Exchange Rates

Bill Reese

International Finance

1

Learning Objectives

In this unit we will learn: How to interpret direct and indirect exchange

rates How to determine cross-rates How rates are quoted How to calculate the bid-ask spread

2

Basic Terms

Spot Rate The price of a currency in terms of another

currency for a trade today

Forward Rate Price agreed upon today for a trade to be

executed at a specified future date (30, 60, 90, 180 or 360 days)

3

Basic Terms

Direct quote• American quote• Domestic currency/foreign currency• Dollars needed to buy one unit of foreign currency• $/€

4

Basic Terms

Indirect quote• European quote• Foreign currency/domestic currency• Units of foreign currency needed to buy one dollar• €/$

5

Quotes

Currency is a commodity Bananas

• $0.5/pound = 2 lbs. for a dollar

Price of dollar = €.813 Price of a euro = $1.23

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Quotes

Currency in denominator is the one being priced• .813 €/$• 1.23 $/€

7

Quotes

You have dollars and want euros $ → € Selling dollars Buying euros

You have euros and want dollars € → $ Selling euros Buying dollars

8

Quotes

You have $5.00. How many euros is it worth if XR is 1.23 $/€? Multiply or divide? Direct quote: $5 x 1.23 $/€ Note that $ won’t cancel out Must invert

Indirect quote or divide

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Quotes

$5 ÷ 1.23 $/€ =

$5 x 1/1.23 €/$ =

$5 x .813 €/$ =

€4.065

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Quotes

Suppose you have €30 and want dollars?• €30 x 1.23 $/€ = $36.90• Note how €s cancel out in numerator and

denominator

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Cross Rates

Cross exchange rate One foreign currency per unit of another foreign

currency

1.23 $/€ and 1.81 $/£

Cross-rate between euro and pound

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Cross Rates

Multiply to cancel out $1.23 $/€ x 1.81 $/£

Can’t do it – must divide or invert

1.23 $/€ ÷ 1.81 $/£ =

1.23 $/€ x 1/1.81 $/£ =

0.68 £/€

13

Cross Rates

If you want €/£ Take reciprocal

1/0.68 £/€ = 1.47 €/£

14

Bid and Ask

There are two XRs Bid: price dealer will pay you for your currency

Rate if you want to sell

Ask: price dealer will sell you units of a currency for

Rate if you want to buy

Ask > Bid

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Bid and Ask

Indirect quotes Ask: 1.29 SF/$ Bid: 1.28 SF/$

Direct quotes Ask: .78125 $/SF Bid: .7752 $/SF

Bid in $ = Ask in SF Bid in SF = Ask in $

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Bid and Ask

Example Ask: .0091 $/¥ Bid: .0090 $/¥

$150 to convert to yen Buy yen at price of .0091 $/¥ Or sell dollars at price of 1/.0091 ¥/$

$150 ÷ .0091 $/¥ = ¥16,483.5

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Bid and Ask

Change your mind – convert back Sell yen at price of .0090 $/¥ Or buy dollars at price of 1/.0090 ¥/$

¥16,483.5 x .0090 $/¥ = $148.35

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Bid and Ask

$150 → $148.35 Lost $1.65 Lost 1.1% of $150 you started with

Bid-Ask Spread

Spread = Ask – Bid

Ask

= (.0091 - .0090)/.0091 = 1.1%

19

Bid and Ask

Spread Transaction cost for round-trip transaction Decreases with greater amounts of currency Increases with less frequently traded currency

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