Foreign Exchange Rates & Quotations:

Foreign Exchange market

American term- European Term

0.4575 per CHF EUR 1.0275 per USD
USD 1.3542 per GBP CHF 1.4500 per USD
INR 46.75 per USD

American Terms: It is quoted as a number of US$ per unit of local currency. $/Rs is an
American Quote.

European Terms: It is quoted as a number of units of local currency per US$ dollar. Rs/$ is a
European quote.

Direct Quote Indirect quote (Reciprocal/Inverse quote)

INR 46.00 per USD in US USD 2.2560 per INR 100 in India
Stated as the no of units of a foreign
Currency per unit of home currency.

Direct Quote: In India Rs/$ is a direct quote. In France FF/$ or FF/t is a direct quote.
Direct quotes are those that give units of the local currency per unit of a foreign currency.
Indirect Quote: Indirect quote is stated as number of units of foreign currency per unit of the
home currency. In India $/Rs, In London $/t, in Germany DM/t is an indirect quote. It is also
called Inverse quote or reciprocal quote.

“Bid” and “Ask” will always be from the bank’s point of view.
The bid rate will always be lower than the ask rate.
Mechanics of Currency trading:
Inter bank market deals are done on the telephone. When asked to quote a price between Rupees
and dollar, a banker gives a ‘two-way quote’, he quotes his two prices.

Rs/$: 45.35 /45.60

In the above example: 45.35 is the “bid” rate and 45.60 is the “ask/offer” rate or

BID RATE:
A price at which one will buy a currency in exchange for another currency.
Rs 45.35/ $ is the price at which the other banker is willing to buy a Dollar from the customer
and exchange (pay to the customer) Rs.45.35. This is called Bid rate.
Here it is the rate of Indian rupee he is willing to pay to buy one USD.

Bid Rate: It is the price at which one is willing to buy a dollar in exchange for Indian rupees.
Bid – the price at which the dealer giving quote is prepared to buy- “bidding for”

ASK/OFFER RATE:
Rs.45.60 is the price at which the other banker is willing to sell a Dollar to the customer and
take Rs.45.60 and give one Dollar. This is called Ask or offer rate.
Ask/offer price – the price at which the dealer is willing to sell is “offering” one unit of base
currency. It is the amount of quoted currency the dealer will want to be paid in return for one
unit of the base currency.

USD/ CHF - US Dollar – Swiss franc

Base currency quoted currency

Bid – offer spread: Difference between the ask rate and bid rate is called Bid- ask spread.
This margin is the market makers compensation for the costs incurred and normal profit on
capital invested in the dealing.
Forward Quotations: Forward quotations are rates quotes for a currency against a particular
currency. It specifies the rate at which one is willing to buy or sell (bid/ask) after a particular
month /year.
Forward contracts: They are agreements between two parties. It is a simple contract to take
delivery at an agreed price, quantity & time in the future.

Short position: If a dealer dealing in foreign exchange has sold more dollars / currencies than
he has bought then he is said to take a net short position.

Long position: If a dealer dealing in dollars/ other currencies has purchased more dollar / other
currencies than he has sold, then he is said to take a long position.

Due to the high volatility of exchange rates, maintaining a short or long position for too long can
be a risky proposition. Building and carrying a net position for a long duration would be
equivalent to speculation and banks exercise tight control over their traders to prevent such
activity.

Zero sum game: Most of the trading takes place between market making banks, gains made by
one banker is reflected in losses made by another.

Vehicle currency: A common currency is generally used for quoting various currencies in
trading in order to economize the number of quotations.
In general US$ is used as vehicle currency as bulk of the trading of convertible currencies takes
place against US$.
In ordinary foreign exchange transaction, no fees are charged, as ‘bid- ask’ spread itself is the
transaction cost.
Unlike the money or capital markets, where different rates of interest are charged to different
borrowers depending on their credit worthiness, in the foreign exchange market no such
distinction is made.
Default risk: In order to reduce the risk wherein a counter party in a transaction may not deliver
on its side of the deal, limits are prescribed on the size of positions a trader can take…

SWIFT: All transactions in the over- the counter is generally done through the communications
network established by this non- profit Belgian co-operative called SWIFT- Society for World
Wide Financial Telecommunication. It has a main and regional center, which is connected by
telecommunication lines.

Settlement date or value date: the days on which settlements are effected are called settlement
date or value date.

Dealing locations: The location of the two banks involved in the trade is dealing location. The
location at which dealings done are called dealing locations.
In case State Bank Of India, Bombay enters into a deal with Citibank, New York, Bombay
and New York are called dealing locations.

Settlement location: places which banks location are credited and debited are called settlement
location.
Ex: In case a deal is made between SBI, Bombay and Citibank, New York and SBI, Bombay
request the Citibank to transfer the proceeds to SBI, Calcutta and Citibank transfer the dollar
from Citibank, San Francisco, the settlement locations in this case is Calcutta & San Francisco.
Similarly, a London bank can sell Swiss francs against USD to a Paris bank. The settlement can
be between the London bank’s branch at New York and Paris bank’s branch at Geneva. These
NY and Geneva branches are called settlement location (on the day of settlement, banks in New
York and Geneva should be opened).

How settlements are made:

Spot transaction: The settlement date or value date- 2 working days is given for settlement. I.e,
two working days from the date of spot transaction should be the settlement date.
In case of forward transaction- find the value date for spot transaction between the two
countries and add one calendar month to arrive at the value date.

Rolling forward: For rolling forward settlement of 3 months, find the spot date and add 3
months to the spot date. If the rolling date is ineligible you can shift forward to the next day and
if it happens to be another month, it must be shifted backwards.
Ex: If Nov 26 is the date deal was made, spot will be Nov 28th plus 3 months i.e 28 the Feb & if
it is holiday, it cannot be moved to March 1st as this goes to the next month and hence it must be
settled on 27th of Feb.

Broken date or Odd date: Banks offer forward contract for maturity that are not whole month
(say 73 days) such contracts are called “broken date” or “odd date”

Expressing Forward Quotations on a point Basis:

When quotations are given as USD/INR: 45.4250/ 45.4290, the last two digits 50 in bid and 90
in quote are called “points” or “pips”. The difference between the offer rate and bid rate is 40
points or 40 pips. If the USD/INR: 45.4255 / 45.4295, it is said that the USD has moved up 5
pips.
When two dealers converse with each other, this is normally shortened as 50/90 which means
that the first four digits 45.42 known as the “big figure” and the professional dealers are
suppose to know what the big figure is.

Note: It must be remembered that the offer rate must always be greater than the bid rate.
The convention of representing A/B where the rate being given as number of units of B per unit
of A will be little confusing as in mathematical fraction A/B means A is divided by B, that is
number of units of A per unit of B.

Mechanics of Inter- bank (Primary market makers) trading:

Primary market makers trade on their own and make a two way bid – offer market.

Inter- bank dealing:

A typical spot transaction between two dealers as follows:

Date: Sep 21.

Bank A: ‘Bank A calling. DLR-CHF 25 please. (Bank A is asking for a Swiss franc versus USD
quote for a size of 25 Million Dollars which is more than the “market lot” of 10 million.
Bank B: “fifty- fifty two. (Means Bank B will buy a USD against Swiss francs at ’50 and sell a
US dollar @ 52. Here both know the big figure of 1.45 and the last two decimals are only
quoted.) 40 and 52 are pips in the forex jargons.
Bank A: “Mine” (Means A is willing to buy 25Millions of USD against Swiss francs from B
who has offered to sell at 52 i.e 1.4552. If she wishes to sell, she might have said yours.)

Bank B: OK. I’ll sell USD 25 Million against CHF @1.4552 value 23, Sept.UBS, Geneva for
CHF.
(Bank B confirms the quantity, price and settlement date. Also specifies where it would like its
CHF to be transferred)

When a dealer A calls another dealer B and asks for a quote between a pair of currencies, dealer
B may or may not wish to take on the resulting position on his own books. If he does, he will
quote a price based on his information about the current market and the anticipated trends and
take the deal on his own books. This is known as ‘warehousing the deal”. If he does not wish to
warehouse the deal, he will immediately call a dealer C, get his quote and show that quote to A.
If A does a deal, B will immediately offset it with C. This is known as “back to back “dealing.
Normally back- to- back deals are done when the client asks for a quote on a currency, which the
dealer does not actively trade in.

Arbitrage: Arbitrage in finance refers to a set of transactions, selling and buying or lending and
borrowing, the same assets or equivalent (having identical cash flows and risk characteristics)
group of assets, to profits from price discrepancies within a market or cross-markets. No risk or
capital is involved.
In foreign exchange market, it is not possible for all banks in different parts of the world to give
identical quotes for a given pair of currencies at a given point of time.
Buying a currency where it is cheaper and selling it in a market where it is costlier, you make a
profit without any involvement of capital or risk is called arbitrage.
Suppose two banks A and B in two different countries quote the following rates:

A : Rs/$: 45.6115/ 45.6170

B: Rs/$: 45.6085/45.6095
US$ can be bought from Bank B @45.6095 and can be sold at 45.6115 for a net profit of
45.6115 – 45.6095 = 0.0020 per dollar without any risk or commitment of capital.

Problem: On a particular day, the following quote is available from a bank. DM/$: 1.6225/35.
Explain the quotation.
Explain the implied inverse quote $/DM.
Another bank quotes $/DM: 0.6154/59. Is there an arbitrage opportunity? If so, how would it
work?
Solution: DM/$:1.6225/35
DM/$:1.6225/1.6235
This means that the bank is willing to buy a Dollar @1.6225DM and willing to sell a $ for
Rs.1.6235.1.62 is the big figure and 25/35 is called points or pips.

DM/$: 1.6225/1.6235
$/DM : 1/1.6235 / 1/1.6225
: 0.6159/ 0.6163
B: $/DM:= 0.6154/0.6159
Arbitrage is not possible as the price at which you can buy from B & the price at which A is
willing to purchase are same. There is no arbitrage.

Problem: The following quotes are available from two banks:

A: FF/$ spot: 4.9570/80
B: FF/$ spot: 4.9578/90
Is there any arbitrage opportunity?
What kind of market will result?
What might be the reason for this?

Solution: A: FF/$: 4.9570/ 4.9580

B: FF/$: 4.9578/44.9590
The selling price of A is 4.9580 and the buying price of B is 4.9578. Hence there is no arbitrage.
The selling price of B is 4.9590 & the buying price of A is 4.9570. Hence there is no arbitrage.
B will find that it is hit on its bid side.

Problem: The buying rate of SFr in New York is $0.5910. A corporate treasurer is going to buy
SFr in Zurich at SFr/$ 1.6650 and sell them in New York. Will he make a profit? If yes, then
how much?
Solution: Buying Rate of SFr/$ in Zurich spot = 1.6650
$/SFr= 1/1.6650 = 0.60060
Price of SFr in Zurich = 0.60060$.
Price of SFr in N.York= 0.5910$
He is going to incur a loss of 0.0090$ in New York.

Problem: Stated below is a table of cross rate:

Analyze the various arbitrage possibilities:

Center DM $ FF ‘t’

Frankfurt - 2.2812 0.4712 4.0218

New York 0.4421 - 0.2110 1.8006

Paris 2.0949 4.7393 - 8.4301

London 4.0207 1.7775 8.4232 -

(Indirect quote)

Solution:
$:
1.DM/ $ in Frankfurt is 2.2812 & in New York is 2.2619(1/0.4421= 2.2619)
Hence buy in New York and sell in Frankfurt.

2. FF/FF in Paris is 4.7393 and in New York it is 4.7393(1/0.2110 = 4.7393)

Hence there is no arbitrage.

3. t/$ in London is 0.5625 & in New York it is 0.5553 (1/1.7775= 0.5553)

Buy $ in New York and sell in London.

FFr:
1. DM/ FFr in Frankfurt is 0.4712 & in Paris is 0.4773. Buy FFr in Frankfurt & sell in Paris.

2. $/FFr in New York is 0.2110 & in Paris is 0.2110(1/4.7393 = 0.2110). Hence there is no
arbitrage.

3. t/FFr in London is 0.1187 & in Paris is 0.1186(1/8.4301)

DM:
1. $/DM in Frankfurt is 0.4383(1/2.2812= 0.4383) & in New York it is 0.4421. Hence buy in
Frankfurt and sell in New York.
2. FFr/DM in Paris is 2.0949 and in Frankfurt it is 2.1222(1/0.4712= 2.1222). Hence buy in Paris
and sell in Frankfurt.

3. T/DM in London is 0.2487(1/4.0207= 0.2487) & in Frankfurt is 0.2486(1/4.0218 = 0.2486).

Hence buy ib Frankfurt and sell in London.

‘t’:
1. DM/t in London is 4.0207 & in Frankfurt it is 4.0218. Hence buy in London and sell in
Frankfurt.

2. $/t in New York is1.8006 & in London it is 1.7775. Hence buy in London and sell in New
York.

3. Ffr/t in Paris is 8.4301 and in London it is 8.4232. Hence buy in London and sell in Paris.

Problem: In London a dealer quotes: DM/t spot: 3.5250/55. Y/t spot: 180.80/181.30.
What do you expect the Y/DM rate to be in Frankfurt?
Suppose that in Frankfurt you get a quote Y/DM spot 51.1530/51.2550, is there any arbitrage
possibility?

Solution: DM/t spot: 3.5250/3.5255, Y/t spot : 180.80/181.30

Y/DM = Y/t x t/DM

= 180.80 x 1/3.5255
181.30 x 1/1/3.5250

= 51.2821
 51.4311

= 51.2821/ 51.4311

In Frankfurt if the rate of Y/Dm is 51.1530/ 51.2550 and in London it is 51.2821/51.4311.

Buy in Frankfurt and sell in London.

Problem: The following quotes are obtained in New York:

$/t: 1.5275/1.5285 SFr/$: 1.5530/1.5535
What rate do you expect for SFr/t spot in London?
If a London bank quotes 2.3730/2.3740, can you make arbitrage profit? If so then how?
Solution:$/t = 1.5275/1.5285 SFr/$= 1.5530/1.5535
SFr/t = SFr/$x $/t = 1.5530x 1.5275 = 2.3722
1.5535 1.5285 2.3745

SFr/t = 2.3722/2.3745

If London quote is 2.3730/ 2.3740

No arbitrage is possible.

Problem: An importer purchased materials from Swiss worth FFr 85,000. There is no quote
available for Rs against SFr. However the following quotes are available. Rs/$: 45.0170/
45.0190 & SFr/ $ = 1.6650/ 1.6675. What will be the value of Indian Rupees the bank will ask
the customer.
Solution:
Rs/SFr = Rs/ $ x $ / SFr = 45.0170 x 1/1.6675
45.190 1/1.6650
 = 45.0170 x 0.5997 = 26.9967
45.0190 0.6006 27.0384

= 26.9967/27.0384

The bank will charge Rs.27.0384 for SFr.

For 85,000 SFr it will charge 85,000 x 27.0384 = Rs.22,98, 264.

Problem: An importer has purchased goods from Germany worth DM60,000. A direct quote was
not available. However the following quotes were available.
Rs/FF: 6.8558/ 6.8609
T/FF: 0.1187/0.1195
T/DM: 0.2487/0.2502
What will be the value of money bank will ask from the customer.
Solution:
Rs/DM: Rs/FF x FF/t x t/DM

= 6.8558 x 1/0.1195 x 0.2487

6.8609 1/0.1187 0.2502

= 6.8558 x 8.3682 x 0.2487

6.8609 8.4246 0.2502

= 14.2681/ 14.4616
Bank will charge Rs.14.4616 per DM.
The customer will have to pay 60,000 x Rs.14.4616 = Rs.8,67,696.
Problem: On Feb 24,2004, a customer requested a bank to remit DeutchGuilder 2,50,000 to
Holland for payment of import of Diamonds under IR L/C. However due to strike the bank
could payment on March 1,2004, the inter bank rates were as follows:
Center Feb 24,2004 March1, 2004
$/Rs(100) $/Rs(100)
1. Mumbai-N.Y. 3.10/3.15 3.07/ 3.12

2.NewYork-London $/t 1.7250/1.7260 $/t 1.7175/1.7185

3.Amsterdam- London DG/t 3.9575/3.9590 DG/t 3.9380/ 3.9390

Bank wants to charge a commission of 0.125%. How much the customer stands to gain/loss due
to delay.
Solution: If the payment had been effected on Feb 24th 2004.
Rs/DG= Rs/$ x $/t x t/DG = 31.7460 x 1.7250 x 0.2526
32.5733 1.7185 0.2539

= 13.8328
14.0696
DG 2,50,000 x 14.0696 x 1.125 = Rs.39,57,075 =00
Payment made on March 1, 2004.
RS/DG = Rs/$ x $/t x t/DG = 32.0513 x 1.7175 x 0.2539
32.5733 1.7185 0.2539

= 13.9767
14.2126

DG 2,50,000 x 14.2126 x 1.125 = Rs.39,97,293 = 70

The loss was Rs. 39,97,293=70 – Rs.39,57,075 = 00
= Rs.40,218 = 70