Exchange Rate Quotations

Exchange Rate Quotes - Basics

Each currency
FE
denoted by Base currency -
Transactions-
unique 3 the one which
Exchange b/w 2
character ISO is bought or sold
currencies
code

Rate of Currency
Exchange - pairings – 2 ISO
price of one codes separated
currency in by a division
terms of another symbol GBP/USD
GBP -Base currency
USD-Secondary/Quoted currency

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 How to Read Quotes

1 unit of sterling can be

Rates – written up to 4 decimal
exchanged for 1.5545 US
points
dollars

GBP/USD = 1.5545

Exception – Japanese Yen 1.55 – Big Figure

Written up to 2 decimal places 45 – Points / Pips

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 PIPS

Movement in the exchange rate is measured by pips

As currency pairs are quoted to a maximum of four

decimal places, the smallest change for these pairs is
1 pip
PIPETTE

The value of a pip can be calculated by dividing

1/10,000 or 0.0001 by the exchange rate

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 Currency Codes

HKD: Hong JPY: Japanese SGD: Singapore

USD: US Dollars
Kong Dollars Yen Dollars

CNY: Chinese GBP: British CAD: Canadian AUD: Australian

Yuan Pounds Dollars Dollars

INR: Indian
CHF:Swiss Franc
Rupees

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 Currency Quotes
Currency quotes show, how many units of the quote currency will be needed to exchange
for one unit of the base currency

USD/INR

Currency on the left Currency on the right

Base Currency Quoted Currency

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 Types of Quotes

Direct Quote Indirect Quote

• Gives units of domestic currency per • Gives the units of foreign currency
unit of a foreign currency per unit of the domestic currency
• Price of foreign currency is quoted in • Price of home currency is quoted in
terms of home currency. terms of foreign currency
• Quoted Currency - Domestic • Quoted Currency - Foreign currency
• E.g. USD/INR = 83.94 Rs. / $ • E.g. – INR/USD = 0.0119 $ / Rs.

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 Types of Quotes

American Terms European Terms Cross Rate

• USD becomes the • USD becomes • Quotation

quoted currency the base currency between two non
dollar currencies

• INR/USD = • USD/INR = • GBP/INR =

0.0220 $ / Rs. 45.30 Rs. / $ 90.4587
Rs./pound

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 Bid and Ask Rates

• Price at which:
• Forex dealer is willing to buy a unit of the base
Bid currency
• Trader will sell the currency

• Price at which:
• Forex dealer is willing to sell a unit of the base
Ask currency
• Trader will buy / offered to buy the currency

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 Bid and Ask Rates
USD 1= INR 83.9490 / 84.0040

Market Maker Trader

Buying 1 USD @ Selling 1 USD @

83.9490 INR 83.9490 INR

Selling 1 USD @ Buying 1 USD @

84.0040 INR 84.0040 INR

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 Spread

Also known as dealer’s For Direct quotes,

Difference between bid
margin or cost of Spread = Ask Price-Bid
price and ask price
transaction Price

Percentage Spread = For Indirect quotes, Percentage Spread =

(Ask Price – Bid Price)/ Spread = Bid Price-Ask (Bid Price – Ask Price)/
Ask Price * 100 Price Bid Price * 100

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Spread

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 Cross Rates
Foreign currency exchange transaction between two currencies that are both valued
against a third currency, usually USD

Calculate the cross rate between EUR & INR using the USD as the common
currency (Base in both cases)

• 1 USD = .91 EUR (USD/EUR)

• 1 USD = 83.98 INR (USD/INR) Cross Rate EUR/INR =
=
• .91 EUR = 83.98 INR
• INR/EUR = = 0.0108 =92.2857
• EUR/INR = = 92.2857

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 Cross Rates

Calculate the cross rate between EUR & INR using the USD as the common
currency (Base in one case and quoted in other)

EUR/INR
INR/EUR =
USD/INR = 83.98 EUR/USD = 1.10 = 83.98 × 1.10
= 92.378 = 0.0108

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Cross Rates – Two Way Quotations
Given: Given:
1 USD = .9020/21 EUR 1 USD = .9020/21 EUR
1 USD = 83.972/79 INR 1 USD = 83.972/79 INR
Find: Find:
Bid Rate for EUR/INR Ask Rate for EUR/INR

Rate at which trader can sell Rate at which trader can buy
1 EUR & receive INR 1 EUR using INR
Trader has EUR in hand Trader has INR in hand
Sell EUR to buy USD Sell INR to buy USD
Sell USD to buy INR Sell USD to buy EUR

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Cross Rates – Two Way Quotations
USD / USD / INR
EUR .9020/21 83.972/79

Market Maker Market Maker

• Market maker will buy 1 • Market maker will buy 1
USD @ 0.9020 EUR USD @ 83.972 INR
• Market maker will sell 1 • Market maker will sell 1
USD @ 0.9021 EUR USD @ 83.979 INR

Trader Trader
• Trader will sell 1 USD @ • Trader will sell 1 USD @
0.9020 EUR 83.972 INR
• Trader will buy 1 USD @ • Trader will buy 1 USD @
0.9021 EUR 83.979 INR
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 Cross Rates – Two Way Quotations

Sell EUR to buy USD Bid Rate EUR/INR = (Bid)

1 USD = .9020/21 EUR
• Since Bid Rate of EUR/USD is not available we can
Sell USD to buy INR not simply take reciprocal of bid rate USD/EUR
1 USD = 83.972/79 INR
• We have to take reciprocal of Ask Rate of USD/EUR
.9021 EUR = 83.972 INR
• = = 93.0850

EUR/INR = 93.0850 =

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 Cross Rates – Two Way Quotations

Sell INR to buy USD Ask Rate EUR/INR = (Ask)

1 USD = 83.972/79 INR

• Since Ask Rate of EUR/USD is not available we can

Sell USD to buy EUR not simply take reciprocal of Ask rate USD/EUR
1 USD = .9020/21 EUR
• We have to take reciprocal of Bid Rate of USD/EUR
.9020 EUR = 83.979 INR
• = = 93.1031

EUR/INR = 93.1031 =

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Cross Rates – Two Way Quotations

EUR/INR = 93.0850/1031

Buying 1 EUR for Selling 1 EUR for

93.0850 INR 93.1031 INR

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 Cross Currency Matrix
Following data is given on Foreign Exchange Market. Prepare a Cross Currency Matrix. USD/INR =
₹69.30, EUR/INR= ₹ 77.70, GBP/INR = ₹ 97.50, JPY/INR = ₹ 0.60
Note: Row indicates base currency and column indicates quoted currency

INR USD EUR GBP JPY

INR 1
USD 69.30 1
EUR 77.70 1
GBP 97.50 1
JPY 00.60 1

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 Arbitrage

Arbitrage is the process of a simultaneous sale and purchase of currencies in two

or more foreign exchange markets

With an objective to make riskless profits by capitalizing on the exchange-rate

differentials in various markets

These opportunities are rare and vanish soon by the actions of arbitrageurs

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 Types of Arbitrage
Locational /
Triangular Covered Interest
Interbank Rate
Arbitrage Arbitrage
Arbitrage
• Exploitation of the • Trading out of the • Using favourable
differences in quotes First currency into a interest rate
rather than second currency, then differentials to invest
movements in the trading it for a third in a higher-yielding
exchange rates of the currency, which is in currency, and hedging
currencies in the turn traded for first the exchange risk
currency pair Currency through a forward
currency contract

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 Interbank Rate Arbitrage
Quotation of Market Scouting Best Rate from
Makers Different Banks

SBI USD 1 = INR 83.6250/6375 SBI USD 1 = INR 83.6250/6375

ICICI Bank USD 1 = INR 83.6175/6300 ICICI Bank USD 1 = INR 83.6125/6225

Buy from ICICI Bank @ 83.6300 Buy from ICICI Bank @ 83.6225
Sell to SBI @83.6250 Sell to SBI @83.6250
Loss - INR 0.0050 per $ Gain - INR 0.0050 per $

Arbitraging is not possible Arbitrage is possible

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 How Arbitraging Opportunities Emerge
Depends upon transaction exposure of banks

SBI - USD 1 = INR 83.6250/6375 Buy Rate – 83.6250 Sell Rate – 83.6375
• Exchange Position in Currency – Oversold – SBI Prefers to buy
• Traders would prefer 83.6250 as compared to ICICI’s Rate @ 83.6125 to sell

ICICI - USD 1 = INR 83.6125/6225 Buy Rate – 83.125 Sell Rate – 83.6225

• Exchange Position in Currency - Overbought – Prefers selling

• Traders would prefer 83.6225 as compared to SBI’s 83.6375 to buy

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 How Arbitraging Opportunities Emerge

After their exchange positions are

balanced, the rates may converge

PNB - USD 1 = INR 83.6200/6325

• Buy rate is worse than SBI & sell rate is worse than ICICI
• Avoids both purchase & sale transactions in $

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 Triangular Arbitrage
• Exploit discrepancies in cross rates between currencies to make
Trading Strategy profit from the differences in exchange rates

• Converting one currency into a second currency, then into a third

Involves currency, and finally converting back to the original currency

• In highly liquid & efficient markets, such are quickly eliminated as

Efficiency traders act on them

• Requires accurate & timely execution of trades to realize profits

Complexity • Transaction costs can impact the profitability of the strategy

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 Process of Triangular Arbitrage
Execute the
Arbitrage
Identify the
Discrepancy • 1: Start with a base currency
Profit
EUR. Convert it into a
second currency USD using
the EUR/USD rate
• Step 2: Convert the USD
• Determine the cross rate into a third currency JPY If the final amount of the
for a currency pair (e.g. using the USD/JPY rate base currency (EUR) is
EUR/JPY) • Step 3: Convert the JPY more than the initial
• Compare it to the rate back to the original base amount, then an
implied by other currency EUR using the arbitrage profit has been
exchange rates cross rate EUR/JPY made
EUR/USD & USD/JPY
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Given
Illustration
EUR/USD

Find EUR/JPY
1.2000
• EUR/USD = 1.2000 – Convert EUR into USD
USD/JPY • USD/JPY = 110.00 – Convert USD into JPY
• Cross Rate EOR/JPY= × = 1.200 × 110.00 = 132.00

110.00 Compare Cross Rate with Direct Rate

EUR/JPY • Direct Rate = Cross Rate =132.00 JPY

• There’s no arbitrage opportunity here
132.00
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 Illustration
Convert 1 EUR to USD

• 1 EUR = 1.2000 USD

Given
Convert 1.2000 USD to JPY
EUR/JPY • 1.2000 USD × 110.00 JPY/USD = 132.000 JPY

Convert 132.000 JPY to EUR

131.00
• Using the direct rate EUR/JPY 131.00 EUR = 1.0076 EUR

Profit
• Profit = 0.0076 per Euro for exploiting the discrepancy
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Triangular Arbitrage with Transaction Cost
GBP / EUR GBP / USD EUR / USD
1.2950/65 1.6025/60 1.2375/90

If trader wants to sell pound and buy Euro (GBP/EUR-Bid)

• Sell GBP & Buy USD = 1.6025
• Sell USD & Buy EUR = 1.2390
• GBP/EUR = = 1.2934

Cross Rate: 1.2934 – worse than direct rate 1.2950

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 Arbitrage Opportunity
If trader wants to buy pound against euro (GBP/EUR-Ask)

• Sell EUR & Buy USD = 1.2375

• Sell USD & Buy GBP = 1.6065
• GBP/EUR = = 1.2978

Cross Rate: 1.2978 – worse than direct rate of 1.2965

Direct Rate Cross Rate

GBP / EUR GBP/EUR
1.2950/65 1.2934/78

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 Illustration
• USD/GBP = 1.7540/45
New York Bank is quoting • CHF/USD = 1.5700/05

London Bank is quoting • CHF/GPB = 2.7385/90

London Rate - CHF/GPB - 2.7385/90 N Y Cross Rate - CHF/GPB - 2.7538/54

Buying in London @ 2.7390 & Selling in N Y @ 2.7538

Arbitrage Profit = 2.7538-2.7390 = 0.0148 per CHF/GBP

Buying in N Y @ 2.7554 & Selling in London @ 2.7358

No Arbitrage opportunity
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 Quotes CHF/USD = 1.5700/05 USD/GBP = 1.7540/45
Market Maker Buy CHF @ USD 1.5700 Buy USD @ GBP 1.7540
Sell CHF @ USD 1.5705 Sell USD @ GBP 1.7545
Trader Buy CHF @ USD 1.5705 Buy USD @ GBP 1.7545
Sell CHF @ USD 1.5700 Sell USD @ GBP 1.7540

Cross Rate CHF/GBP (Bid) Cross Rate CHF/GBP (Ask)

• Sell CHF to buy USD • Sell GBP to buy USD

• CHF/USD = 1.5700 • GBP/USD = 1.7545
• Sell USD to buy GBP • Sell USD to buy CHF
• USD/GBP = 1.7540 • USD/CHF = 1.5705
• CHF/GBP = 1.5700×1.7540 = 2.7538 • CHF/GBP = 1.7545×1.5705 = 2.7554

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 Covered Interest Arbitrage
Assume currency X and currency Y are trading at parity in the spot market (i.e.,
X = Y), while the one-year interest rate for X is 2% and that for Y is 4%.

Borrow 500,000 of
currency X @ 2% per Convert the 500,000 X
Lock in the 4% rate on
annum, which means that into Y (offers a higher
the deposit amount of
the total loan repayment one-year interest rate) at
500,000 Y
obligation after a year the spot rate of 1.00
would be 510,000 X

After one year, settle the Simultaneously enter into

Repay the loan amount of forward contract at the a forward contract
510,000 X and pocket the contracted rate of 1.0125, 520,000 Y into currency
difference of 3,580 X which would give the X at the one-year forward
investor 513,580 X rate of X = 1.0125 Y

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 Activity - Situational Analysis
USD/INR = 68.30
GPB/INR = 97.52
GBP/USD = 1.431

Is triangular arbitrage possible?

Calculate profit from strategy if you have USD 1,00,00,000.
Assume there are no transaction costs.

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