Forex Quotations

DIRECT quotation is the price of one unit of a foreign currency in

terms of the home countrys currency . For example
Rs. 42.50 / $
INDIRECT quotation is the price of one unit of the home countrys
currency in terms of a foreign currency; e.g..
$.0235/per Re..
Direct quotation is also called European .Term Quotation.
Indirect quotation is also called American Term.Quotation
when the rate is in terms of dollars.
Since 2nd August, 1993, all quotations in India use the direct method
of quotation .

Some quotations are in terms of so many rupees against one unit

while others are so many rupees against 100 units ; e.g.
Rs. 44.70 = $ 1

Rs. 42.86 = Euro 1

Rs. 2.2200 = ITL 100 (Italian lira)
Rs. 42.4400 = JPY 100

Spread
Spread means the difference between a banks buying (bid) and
selling (offer or ask) rates in an exchange rate quotation. It
fluctuates according to the level of stability in the market, the
currency in question and the volume of the business. Thus if there
is a degree of volatility in an exchange rate, and if business is thin,
and if (rumours persist about the currency that ) the current rate is
unsustainable, the dealer will protect himself by widening the
quote. That is, he will offer less currency while selling but demand
more while buying. The spread represents gross return to the
dealers for the risks inherent in making a market.The spread can
also be expressed as a percentage. That isPercent spread

ask price- bid price/ask price x 100

x 100

When dollar is quoted at Rs 44. 3100-44.9500s the percentage

spread equals

44.9500-44.3100
44.9500

x 100

= 1.42 %

Usually, among dealers, only the last two digits are quoted in a
transaction, to save time and the rest is understood. Thus a dealer
in New Delhi may quote a spot price for the dollar which is US $ 1
= Rs.44.3150-44.3195 only by referring to the last two digits I.e;
50-95 instead of quoting the rate in its entirety. The last digits are
called points. Most quoted currencies are expressed to four
decimal places.

Exchange Arithmetic
Assume the buying rate for DM spot in New York is $ 0.40
(a)What would you expect the price of US $ to be in Germany?

(b)If the $ in Germany is 2.6 DM= $ 1, how is the market

supposed to react ?
Solution

Given : 1 DM = $ 0.40 in New York

(a)Price of US $ in Germany should be
1/0.4 =2.5 DM =$ 1
= 2.5 DM = $1

(b) If the dollars in Germany is 2.6 DM =$1, then people would be

expected to buy dollars in New York (where they are cheaper
compared to Germany) and sell dollars in Germany.

Exercise-On the same date that the DM spot was quoted $ 0.40
in New York , the price of pound sterling was quoted $ 1.80.

(a) What would you expect the price of the pound to be in

Germany?

(b) If the pound was quoted in Frankfurt at DM 4.40/Pound, what

would you do to profit from the situation?
Solution :

(a) In New York

DM =$0.40,

Pound =$1.80

Thus DM/$ =2.5 & $/Pound=1.8

Therefore,DM/Pound=2.5x1.8 =4.5

(b) In Frankfurt, DM 4.40=Pound1, while in

New York, DM 4.5 =Pound1

Then to profit from the situation, we will buy pounds in

Frankfurt and sell them in New York.

Cross Rates

The US dollar acts as a vehicle currency in the forex market .

Arbitrage transactions to exploit the price differences allow
computation via cross rates.
Assume in New Delhi , rupee is trading at Rs.42.5=/$ whereas in
Tokyo, yen is quoted at 140 yen /$
Yen/Re parity can, therefore, be derived and it will be
Yen 3.29/Re
Exercise-The quotation of US $ /DM is 1.3972 and US $/C$ is
1.3679. Find the rate for C$/DM
The cross rate would be
Us $
DM 1.3972

C $ 0.9790/DM

C$ 1.3679
US $

Arbitrage

Arbitrage can be defined as an operation that consists in deriving a profit

without risk from a differential existing between different quoted rates.
Two dealers A &B have quoted the following rates :

Dealer A (Paris)

Dealer B(New York)

Ffr 5.5012/US $

US $ 0.1817/Ffr.

We assume that buying and selling rates for these dealers are the same .
We find out the reciprocal rate for the quote given by the dealer B, which
is
Ffr 5.5036/US $ (= 1/0.1817 )
A trader buys, say, US $ 10,000 from the dealer A by paying
Ffr.55012. Than be sells these US dollars to the dealer B and receives Ffr
55,036 . In the process, be gains Ffr 24) (=55036-55012)

Mid.Term .Sept.98

Q1

$/c$

0.90

$/DM =

0.30

DM/c$ =

3.02

Any arbitrage opportunity? If so, work out for $ 1 million.

Yes, the appropriate cross exchange rate should be IC$=3
DM..Thus, the actual value of the C$ is more than what it should
be. One should obtain c $ with US $,sell the c $ for marks and then
exchange marks for US $. With $ 1,000,000,this strategy would
generate $ 1,006,667 representing a profit of $ 6,667
$ 1000,000= C$ 11,11,111

($ = 1.1111 c$)

C$ 11,11,111= DM 33,55,555

(c$=3.02 DM)

= $ 1006,667

(DM=0.30 $)

Exercise-Calculate arbitrage gains, assuming there are no

transition costs.
Rs.55.500

Pound 1 in London

Rs.35.625

$1 in Delhi

$ 1.5820

Pound1 in New York

From the gives data, a triangular currency arbitrage is possible

since the dollar /pound rate found by using the rates at London and
Delhi is different from that of New York .
i. Use $ 1000 to buy rupees in Delhi. The arbitrageur will get Rs
35,625(=1000x35.625)
ii.Sell Rs 35,625 inLondon to get Pounds 641.89 (=35625/55.5)
iii Sell Pounds s641.89 in New York to get $ 1015.47
(=641.89x1.5820)

Exercise-Suppose,Dealers A&B are located at New York and

they quote as followsA

$0.60/Sfr

$0.60/Sfr

$0.51/DM

$ 0.52/DM

Since three currencies are involved here, we find cross rates

between SFr & DM as well. These are :

SFR 0.85/DM (=0.51/0.60) at the Dealer A and sfr.0867/DM

(=0.52/0.60) at the dealer B. Thus the rates are :
A

$0.60/Sfr

$0.60/Sfr

$0.51/DM

$ 0.52/DM

Sfr 0.85/DM

Sfr 0.867/DM

i.

Thus there is no arbitrage gain possible between the US

$ and Sfr.

ii. DM against the $ is being quoted higher at the dealer B .

So buy DM from the dealerA and sell them to B.
iii. Similarly buy DM against Sfr from the dealer A and sell
then to B