Foreign Exchange

FOREIGN EXCHANGE Foreign Exchange Market Framework The following are typical exchange rates as reported in The Wall Street Journal for trading among banks in the amount of US$1 million or more, for example, for the GBP

Spot Rate 1-month forward 3-month forward 6-month forward

U.S. $ Equivalent (dollars per pound) Monday Friday 1.5996 1.6084 1.5956 1.6048 1.5894 1.5982 1.5796 1.5884

GBP per U.S. $ (pounds per dollar) Monday Friday 0.6252 0.6217 0.6267 0.6231 0.6292 0.6257 0.6331 0.6296

FOREIGN EXCHANGE Foreign Exchange Market Framework

Important features of these exchange rates: • Rates are quoted for the previous two trading days are known as outright quotes • The first two columns are known as rates on U.S. terms, and the last two columns are called rates on European terms • For the first two columns the base currency is the British pound (£) • For the last two columns the base currency is the U.S. dollar ($)

FOREIGN EXCHANGE Foreign Exchange Market Framework

Important features of these exchange rates: • The last two columns are simply the reciprocal of the first two columns • The first two columns are direct rates for the British pound (£) and indirect rates for the U.S. dollar ($) • The last two columns are direct rates for the U.S. dollar ($) and indirect rates for the British pound (£)

FOREIGN EXCHANGE Foreign Exchange Market Framework

Important features of these exchange rates: • The first row depicts the exchange rate in the spot market • The next three rows are forward rates for one month, three months and six months • In the spot market, currency either appreciates or depreciates in daily trading

FOREIGN EXCHANGE Foreign Exchange Market Framework Spot Market • The following examples show how to calculate currency appreciation or depreciation in the spot market Using direct quotes for the U.S. dollar Spot Monday – Spot Friday (0.6252 – 0.6217) Spot Friday 0.6217 0.56% • The U.S. dollar ($) has appreciated by 0.56 percent against the British pound (£) in the previous two trading days, that is, Friday and Monday

FOREIGN EXCHANGE Foreign Exchange Market Framework Spot Market • The following examples show how to calculate currency appreciation or depreciation in the spot market Using indirect quotes for the U.S. dollar Spot Friday – Spot Monday (1.6084 – 1.5996) Spot Monday 1.5996 0.56% • The U.S. dollar ($) has appreciated by 0.56 percent against the British pound (£) in the previous two trading days, that is, Friday and Monday

FOREIGN EXCHANGE Foreign Exchange Market Framework Spot Market • The following examples show how to calculate currency appreciation or depreciation in the spot market Using direct quotes for the GBP Spot Monday – Spot Friday (1.5996 –1.6084) Spot Friday 1.6084 - 0.56% • The British pound (£) has depreciated by 0.56 percent against the U.S. dollar ($) in the previous two trading days, that is, Friday and Monday

FOREIGN EXCHANGE Foreign Exchange Market Framework Spot Market • The following examples show how to calculate currency appreciation or depreciation in the spot market Using indirect quotes for the GBP Spot Friday – Spot Monday (0.6217 –0.6252) Spot Monday 0.6252 - 0.56% • The British pound (£) has depreciated by 0.56 percent against the U.S. dollar ($) in the previous two trading days, that is, Friday and Monday

FOREIGN EXCHANGE Foreign Exchange Market Framework Forward Market • The following examples show how to calculate currency premium or discount in the forward market Using direct quotes for U.S. dollar Forward Rate – Spot Rate 360

(0.6267 –0.6252)

360

Spot Rate n 0.6252 30 3.0% • where n= number of days in the forward contract. • The U.S. dollar ($) is selling at premium against British pound (£) in a 1-month forward market.

FOREIGN EXCHANGE Foreign Exchange Market Framework Forward Market • The following examples show how to calculate currency premium or discount in the forward market Using indirect quotes for U.S. dollar Spot Rate – Forward Rate 360

(1.5996 –1.5956)

360

Forward Rate n 1.5956 30 3.0% • where n= number of days in the forward contract. • The U.S. dollar ($) is selling at premium against British pound (£) in a 1-month forward market.

FOREIGN EXCHANGE Foreign Exchange Market Framework Forward Market • The following examples show how to calculate currency premium or discount in the forward market Using direct quotes for GBP Forward Rate – Spot Rate 360

(1.5956 –1.5996)

360

Spot Rate n 1.5996 30 - 3.0% • where n = number of days in the forward contract • The British pound (£) is selling at a discount against the U.S. dollar ($) in a 1-month forward market

FOREIGN EXCHANGE Foreign Exchange Market Framework Forward Market • The following examples show how to calculate currency premium or discount in the forward market Using indirect quotes for GBP Spot Rate – Forward Rate 360

(0.6252 – 0.6267)

360

Forward Rate n 0.6267 30 - 3.0% • where n = number of days in the forward contract • The British pound (£) is selling at a discount against the U.S. dollar ($) in a 1-month forward market

FOREIGN EXCHANGE Foreign Exchange Market Framework Bid-Ask Rates • The bid rate is a currency broker's buying rate for the U.S. dollar ($) and the selling rate for the British pound (£) • The ask rate is the currency broker's selling rate for the U.S. dollar ($) and the buying rate for the British pound • Bid rates are always lower than ask rates Spot 1-month Forward 3-month Forward

Bid Rates £0.6275/$ £0.6280/$ £0.6300/$

Ask Rates £0.6281/$ £0.6290/$ £0.6328/$

• The bid-ask spread represents the broker's cost and the profit on the transaction

Bid Ask Spread =

Ask Rate – Bid Rate Ask Rate

FOREIGN EXCHANGE Foreign Exchange Market Framework Bid-Ask Rates • Point quotes are reported as 0.6275 – 81, 5 – 9, 25 – 47, where 0.6275 is the spot bid rate • 81 represents the last two digits of the spot ask rate • 5 is the difference between the spot bid rate and the 1month forward bid rate • 9 is the difference between the spot ask rate and the 1month forward ask rate • 25 is the difference between the spot bid rate and the 3month forward bid rate • 47 is the difference between the spot ask rate and the 3month forward ask rate

FOREIGN EXCHANGE Foreign Exchange Market Framework Cross Rate • A cross rate is the exchange rate between two nondollar-denominated currencies • The following examples show the equations used to determine the cross rates in different situations • Currency A in $ / Currency B in $ = Value of 1 unit of currency in A in units of currency B • Exchange rates as quoted are ¥117.53/$ and and you wish to determine the rate between ¥/€ ¥117.53/$ €0.8624/$ = ¥136.30 / € • Mathematically, the dollar amounts will cancel out