1. Exchange Rates Bill Reese International Finance 1

2. Learning Objectives In this unit we will learn:  How to interpret direct and indirect exchange rates  How to determine cross-rates  How rates are quoted  How to calculate the bid-ask spread 2

3. Basic Terms Spot Rate  The price of a currency in terms of another currency for a trade today Forward Rate  Price agreed upon today for a trade to be executed at a specified future date (30, 60, 90, 180 or 360 days) 3

4. Basic Terms Direct quote American quote Domestic currency/foreign currency Dollars needed to buy one unit of foreign currency $/€ 4

5. Basic Terms Indirect quote European quote Foreign currency/domestic currency Units of foreign currency needed to buy one dollar €/$ 5

6. Quotes Currency is a commodity Bananas $0.5/pound = 2 lbs. for a dollar Price of dollar = €.813 Price of a euro = $1.23 6

7. Quotes Currency in denominator is the one being priced.813 €/$ 1.23 $/€ 7

8. Quotes You have dollars and want euros $ → €  Selling dollars  Buying euros You have euros and want dollars € → $  Selling euros  Buying dollars 8

9. Quotes You have $5.00. How many euros is it worth if XR is 1.23 $/€?  Multiply or divide?  Direct quote: $5 x 1.23 $/€  Note that $ won’t cancel out  Must invert Indirect quote or divide 9

10. Quotes $5 ÷ 1.23 $/€ = $5 x 1/1.23 €/$ = $5 x.813 €/$ = €4.065 10

11. Quotes Suppose you have €30 and want dollars? €30 x 1.23 $/€ = $36.90 Note how €s cancel out in numerator and denominator 11

12. Cross Rates Cross exchange rate  One foreign currency per unit of another foreign currency 1.23 $/€ and 1.81 $/£ Cross-rate between euro and pound 12

13. Cross Rates Multiply to cancel out $ 1.23 $/€ x 1.81 $/£ Can’t do it – must divide or invert 1.23 $/€ ÷ 1.81 $/£ = 1.23 $/€ x 1/1.81 $/£ = 0.68 £/€ 13

14. Cross Rates If you want €/£  Take reciprocal 1/0.68 £/€ = 1.47 €/£ 14

15. Bid and Ask There are two XRs  Bid: price dealer will pay you for your currency Rate if you want to sell  Ask: price dealer will sell you units of a currency for Rate if you want to buy  Ask > Bid 15

16. Bid and Ask Indirect quotes  Ask: 1.29 SF/$  Bid: 1.28 SF/$ Direct quotes  Ask:.78125 $/SF  Bid:.7752 $/SF Bid in $ = Ask in SF Bid in SF = Ask in $ 16

17. Bid and Ask Example  Ask:.0091 $/¥  Bid:.0090 $/¥ $150 to convert to yen  Buy yen at price of.0091 $/¥  Or sell dollars at price of 1/.0091 ¥/$ $150 ÷.0091 $/¥ = ¥16,483.5 17

18. Bid and Ask Change your mind – convert back  Sell yen at price of.0090 $/¥  Or buy dollars at price of 1/.0090 ¥/$ ¥16,483.5 x.0090 $/¥ = $148.35 18

19. Bid and Ask $150 → $148.35  Lost $1.65  Lost 1.1% of $150 you started with Bid-Ask Spread Spread = Ask – Bid Ask = (.0091 -.0090)/.0091 = 1.1% 19

20. Bid and Ask Spread  Transaction cost for round-trip transaction  Decreases with greater amounts of currency  Increases with less frequently traded currency 20