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Chapter 8, , Foreign Exchange Arithmetic, , Foreign Exchange Arithmetic, , Basic Rules Regarding Exchange Rates, Types of Foreign Exchange Quotations, Classification of Transaction based on Value Date, Direct and Indirect Quotation, , Features of Forward Rates, , Broken Date forward Quotations, Annualized forward Margin, , Arbitrage, , Triangular Arbitrage, , Covered interest Arbitrage, Determinants of Exchange Rate, Purchasing Power Parity, , interest Rate Parity, , Objective Questions, Questions for Seif-Practice, ——————————, , 81 FOREIGN EXCHANGE ARITHMETIC:, As already mentioned, the mechanism of conversion of one, ites fic acter in called Soreiga onchange Thar io aor, network of nostro and vostro accounts maintained, between international banks. The market where this dealing is, done is called as foreign exchange market (Forex market).Thus, it, ‘Sa market in which foreign currencies are bought and sold for, tic currency. The forex market is a very significant ground, exporters and importers as they need foreign currency fof, , transactions., , S, , 8.2, 83, 84, 85, 86, 87, 88, 89
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tional Banking and Finance (By, 0 Mint sch one curre, , The currency exchange rate is the rate at we, can be exchanged for another. It is always 4, EUR/USD (the Euro and the US Dollar). Exe duction, based on economic factors like inflation, indus » whether, and geopolitical events. These factors will influence =, buy or sell a currency pair., , Example of a Forex Trade:, , The EUR/USD rate represents the number of US Doles be, Euro can purchase. If you believe that the Euro will “ae in, value against the US Dollar, you will buy Euros with US Dollars,, If the exchange rate rises, you will sell the Euros back, making @, profit., , It is to be noted that neither there is a physical existence of, market nor are the currencies transferred physically; the receipts, and payments are facilitated through demand deposit accounts, Provided by the banks. Thus every forex transaction requires, intermediation of the banks. One more important feature of the, forex market is that the exchange of currencies takes place on the, , basis of the exchange rate determined by the d, h lemand and, of respective currencies in the market. : “ee, , uoted in pairs like the, hange rates fluctuate ", , , , 83 i, , The tyr, , () Bid a, , Q), , buyer, quote, buy th, dealer
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spread. Spread is always positive,, , There are some factors that affect Spread such as volatility in, the number of buyers and Sellers in the market, volume of, , transactions in th, ey © market, regulations imposed by Central, , 83 TYPES OF FOREIGN EXCHANGE QUOTATIONS:, The types of foreign exchange transfer are as below:, , () Bid and ask Price: In foreign exchange market there are, buyers and sellers. One party buys and one party sells. Bid, quote is the price at which the exchange dealer is ready to, buy the currency and ask quote means the price at which the, , dealer is ready to sell the currency., , Direct quote: Direct quote is also known as price quotation., Under the direct quotation, the variations of the exchange, tates are inversely related to the changes in the value of the, domestic currency. When the value of the domestic currency, Tises, the exchange rates fall; ae the value of the, domesti rrency falls, the exchange rates rise. Most, Sigs direct quotation. Most of the exchange rates in, the market such as USD/JPY, USD/HKD and USD/RMD are, also quoted using direct quotation. The exchange rate of the, domestic currency is expressed as equivalent to a certain, number of units of a foreign currency. It is usually expr, , as the amount of domestic currency that can be exchanged for
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(8) Indirect Quote: Indirect quote is also known as the quantity, quotation. Under indirect quotation, the rise and fall of pie, exchange rates are directly related to the changes in value of aa, the domestic currency. When the value of the domestic. pe, currency rises, the exchange rates also rise; and when the —, value of the domestic currency falls, the exchange rates fall ag (8) Cross ¢, well. Most Commonwealth countries such as the United the cu, Kingdom, Australia and New Zealand use indirect quotation, currenc, Exchange rates such as GBP/USD and AUD/USD are quoted currenc, indirectly. The exchange rate of a foreign currency is not inv, expressed as equivalent to a certain number of units of the foreign, domestic currency. This is usually expressed as the amount of exchang, foreign currency needed to exchange for 1 unit or 100 units of an indix, domestic currency. The more valuable the domestic currency, differen, the greater the amount of foreign currency it can exchange Pi oney i, and the lower the exchange rate. When the domestic currency pa, becomes less valuable, it can exchange for a smaller amount, of foreign currency and the exchange rate drops. ae, (4) Inter-Bank Quote: The most professional way to do forei waa, exchange transaction is inter-bank quote. In thts ea of the professional brokers give quote. Th ee ——a, two ways: . they can be quoted in Ane, a Quote and American Quote: Pound, a European quote, it sj no, foreign currency needed to puschost s rumeet OF units of EUR/GE, a quote, it shows the number a ac Whereas, in Pairs., purchase one unit of foreign cuirency. of USD needed (9) Spread «, , , , (5) Mid Quote: It is the quote or, - Price which, Bid and Ask quote or price. in simple is the average of the, fate between the ask price and the bid price "at is the middle
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Exchange Arithmetic, , . Forward quote: When the by seller agree to carry, out pan ata future daha fee rate a, oe change inspite of change mao the ranwacion does, the day of the transaction, es, , Cross eee Rate: It is, , we ia, , the exchange rate in which both, the transaction are not official, , i ‘xchange rate between two unofficial, currencies. Generally, it is the quote in which US. dollar is, , not involved to express the rate of another currency. One, foreign currency is traded for another without having first to, exchange the currencies into American dollars.. Historically,, an individual who wished to exchange a sum of money into, different currency would be required first to convert that, money into U. S dollars, and then convert it into the desired, currency; cross currencies help individuals and traders, bypass this step. The GBP/JPY cross, for example, was, invented to help individuals in England and Japan who, wanted to convert their money directly without having to, first convert it into U.S. dollars., , An exchange rate between Japanese Yen and Great Britain, Pound JPY /GBP can be an example of cross currency rate as, in this quote, US $ is not involved. For trade purposes the, EUR/GBP, EUR/CHF, EUR/JPY are common cross currency, , (9) Spread quote: This is also known as Bid-offer spread. It is a, , rticipants will to buy or sale goods or, services. It is divided in direct spread and indirect spread., When the ask price is greater than bid price then t is direct, the bid price is greater than ask price, , quote at which the pa!
