05
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Introduction
How rates are quoted
Reciprocal Quotations
Points and pips
Two way quotations
Cross Rates
Chain Rule
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Direct rates
If the foreign currency is kept constant and
the home currency is varied then it is known
as a direct rate.
Direct rates expresses the number of units
of the home currency in terms of a single
unit of a foreign currency.
US Dollar 1 =
Rs.42.55
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Home currency rates are also known as
"pence rates" in the United Kingdom (they
could be called paisa rates in India).
They are designated as direct rates,
because the rupee cost of a single foreign
currency unit can be obtained directly and
the number of foreign currency units to the
rupee is fixed and certain.
The general rule while quoting direct rates
by banks is to Buy low and sell high.
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Indirect rates
If on the other hand the home currency is
kept constant and the foreign currency is
varied, then the rate is known as an
indirect rate.
Indirect rates expresses the number of
units of a foreign currency to unit/s of
home currency.
Rs.100 = 2.234
The rule followed by banks while quoting
indirect rates is to Buy high sell low.
"High" means higher rates and "Low"
means lower rates in terms of figures.
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Currencies can be quoted in terms of the
number of units of currency X to per unit
of currency Y or the number of units of
currency Y per unit of X.
The two rates represent equal value and
are reciprocals of each other.
To convert one method to another, the
number 1 should be divided by the rate.
US$ 1/ Rs. 42.55 = Re.1 = $0.02350
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Exchange rates for major currencies
excluding the Yen and the Italian Lira are
usually quoted to four decimals in the
wholesale market.
The fourth decimal (0.0001) is called a
point.
The fifth decimal place (0.00001) is referred
to as a pip.
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In foreign exchange markets the normal
practice is to quote two ways i.e. one rate
for selling and another for buying.
This is also known as the bid and offer
rate.
The rate at which the quoting bank is
selling is known as the offer rate and the
rate at which it (the quoting bank) is
buying is known as the bid rate.
When a dealer is asked for a quote he
usually gives a two way quote.
The quote is structured in such a way
that if he wants to sell, he’ll make the
sale quote more attractive.
The advantages of this system are that
(a) A market exists for buyers and sellers
(b)
It gives depth and liquidity to the
market
(c) It is a transparent system
(d) It clearly shows the dealer’s profit
When asking for a quote, the individual does not
need to reveal whether he is a buyer or a seller.
If the quote is a direct quote it will be
US Dollar 1 = Rs. 42.55 - 42.70
The first rate is the buying (bid) rate and the
second rate is the selling (offer) rate. The
difference is the profit the dealer makes. This
profit is also known as "the dealer's turn".
If the quote is an indirect one it will be
Rs.100 = US Dollar 2.8235 - 2.8265
The first rate is the selling (offer) rate and the
second rate is the buying (bid) rate
Sometimes both the currencies are foreign
currencies.
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A cross rate can be defined as the relative
value of two currencies determined by
comparing the value of each of the two
currencies against a common third
currency.
A bank rarely keeps accounts in all
currencies.
This is not feasible and it would be
expensive as banks with which foreign
currency accounts are maintained would
expect minimum balances to be kept.
Banks keep accounts in the currencies
they normally deal with such as the US
Dollar, Pound Sterling, Japanese Yen,
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If a customer wishes to send a remittance to
Belgium from India, the bank would
purchase US Dollars or Pound Sterling
overseas and then dispose these overseas
to purchase Belgian Francs.
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One should always remember who is the
quoting party and who is facing the
quote.
In practice if one asks for a quote, the
party asked (quoting party) would give a
quote.
It is for the Bank then to complete the
transaction (do the deal) or not.
The party asking cannot dictate a price.
As all currencies are quoted against the
dollar, it may be necessary to work out
the cross rates for currencies other than
the dollar.
In order to arrive at cross rates, the chain
rule is used.
The various steps in the Chain Rule are:.
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Rule I
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Rule II
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Rule III
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State the final intention.
Start with the currency to be utilised for
the purchase of the currency finally to be
bought.
The currency in the second equation is
considered (US Dollar 1) and the
information regarding the type of
transaction is used.
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Rule I State the final intention.
Let us assume that a customer wishes to
purchase Belgian Francs. The statement will
therefore be :
“How many rupees
= Belgian Francs 1”
Rule II Start with the currency to be utilised for
the purchase of the currency finally to be
bought.
In this example the US Dollar is to be used to
purchase Belgian Francs.
Thus it would be “If Belgian Francs 20.0500 =
USD 1”
Rule III The currency in the second equation is
considered (US Dollar 1) and the information
regarding the type of transaction is used.
In this example rupees are to be sold to
purchase US Dollars.
Hence
Rule 1 How many rupees = Belgian Francs
1
Rule 2 If Belgian Francs 20.0500 = US
Dollar 1
If US Dollar 1
= Rs.43.5650
Rule 3 Therefore
43.5650
Belgian
Franc
1
20.0500
= Rs. 2.1728
or Rs. 2.17
=
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Banks dealing in sale and purchase of
foreign currencies would adopt the same
business principle in determining and
calculating their selling and buying rates.
Buying in this connection as far as a bank is
concerned means when it buys foreign
currency from a customer.
Sale means exactly the opposite.
The principle banks use is “Buy high, sell
low” or “Take more, give less”.
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It should be remembered that in executing
cross rate deals normally only one price is
quoted between the client and the
institution making the market price (the
price maker – usually a bank).
The price maker may be able to trade the
transaction on one price when it tries to
cover the transaction.
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Banks and dealers in foreign exchange quote
the rates that they are prepared to buy a
particular currency and the rate they are
prepared to sell the currency.
The rates quoted are direct quotes (where the
local currency is quoted to a unit of the foreign
currency) or indirect quotes (where the foreign
currency is quoted to a fixed amount of the
local currency.
If a bank does not deal in a particular currency,
it derives a rate for that currency by a cross
rate.
This is by buying that currency from a bank that
deals in this third currency and applying the rate
at which it buys the third currency (the currency
◦ Banks and dealers quote the rates they are
prepared to buy and sell foreign currency.
◦ Rates quoted are direct quoted or indirect quotes.
◦ If the bank does not deal in a particular currency, it
derives a rate by a cross rate