FOREIGN

EXCHANGE
MARKETS
Part 1
PARVESH AGHI
 Foreign Exchange
Market

28 July 2020 2
Foreign Exchange Market
Most countries of the world have their own
currencies: the Indian rupee , the U.S dollar.,
the euro in Europe, the Brazilian real, and the
Chinese yuan, just to name a few.

The trading of currencies is what makes up

the foreign exchange market.

3
What are Foreign Exchange
Rates?
Two kinds of exchange rate transactions make up the foreign exchange market:

Spot transaction, is an Forward transaction is

agreement between two an agreement between
parties to buy one you and the bank to
currency against selling purchase one currency
another currency at an against selling another
agreed price for currency at a fixed price
settlement on the spot for delivery on an
date.  agreed date in the future

4
Foreign Exchange Market: Exchange Rates

Foreign Exchange Rates are published daily in

newspapers and internet sites such as
www.finance.yahoo.com .

Exchange rates for a currency such as rupee are

quoted in two ways US dollar per unit of domestic
currency or domestic currency per US dollar.

For example, on 7th June 2020 , one $ was quoted

as Rs 75.56 and 1 Rupee = $0.01323 .
5
Foreign Exchange Market: Exchange Rates

American generally would regard the exchange

rate with rupee as $0.01323 per rupee ( or $
1.312 per Rs 100) while Indians think of it as Rs
75.56 per Dollar.

Exchange Rates are quoted for the spot

transaction ( the spot exchange rate) And for
forward transaction ( the forward exchange rates
that will take place one month , three months ,
and six months in the future
6
How is Foreign Exchange Traded?
One of the most fascinating things about this market –
there is no brick and mortar marketplace for Forex
trading.

Every transaction is done electronically over-the-

counter.

Unlike the stock exchange, the Forex market remains

open round the clock with currencies traded across
every time zone, five days every week.

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Forex markets

The foreign exchange or forex

market is the largest financial
market in the world – larger
even than the stock market,
with a daily volume of $5
trillion, vs. $85 billion for
equities worldwide.
8
BASIC
CONCEPT
S

9
 Direct & INDIRECT
QUOTES

Saturday, October 17, 2020 10

Direct and Indirect Quote

Foreign exchange A direct quote is the home

Depending upon the home currency price of one-unit
quotation can be either a
currency of the person foreign currency
direct quotation and or an
concerned.
indirect quotation $1= Rs 75

Direct and indirect quotes

are reciprocals of each Direct quote = 1/indirect
other quote and vice versa
Rs 1 = $ .01333

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Direct Quote

Direct quotation Direct

Quotation
for India

is when the one $ Rs

1 = 75
unit of foreign
currency is
expressed in Direct Quotation ( for USA)

terms of domestic £
1 =
$
1.26
currency.

12
Indirect quote

Indirect quotation for India

Indirect quotation Rs $
is when one unit 1 = 0.0133

of domestic
currency us Indirect quotation for USA
expressed in $ ₤
terms of 1 = .7936

foreign currency. 
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Direct and indirect quotes
Direct and Indirect quotes are reciprocals
of each other, which can be
mathematically expressed as follows.

Direct quote = 1/indirect quote and vice

versa

14
Direct indirect quote

An indirect quote is just the

In a direct quote, the domestic
opposite: the foreign currency
currency is the base currency,
is the base currency, and the
while the foreign currency is
domestic currency is the quote
the quote currency.
currency.
1$ = Rs 75
1Rs = $ 0.01333

15
PRACTICE
QUESTIONS

Saturday, October 17, 2020 16

Exercise 1

€1 = US$1.1332 US$1 = € ?
Direct quote Indirect quote

US $ 1= €
1/1.1332
.8824
17
Exercise 2

£1 = US$1.2617 US$1 = £?
Direct quote Indirect quote

US $ 1=£
1/1.2617
0.7926
18
Exercise 3

NZ$1 = US$0.6562 US$1 = NZ$?

Direct quote Indirect quote

US $1 =NZ$
1/0.6562
1.5239
19
Exercise 4

$1 = Rs 75 1 Rupee = $ ?
Direct quote Indirect quote

1 Rupee
1/75
=$ .0133
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Quiz
From a Canadian’s point of view, which of each pair of quotes is the direct
quote? Which is the indirect quote?
(a) CAD/GBP 1.73 ;GBP/CAD 0.578
(b) USD/CAD 0.76 ; CAD/USD1.32
(c) CAD/EUR 1.57; EUR/CAD 0.64
answer
(a) direct; indirect.
(b) indirect; direct.
(c) direct; indirect.
Example
You are given the following spot quote:
EUR/GBP 1.1115-1.1140
(a) The above quote is for which currency?
(b) What is the bid price for EUR in terms of GBP?
Answer
(a) EUR/GBP equals the number of EUR per 1
GBP; therefore, the above quote is for GBP in
terms of EUR.
(b) The bid price for EUR in terms of GBP is
GBP/EUR 1/1.1140 = .8976.
Example
You read in your newspaper that yesterday’s spot quote was CAD/GBP
1.7334­- 1.7380.
(a) This is a quote for which currency?
(b) What is the ask rate for CAD?
(c) What is the bid rate for GBP?
Answer
(a) This is a quote for GBP in terms of CAD.
(b) The ask rate for CAD is 1/1.7334 = 0.5770
(c) The bid rate for GBP is 1.7334.
EXAMPLE
You have just graduated from the University of Florida and are leaving on a whirlwind tour
to see some friends. You wish to spend USD 1,000 each in Germany, New Zealand, and
Great Britain (USD 3,000 in total). Your bank offers you the following bid-ask quotes:
USD/EUR 1.1304-1.1305
USD/NZD 0.67­0.69, and
USD/GBP 1.90-1.95.
(a) If you accept these quotes, how many EUR, NZD, and GBP do you have at departure?
ANSWER (a)

EUR 884.56
NZD 1,449.27
GBP 512.82
EXAMPLE
You have just graduated from the University of Florida and are leaving on a whirlwind tour to
see some friends. You wish to spend USD 1,000 each in Germany, New Zealand, and Great
Britain (USD 3,000 in total). Your bank offers you the following bid-ask quotes:

USD/EUR 1.1304-1.1305,

USD/NZD 0.67­0.69, and

USD/GBP 1.90-1.95.

(b) If you return with EUR 300, NZD 1,000, and GBP 75, and the exchange rates are unchanged,
how many USD do you have?
answer
(b) 339.12 + 670 + 142.5 = USD 1151.62
EXAMPLE
You have just graduated from the University of Florida and are leaving on a whirlwind tour to see some friends.
You wish to spend USD 1,000 each in Germany, New Zealand, and Great Britain (USD 3,000 in total). Your
bank offers you the following bid-ask quotes:

USD/EUR 1.304-1.305,

USD/NZD 0.67­0.69, and

USD/GBP 1.90-1.95.

(c) Suppose that instead of selling your remaining EUR 300 once you return home, you want to sell them in Great
Britain. At the train station, you are offered GBP/EUR 0.66-0.68, while a bank three blocks from the station offers
GBP/EUR 0.665-0.675. At what rate are you willing to sell your EUR 300? How many GBP will you receive?
answer
(c) You will sell at GBP/EUR 0.665; you will receive GBP 199.5.
 American terms &
European terms

Saturday, October 17, 2020 33

American terms & European
terms

Currency pairs versus U.S.

dollars tend to be quoted in
one of two ways; in either
American or European terms.
Saturday, October 17, 2020 34
American terms & European
terms
American terms European terms
US dollar price per unit of foreign Foreign currency units per
currency dollar
Example Rs1= $.01332 Example $1 = Rs 75
€ 1 = $.909 $1 = €1.10
A direct quote in the United States A direct quote outside the
United States
A indirect quote outside the United An indirect quote in the
States United States

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 Bid, Offer and Spread

Saturday, October 17, 2020 36

Bid, Offer and Spread

A foreign exchange quotes are two-way

quotes, expressed as a 'bid' and ask’ rates.

Bid is the price at which the dealer is willing

to buy another currency.

The ask or offer is the rate at which he is

willing to sell another currency.

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BID / ASK

ASK, SELL ,
BID, BUY –
OFFER – dealers
dealers buy price
sell price

38
Bid, Offer and Spread

For example, a dealer may quote Indian rupees as Rs 75.80 - 75.90

vis-a-vis dollar.

That means that he is willing to buy dollars at Rs 75.80/$ (sell rupees

and buy dollars), while he will sell dollar at Rs 75.90/$ (buy rupees
and sell dollars).

The difference between the bid and the offer is called the spread.

The offer/ask is always higher than the bid as inter-bank dealers make
money by buying at the bid and selling at the offer/ask

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Bid / Ask & Spread
If you want to buy currency, you have to pay the
higher ask price, but if you want to sell currency,
you have to sell it at the lower bid price.

So if you were to buy currency, then immediately

sell it back to the same dealer, the dealer would
make money, and you would lose money.

Thus, the spread is the transaction cost of trading

currency.
40
Example
George is an American businessmen visiting Europe. The cost of
purchasing euros at the airport is as follows:

EUR 1 = USD 1.20 / USD 1.30 (BID / ASK)

George wants to buy EUR 10,000

The higher price (USD 1.30) is the cost to buy each euro. So he would
have to pay the dealer the ask price USD 13,000 ( 10,000 X 1.3)

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PRACTICE
QUESTIONS

Saturday, October 17, 2020 42

Exercise 5

if 1C$ = $ 0.7703 ,
Given the following
find how many dollars
quotes , answer the
we get by selling C$
following.
10,000 ?

We have to sell C$ we
need C$ quote . Since
C$ 10,000 X $0.7703 =
we have, it we can use
$ 7703
the quote directly to
answer the question
43
Exercise 6
We have to sell ¥ we
if 1¥ = $ 0.0093 , find
need ¥ quote . Since
how many dollars we
we have it ,we can use
get by selling ¥
the quote directly to
20,00,000 ?
answer the question

¥ 20,00,000 X $0.0093
= $ 18,600

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Exercise 7
if 1$ = .94 Swiss Franc ,
find how many dollars we
get by selling 50,000 Swiss
Francs ?
We have to sell Swiss Franc
we need Swiss franc
quote Since we have dollar
quote we convert dollar
quote to swiss franc quote
before using it

Therefore 1 Swiss Franc =

1/.94= $ 1 .0638
50,000 SF X $1 .0638 =
$53,191

45
Exercise 8
We have to sell Rupees so
we need INR quote . Since
if 1 S$ = Rs 54.13 , find how
we have Singapore dollar
many Singapore dollars we
quote we convert
get by selling 5,00,000
Singapore dollar quote to
Rupees ?
Rupee quote before using
it.

Therefore : 1Rupee = S$
1/54.13= $ .01847
500,000 Rs X S$ .01847 =
S$ 9,237

46
Exercise 9
We have to sell Rupees so
if 1$ = Rs 68.61 , find we need INR quote .
how many dollars we get Since we have dollar
by selling 25,000 quote we convert dollar
Rupees ? quote to Rupee quote
before using it.

Therefore 1Rupee =
$ 1/68.61= $ .014575
25,000 Rs X $ .014575 =
$ 364.38

47
Exercise 10
We have to sell Rupees so
if 1 £ = Rs 86.34 , find we need INR quote .
how many pounds we Since we have pound
get by selling 25,000 quote we convert pound
Rupees quote to Rupee quote
before using it.

Therefore 1Rupee = £
1/86.34= £ .014575
25,000 Rs X £ 1/86.34 =
25,000/ 86.34= £ 289.55

48
Exercise 11
We have to sell Rupees so
we need INR quote .
if 1€= Rs 77.44 , find how
Since we have Euro
many Euros we get by
quote we convert Euro
selling 25,000 Rupees ?
quote to Rupee quote
before using it.

Therefore 1Rupee = €
1/77.44
25,000 Rs X € 1/77.44 =
25,000/ 77.44= €
322.83
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CROSS RATES

Saturday, October 17, 2020 50

Cross Rates
The exchange Examples
rates expressed 1 £ = Rs 94.49
by any 1 € = Rs 85.03
currency pair 1 ¥ = Rs .70
that does not 1 € = £.90
involve the 1 swiss franc = €.94
U.S. dollar are
called cross
rates.
Exchange currency pair which does not involve dollar is called cross rate 51
Cross currency rate calculation
The USD is the base
Cross currency rate is 1 $ = Rs 75 E
currency in one
calculated by
pairing and the quote 1 € = $ 1.13 A
multiplying
currency in the other 1 €= ? Rs
two exchange rates
pairings

1€ = Rs 84.75
 
(75 x1.13)

52
Exercise 12
1 $ = € .88
1¥ = $ .0093  
1¥ = ? €

1 ¥= € .00818
(.88x.0093)

53
Exercise 13
1 $ = Rs 75
1₤ = $ 1.26  
1₤ = ? Rs

54
Example
$1=Rs 75 $1=Rs 75
£ 1 = 1/.79 =
$1 =£ .79 £ 1= $ 1.27
$1.27
1₤ = ? Rs

£ 1=Rs 95.25
(75x1.27)

Saturday, October 17, 2020 55

Example
$1= EUR .88 $1=EUR 0.88
£ 1 = 1/.79 =
$1 =£ .79 £ 1= $ 1.27
$1.27
1₤ = ? EUR

£ 1= EUR 1.117
(0.88x1.27)

Saturday, October 17, 2020 56

 Exercise 14
Given
US$1 = ¥ 107.31
£ 1 = US$1.26
A$ 1 = US$ 0.70

(a) Calculate the cross rate for pounds in yen terms

(b) Calculate the cross rate for Australian dollar in yen terms
(c) Calculate the cross rate for pounds in Australian dollar terms

57
(a) Calculate the cross rate for pounds in yen terms

 1£ =?¥
US$1 = ¥ 107.31 dollar buying rate ( European terms)
£ 1 = US$1.26 pound buying rate ( American terms )

= 107.31 x 1.26
£1= ¥135.21

Saturday, October 17, 2020 58

(b) Calculate the cross rate for Australian dollar
in yen terms

 
A$1= ¥?
US$1 = ¥ 107 .31 dollar buying rate
A$ 1 = US$ 0.70 A$ buying rate

= 107.31 x .70= 75.12

A$1 = ¥ 75.12

Saturday, October 17, 2020 59

(c) Calculate the cross rate for
pounds in Australian dollar terms
₤  1 = A$ ?

A$1= US$ 0.70 A$ dollar buying rate

US $ 1= A$ 1.4285 converted to dollar buying rate

£1 = US$1.26 pound buying rate

= 1.4285 x 1.26 = 1.80

£ 1= A$ 1.80

Saturday, October 17, 2020 60

RULES
C R O S S R AT E S
Example

$1= Rs 75-76

BID :Rs1 = $1/76 ASK: Rs =$1/75

Example

Rs 1 = $.01315 - $.01333
BID is always lower than ASK
Rules –Explanation

$1= Rs 75-76 Rs 75 Bid Price Rs 76 Ask price

$1= Rs 75 is Rs 1= $ 0.1333 is
$1=Rs 75 is a
dollar buying Rupee selling
Rupee selling
price direct quote price indirect
price direct quote
-India quote
Rules –Explanation
$1= Rs 76 dollar $1 =Rs 76 is Rupee Rs 1= $ .01315
selling price direct buying price direct Rupee buying price
quote quote indirect quote

Therefore Rs 1= $ . $ .1315 Bid price

01315 / $ .01333 $ .1333 Ask price
 Explanation
Selling dollar is like buying rupees and vice versa ? From the first quote we
get dollar sale rate as $1 = Rs 75 from the second quote we get rupee buying
rate as Rs 1 = $0.1333 but both the quotes are one and the same
mathematically . Hence we say,

Bid (₹ /$)= 1 / Ask ( $ / ₹)

Ask (₹/$ ) = 1 / Bid ( $ / ₹)

67
EXERCISE 15
if exchange rate in Mumbai inter – bank
market is US $1 = Rs 75.2550/ 2600 and
in London inter-bank market is US $ 1=
£ 0.7945/ 0.7974.

What would be the exchange rate

between Indian Rupee and Pound sterling
( asked rate)
68
Solution
Mumbai inter-bank we need to purchase US $ by Surrendering (selling)
Rupee & Sell US $ in London inter- bank market to purchase Pounds

First Leg : Buy Dollar and Sell Rupee

Second Leg : Buy Pound and Sell Dollar

US $1 = Rs 75.2550/ 2600

Dollar buying rate (customer) US $ 1= Rs 75.2600

69
solution
US $ 1= £ 0.7945 / 0.7974.

1£ = $ 1/0.7974: 1/0.7945

1£ = $ 1.2540 : 1.2586

Pound buying rate ( customer) 1£ = $ 1.2586

1 £ = Rs 75.2600X 1.2586= Rs 94.7222

70
solution
Dollar buying rate US $ 1= Rs 75.2600

Pound buying rate 1£ = $ 1.2586

Rs / $ x $ /£ = Rs /£

Rs/ £ = 75.2600 x 1.2586 =

1£ = Rs 94.7222
71
16
The rate between Japanese ¥ and the U.S. $ is
$:¥ = 119.15 - 121.85 and the rate between the euro and the
U.S. $ is $:€ = 0.8021 - 0.8033.
What will be the direct quote between the yen and the euro in
Japan ?

© THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA Saturday, October 17, 2020 72

Solution
Bid Asked

US$1 = Yen 119.15 – 121.85

US $ 1 = Euro .8021 - .8033

Euro 1= US $ 1.2448 – 1.2467

Therefore

Euro 1 = Yen 119.15 x 1.2448 – 121.85 x 1.2467

Euro 1 = Yen 148.31 – 151.91

The lower rate is the bid, and the higher rate is the ask. Therefore, the rate between yen and euro is €:¥ = 148.31 –
151.91

Saturday, October 17, 2020 73

 PIPs

Saturday, October 17, 2020 © THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA 74

Price Interest Point (Pips)
A pip is the
Most currency pairs The pip change is
smallest price move
are priced out to the last (fourth)
that an exchange
four decimal places decimal point.
rate can make

in Indian interbank Hence minimum

market, USD-INR value change will
rate is quoted up to be to the tune of
4 decimal point 0.0001

75
( Price Interest Point )Pips
Spot EUR/USD
is quoted at a
bid price of
1.0213 and an
ask price of
1.0219. The
difference is
USD 0.0006
equal to 6
“pips”.
76
( Price Interest Point )Pips
It is the smallest unit by which a currency
quotation can change.

E.g., USD/INR quoted to a customer is INR 61.75.

The minimum value this rate can change is either
INR 61.74 or INR 61.76.

In other words, for USD/INR quote, the pip value

is 0.01.
77
Pips
In other words, for USD/INR quote, the pip value is
0.01. Pip in foreign currency quotation is similar to
the tick size in share quotations.

However, in Indian interbank market, USD-INR rate

is quoted upto 4 decimal point. Hence minimum
value change will be to the tune of 0.0001.

Spot EUR/USD is quoted at a bid price of 1.0213

and an ask price of 1.0219. The difference is USD
0.0006 equal to 6 “pips”.

78
Your time is limited, so don't waste
"

it living someone else's life. Don't

be trapped by dogma – which is
living with the results of other
people's thinking."
- -STEVE JOBS