FOREIGN EXCHANGE RATES

Basic calculation-cont.

FOREIGN CURRENCY
Basis Point As cent represents one hundredth of a dollar 1 dollar = 100 cents = 100 basis points

So basis point represents one-hundredth of a cent 1 cent

For example $/ 1.8525. This means that there is one dollar, 85 cents and 25 basis points to the pound or there is one dollar and 851/4 cents to the pound Illustration $/ 1.8645

Narrate the exchange rate in terms of basis points There is one Dollar, 86 cents and 45 basis points to the pound Illustration $/ 1.0550

Narrate the exchange in terms of basis points

There is one Dollar, 5 cents and 50 basis point to the pound

INVERTING EXCHANGE RATES:

If you are given a middle rate: $/ 1.5385, this indicates that $1.5385=pound 1. Notice that the exchange rate can be found from the inversion of the $/ exchange rate.

Thus /$ = 1/1.5385 = 0.6500

In other words 0.6500 (or 65 p) = $1

Illustration If exchange rate: $/ 1.5240; and Y/ 235.20 Determine Exchange rate Y/$ Solution

Y/$ =

235.20 = 154.33 1.5240

Illustration 2
If exchange rate: DM/ 2.5150; and PTE/ 205.80 Determine Exchange rate PTE/DM

Solution 2 Illustration 3

PTE/DM = 205.80 = 81.83 2.5150

If exchange rate: Y/$ 154.33; and Y/ 235.20 Determine Exchange rate /$

Solution 3

/$ = 154.33 = 0.6562 235.20

Illustration 4
If exchange rate: SFF/ 4.3510; and $/SFF 0.4450 Determine Exchange rate $/

Solution 4

$/ =0.4450 * 43510 = 1.9362

However, be careful if you wish to turn exchange rate around in this way and you are given a buying and selling rate. Not only should you take the inverse of each, but also switch each around s follows:

$/ /$
/$

1.482 1 1.485
0.6734

1.485 1 1.482
0.6748

Illustration 6
If exchange rate: Rs./$ 55 58 ; and Rs./Y 0.4852 0.4910 Determine Exchange rate $/Y

Rs./$ 1 58
$/Rs. Rs./Y

55

58 1 55
0.01818 0.491

Rs./$

0.1724 0.4852

$/Y

0.008365

0.008926

Illustration 6
If exchange rate: $/ 1.522 1.526 ; and Y./ 234.8 235.4 Determine Exchange rate Y/$

SOLUTION Illustration 6
$/

1.522 1 1.526
Y/ Y/$ 234.8 153.8663

1.526 1 1.522
235.4 154.6649

/$

Spot Market
Is where you can buy and sell currencies for immediate (i.e. on the spot) exchange or delivery.

Forward Market
Is where you can arrange a deal now to buy or sell a specific amount of currency at a specific rate of exchange (the forward rate) for exchange/delivery on a specific future date (the forward date). Although spot markets exist for most of the worlds currencies, for many of the more minor currencies there is no forward market, because there is insufficient demand. The four major trading currencies in the world are the US$, , Y and DM and the forward market amongst these currencies can stretch up to 10 years forward. Standard periods of time forward are one month, three months and these rates and together with the spot rate are instantly available. Other forward rates such as the 84 days forward rate have to be specially quoted by the bankers.

Spot and forward rates may be given as follows:

$/pound spot $/pound one month forward $/pound three months forward 1.5840 1.5860 1.6290 1.6335 1.6525 1.6560

However it is more likely that instead of being given the forward rates like this you are given them as a rate of discount on the spot rate: $/pound spot One month forward 1.5840 1.5860 4.50 c 4.75 c discount

Three months forward

6.85c 7.00 c discount

To obtain the actual forward rate, you add the discount to spot rate Therefore: Spot Add discount 1 month forward And 1.5840 1.5860 0.0450 0.0475 1.6290 1.6335

Spot
Add discount 3 months forward

1.5840 1.5860
0.0685 - 0.0700 1.6525 - 1.6560

NOTE When Forward rates > Spot rates

Forward rates are at discount to the spot rates

To illustrate further
If you want to buy $/Pound spot, for every 1 Pound you would receive $1.5840, but if you bought $ for 3 months/ forward delivery you get $ 1.6525 for every 1 Pound. Thus in the forward markets, the $ is becoming cheaper to buy. Putting this more technically, the $ is weakening or depreciating against the Pound. It is becoming less valuable. (And Pound therefore is appreciating ) More generally, If forward rates are at a discount, the first currently is depreciating against the second currency is your pair of currencies.

When Forward rates < Spot rates Forward rates are at Premium to the spot rates

When forward rates are quoted at a premium, we subtract the premium from the spot rate to find the forward rate. Therefore Whenever forward rates are smaller numbers than spot rates, the forward rates are at a premium

And
this signifies that the first currency is appreciating against the second of the pair of currencies.

Illustration 7
$/pound spot 1 month forward 1.8420 0.85 c 1.8260 0.75 c Premium

Determine one month forward rate Solution

Spot - premium 1.8420 85 1.8260 75 1.8185

1 month forward 1.8335

The $ is becoming more valuable, it is appreciating against Pound. Every 1 Pound buys you $ 1.8420 at spot, but only buys you $1.18335 in one months time.

Illustration 8
$/pound spot 12 months forward 1.5210 8.65 c Discount

Determine Twelve months forward rate Solution

Spot rate $/ + discount 12 months forward rate 1.5210 0.0865 1.6075

So far we have learnt

Two Things If forward rate at a premium

If forward rate at a discount

1st Currency is depreciating against the 2nd currency

1st Currency is appreciating against the 2nd Currency

We can also express rate of depreciation/Appreciation as %age of spot rate

For Example $/pound spot 12 months forward

1.5210 8.65 c Discount

Determine Twelve months forward rate Rate of Depreciation = Discount x 100%= 0.0865 x 100%=5.69% Spot rate 1.5210
Which indicate (as it is a discount) that a forward rate represents a 5.69% depreciation of the $ on the spot rate. As a result, the forward rate can be calculated as: Forward rate 12 month forward = spot rate x (1+ rate of depreciation) = 1.5210 x (1 + 0.0569) = 1.6075

Similarly Rate of Appreciation = Premium x 100% = x % Spot rate Forward rate = Spot rate x (1 rate of appreciation)

Illustration 9
$/pound spot 1.6580 12 months forward 5c Premium Determine Twelve months forward rate

Solution 9 Rate of Appreciation= 0.05

1.6580 Therefore the forward rate represents a 3% appreciation in the $ giving 12 Months forward rate $/ = 1.6580* (1 0.03) = $ 1.6083

= 0.03 or 3%

Illustration 10
Suppose you are told that $/pound Spot is 1.5345 and the $ is expected to depreciate by 5% per year over the next two years and thereafter appreciate by 7% per year.

Required Calculate the forward rates for the next 5 years. Solution
One year forward
Two years forward Three year forward Four year forward Five year forward

$1.5345 * (1+ 0.05) = $1.6112

$1.6112 * (1 + 0.05) = $ 1.6918 $1.6918 * (1- 0.07) = $ 1.5734 $ 1.5734 * (1 - 0.07) = $ 1.4632 $ 1.4632 * (1 0.07) = $ 1.3608