=RS 45.25, GBP 1=USD 1.77
Base Variable Base Variable
 Methods of Quotation

Method – I Method – II
One Orange = Rs 2 Rs. 10 = 5 Oranges
One Apple = Rs 2.50 Rs. 10 = 4 Apples

Price under both the methods is the same though expressed differently

Method - I Method - II
DIRECT(FC fixed) INDIRECT( HC fixed)
USD 1 = Rs 45.18 Rs 100 = USD 2.2133
GBP 1 = Rs.85.99 Rs 100 = GBP 1.1629
EUR 1 = Rs 57.92 Rs 100 = EUR 1.7265

With Effect from 02.08.1993, all exchanges are quoted in Direct Method
 Understanding Two Way Exchange Quotes

IN FOREX MARKETS THERE ARE TWO WAY QUOTES

i.e. BOTH BUYING AND SELLING RATES ARE GIVEN

• 1 USD = INR 45.16/ 18

• BUYING RATE $/RE = RE 45.16
• SELLING RATE $/RE = RE 45.18

In the abovementioned quote, lowest is market buying rate

and highest is market selling rate.
 Understanding Two Way Exchange Quotes

One of the features of the FX markets is that this is the

nearest form of perfect markets existing today.

One of the reasons why this is so is that prices are always

Quoted as TWO WAY QUOTES

U S D 1 = C H F 1 .2 5 7 0 /7 3

C H F 1 .2 5 7 0 C H F 1 .2 5 7 3

B U Y IN G R A T E S E L L IN G R A T E
 Understanding Exchange Rates

• Dollar/Swiss Francs -- USD/CHF

• Note the order of the currencies
• “USD” comes before the “CHF”

• The first currency($) - Base currency

• Second currency (CHF) - Terms currency
• It is important to remember that Bid &
Offer in trading always refers to the BASE
CURRENCY.
 Understanding Exchange Quotes
• In the FX market, Time is of great importance.
• Therefore, there are short forms for everything.
• While quoting, the dealers use only the third &
fourth decimals.
• USD/CHF 1.2540 / 45
• USD/INR 45.1675 / 00
• GBP/USD 1.8000 / 10
• BIG FIGURE
• In a live dealing scenario dealers would quote only
40/45 , 75/figure , figure/10 and the market assumes
that all players already know the BIG FIGURE
 Calculating Cross Rates
• India is a market maker for Indian Rupee
• Dollar/ Rupee trading ( the first quotes) start in the Mumbai
Market
• BUT WHAT ABOUT OTHER CURRENCIES ?
• WHERE DO RATES FOR CHF, GBP, EUR ETC COME FROM?
HOW ARE THEY CALCULATED?

• A CHF/RUPEE RATE IS A CROSS OF DOLLAR/RUPEE &

DOLLAR / CHF.
• DOLLAR / RUPEE = 45.35/36

• DOLLAR / CHF = 1.3440 / 45

• CHF / RUPEE = 33.73 / 75

• In other words, 45.36 / 1.3440 = 33.75 AND
• 45.35 / 1.3445 = 33.73
 Types of Transaction: Value Date Concept
• Due to vastness of the market and origin of transactions and
settlements may take place at different time zones, most of
times deal dates and settlement date differs. Market uses
different terminology which are used universally to avoid
conflict

Type of TXN Date of Deal Value Date

Cash/Ready 15.11.2006 15.112006
Wednesday Wednesday
TOM 15.11.2006 16.11.06
Wednesday Thursday
Spot 15.11.2006 17.11.06
Wednesday Friday
Forward 15.11.2006 Any day after
Wednesday 17.11.06
 Forward Rates

• What is a Forward Rate ?

• Rate agreed for settlement on an agreed
date in the future
• All rates are derived from Spot rates
• Forward rate is the spot rate adjusted for
the premium / discount

• Forward Rate = Spot Rate + / - premium

or discount
 Premium/Discount

• Forward price = Spot price plus or minus forward

margin.
• Premium –forward value of currency is higher
than spot rate. A currency with lower rate of
interest is said to be at premium in the forwards.
Forward margins added to spot rate.
• Discount – forward value of currency is lower
than spot rate. A currency with higher rate of
interest is said to be at discount. Forward
margins deducted from spot rate.
 FORWARD RATE

• Many forex transactions mature on future date

• Forward rate=Spot rate +/-Forward Margin
• If forward margin tends to make a ccy cheaper
against the other ccy it is known as discount
• If forward margin tends to make a ccy dearer
against the other ccy it is known as premium
• Forward margins are quoted in terms of variable
ccys.
• When one ccy is in premium the other one must
be in discount or vice versa
 CONTD

• SPOT USD 1= RS 45.25

• 1M FWD MARGIN = ?
• 1M FWD RATE = ?
• FWD MARGIN( +) RS IS IN
DISCOUNT/USD IS IN PREMUM
• FWD MARGIN (- ) RS IS IN
PREMIUM/USD IS IN DISCOUNT
 MERCHANT RATES

• Bid rate the rate at which the quoting Bank

is willing to buy one unit of base ccy
against against selling of variable ccy.
• Offer rate is the rate at which the quoting
bank willing to sell one unit of base ccy
against buying of variable ccy.
• UCO BK’S QUOTE USD 1=RS
45.25/45.26
• Bid Offer
 AMERICAN AND EUROPEAN TERMS

• AMERICAN TERM IS DIRECT.

• EUROPEAN TERM INDIRECT.
• EXAMPLE-THE RATE $ 1.5 PER POUND IS AN
AMERICAN TERM.
• THE QUOTE $1= INR 45 IN EUROPEAN
TERM.
• ? AMERICA OR EUROPE.
• (a) 3.419$ PER QUWAITI DINAR- IN USA IT IS
A DIRECT MODE- AMERICAN TERMS.
• EUROPEAN TERM- 1/AMRICAN TERM : .2925
KWD PER USD
 BID AND ASK

• THE BANK’S QUOTE OF BID AND ASK IS

FROM THE BANKER’S PERSPECTIVE.
• BID= BUY
• ASK=SELL
• IF THE BID RATE FOR USD IS 40 IT MEANS
THAT THE BANK IS READY TO BUY 1$ FOR
Rs.40
• IF THE ASK RATE IS FOR USD IS 41, IT
MEANS THAT THE BANK IS (ASKING IF
SOMEONE WILL BUY) SELLING 1$ FOR
Rs.41.
 Two way quote

• BID QUOTE AND ASK QUOTE

• Ex: Re/$- 40.42 – 41.63
• Rs.40.42-bid(buying)-( Bank point of view)
• Rs.41.63-ask(selling)
• Rs.40.42=1$ means the quote is in india
• Yen33= Re.1 means the quote is in Japan
• If you want to buy, if you have $, you will get
Rs.40.42
• If you want to sell Rs. and buy $ you part with
Rs.41.63.
 Spread

• ASK MINUS BID=SPREAD

• EX. 40-41
SPREAD=
Rs.41-40=Rs.1
Factors:a) Stability of the exchange rate
b) depth of the market-volume of
transaction
High volume(deep market)-narrow spread
Low volume (thin market)-wider spread
 SPOT RATE
• RATE OF EXCHANGE FOR IMMEDIATE
SETTLEMENT
• IT IS SETTLED ON THE SECOND WORKING
DAY
• SATURDAY AND SUNDAY ARE HOLIDAYS
• EX:SPOT RATE:Rs./$40.35-41.36 SUPPOSING
YOU HAVE 124000 DOLLAR RECEIVED ON
THURSDAY THE BANK WILL SETTLE
124000*40.35=50,03,400 ON THE FOLLOWING
MONDAY
 FORWARD RATE

• RATE CONTRACTED TODAY FOR

EXCHANGE OF CURRENCIES AT A
SPECIFIED FUTURE DATE
• THERE IS A FORWARD BID AND
FORWARED ASK
• CASH DELIVERY-ON THE SAME DAY
• TOM DELIVERY-ON WORKING DAY ON
THE FOLLOWING DAY
 APPRICIATION AND DEPRECIATION
• IF F>S IN A DIRECT QUOTE THE FOREIGN
CURRENCY IS APPRECIATING
• Home depreciate
• Indirect quote: Foreign depreciates and HOME
APPRECIATES
• Ex: 1. SPOT: SGD .O370=Re 1
• IN SINGAPORE ; FORWARD RATE THREE
MONTHS HENCE 0.0360
• SGD APPRECIATES OR DEPRECIATES?
• SPOT USD 1.5865= 1 POUND IN UK.
FORWARD 1 MONTH 1.5833 .
• ?DEPRECIATE OR APPRICIATE
 FORWARD RATE, PREMIUM AND DISCOUNT

• IF SWAP ASK> SWAP BID-FOREIGN

CURRENCY IS APPRECIATING HENCE
ADD SWAP POINTS
• IF SWAP ASK <SWAP BID FOREIGN
CURRENCY IS DEPRECIATING. HENCE
DEDUCT THE SWAP POINTS.
Determinents and select theories of
Exchange Rates
• General facts:
Pound, Euro and US dollar are having higher values than other
currencies like rupee, yen,franc etc.
What are the major factors?

• Factors
• Inflation rates
• 2. Interest rates
• 3. Balance of payment position
• 4. Volume of international reserves
• 5. Level of activity and employment
 1.Inflation rates

• If domestic inflation rate >foreign inflation rate-

• domestic goods are costlier than foreign goods
• It encourages import of foreign goods
• Foreign goods are cheaper
• More demand for foreign currencies
• Foreign currencies are costlier
• Decline in the value of domestic currencies
If domestic inflation rate < foreign inflation rate
• Domestic goods are cheaper
• Encourages export
• Foreign exchange inflow increases
• Domestic currency appreciates
 The purchasing power parity(PPP) theory
• Goods of equal value in different countries are equated
through an exchange rate
• Ex: If a book costs in USA say $2 but the same book is
available in India for Rs86 the exchange rate between
these currencies should be Rs.43/$
• PPPr=Spot rate x [1+r(H)]/[1+r(F)]
= spot rate x P(H)/P(F)
Where PPPr=purchasing power rate
r(H) and r(F)-inflation in the home and foreign countries
P(H) and P(F)-price indices of home and foreign countries.
 2.Interest rates
• If interest rate in home country( India 10%)>
foreign country(USA 4%)
USA funds are likely to be attracted in India as the
investor can earn better return in India rater than
In USA
Flight of funds from USA to India
There will be more demand for rupees in America
causing appreciation for Indian rupee
More dollar is required to buy rupees in America
which devalue US Dollar
 The Interest rate Parity theory
• The premium or discount of one currency in relation to
the other should reflect the interest rate differentials
between the two currencies.
• Forward rate = spot rate x[1 + I(F)]/[1 +I(H)]
• Where I(F) and I(H) represent interest rates on foreign
and home currencies.
• What is the impact?
• Impact
• Foreign currency is at a premium when interest rate is
higher in foreign country than home
• Home currency is at a discount
 3. Balance of payment position
• Deficit balance of payments –not able to meet the
demand of such currency say dollar leads to devalue of
home currency
• It discourages import as foreign goods becomes costlier
• It encourages export as domestic goods are cheaper in
foreign country
• Favourable balance of payments?
• The value of such a country appreciates and likely to
appreciate
 4.Volume of International Reserves/Foreign exchange

• It includes gold
• The reserve supports or stabilizes
whenever currency depreciates.
• Release or sell foreign exchange reserves
so that demand for foreign met so further
devaluation is reduced.
• The monetary authority can with stand
only to the extend to the reserves in hand.
5.Level of Activity and employment

• Higher level of economic activity and full

employment have good potential and
prospects of appreciation in the value of
currencies.
 conclusion
• Low inflation rate
• Higher interest rates
• Surplus balance of payment
• Possession of sizeable foreign exchange reserves
• Higher level of economic activity
Do have positive or negative impact on exchange rate?
• Positive impact
 conclusion
•Higher inflation rate
•Low interest rate
•Big/persistent deficit in the balance of payments
•Inadequate reserves with the monetary authority
•Low level of economic activity
What is the impact?
• Depreciates exchange rates