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

U.S. $ Equivalent GBP per U.S. $

(dollars per pound) (pounds per dollar)
Monday Friday Monday Friday
Spot Rate 1.5996 1.6084 0.6252 0.6217
1-month forward 1.5956 1.6048 0.6267 0.6231
3-month forward 1.5894 1.5982 0.6292 0.6257
6-month forward 1.5796 1.5884 0.6331 0.6296
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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 ($)
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Foreign Exchange Market Framework
Important features of these exchange rates:
• The last two columns are simply the
reciprocal of the first two columns
• The first two columns are direct rates for the
British pound (£) and indirect rates for the
U.S. dollar ($)
• The last two columns are direct rates for the
U.S. dollar ($) and indirect rates for the
British pound (£)
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Foreign Exchange Market Framework
Important features of these exchange rates:
• The first row depicts the exchange rate in the
spot market
• The next three rows are forward rates for
one month, three months and six months
• In the spot market, currency either
appreciates or depreciates in daily trading
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Foreign Exchange Market Framework
Spot Market
• The following examples show how to calculate currency
appreciation or depreciation in the spot market
Using direct quotes for the U.S. dollar
Spot Monday – Spot Friday (0.6252 – 0.6217)
Spot Friday 0.6217
0.56%
• The U.S. dollar ($) has appreciated by 0.56 percent against the
British pound (£) in the previous two trading days, that is, Friday
and Monday
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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 ($) has appreciated by 0.56 percent against the
British pound (£) in the previous two trading days, that is, Friday
and Monday
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Foreign Exchange Market Framework
Spot Market
• The following examples show how to calculate currency
appreciation or depreciation in the spot market
Using direct quotes for the GBP
Spot Monday – Spot Friday (1.5996 –1.6084)
Spot Friday 1.6084 - 0.56%
• The British pound (£) has depreciated by 0.56 percent against
the U.S. dollar ($) in the previous two trading days, that is, Friday
and Monday
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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
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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.
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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.
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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
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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
($) in a 1-month forward market
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Foreign Exchange Market Framework
Bid-Ask Rates
• The bid rate is a currency broker's buying rate for the U.S.
dollar ($) 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

Bid Rates Ask Rates

Spot £0.6275/$ £0.6281/$
1-month Forward £0.6280/$ £0.6290/$
3-month Forward £0.6300/$ £0.6328/$
• The bid-ask spread represents the broker's cost and the
profit on the transaction
Ask Rate – Bid Rate
Bid Ask Spread =
Ask Rate
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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 1-
month forward bid rate
• 9 is the difference between the spot ask rate and the 1-
month forward ask rate
• 25 is the difference between the spot bid rate and the 3-
month forward bid rate
• 47 is the difference between the spot ask rate and the 3-
month forward ask rate
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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