Understanding Foreign Exchange Foreign exchange is any transaction that involves more than one currency.

So, buying dollars with Indian rupees or selling dollars for euro or any such transaction involves foreign exchange. At this point of time, knowledge about foreign exchange is necessary as we have adopted globalization and there is easier movement of funds in and out of our country. Companies go for raising funds abroad, as funds are available at cheaper rates in global markets, than in domestic market. Similarly, in order to find customers for their products and suppliers for their inputs and for service providers Indian firms are going for cross border tieups. Foreign Currency Arithmetic: Foreign currencies are quoted against one another in three ways direct quote, indirect quote and international quote. To understand the concept of direct and indirect quote we can take an example of buying a pencil. We can buy a pencil for INR.2. So it can be written as, 1 Pencil = INR 2 Direct quote. INR 1= Pencil Indirect quote.

It can also be quoted as,

So the explanation to this is, We pay a price to buy a product. If the value of one product is mentioned in terms of price, it is called direct quote. Whereas, if the purchasing power of one unit of price is mentioned it is indirect quote. Lets go to foreign exchange now. We now want to buy one dollar. As we are buying US dollar, foreign currency, is the product and our Rupees, home currency, is the price we pay for buying the product. The bank is giving us the quotes. Direct quote 1$ = INR 50 Indirect quote INR 1 = 0.02$ (1/50)

So, in this way we can understand the quotes that are mentioned. There arises a doubt for everyone. In India the price is Indian rupees and product is US Dollars. What will it be in USA? The answer is simple. In USA , US dollars, home currency of USA, will be the price and Indian rupees, foreign currency for USA, will be the product. Hence The direct and indirect quotes get interchanged. So it will be like, In USA, Direct quote INR 1 = 0.02$ Indirect quote 1$ = INR 50 In India, Direct quote 1$ = INR 50 Indirect quote INR 1 = 0.02$

So direct and indirect quote is the equation of home currency against foreign currency, or vice versa, in two different ways. The third and the final type of quoting foreign exchange is the international quote or cross currency quote. International quotes are those quotes that does not involve the home currency. For example,

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Understanding Foreign Exchange

1 Euro = 1.3670 USD The above given quote, is direct quote in USA , indirect quote in Euroland and International quote in any other country, for example India or china or Japan etc. So, international or cross currency quote is a foreign exchange quote that involves two or more foreign currencies, but not home currency. So, thats about basics on foreign exchange quotes. Following articles will be about the next part i.e. bid and ask rate, spread and swap points. Quoting of one currency against another is not done at same rate for buying and selling. A dollar cannot be both bought and sold for same amount of rupees at any point of time. 1$ = 47.5 47.75 The above is a direct quote in terms of Indian rupees. Now we have to understand this quote. Always there are two rates in the foreign exchange market. They are bid rate or buying rate and ask rate or selling rate. In any quote the smaller amount at the left side is called bid rate and the larger one at the right side is called the ask rate. In the given quote, Bid rate = 47.5, Ask rate = 47.75. Bid rate is the rate at which a bank buys a currency, whereas ask rate is the rate at which it sells the currency. RBI buys an USD by giving INR.47.5 and sells an USD for INR 47.75. Why there are two rates? The answer is, RBI which maintains the forex market and performs all other functions for stabilizing the currency movements, needs a return. The difference between the buying rate and selling rate is the benefit for RBI. Let us now understand the mechanism of bid and ask rates. Bid rate is the rate at which bank buys a currency and ask rate the vice versa. This is exactly the opposite in the market. Bid rate is the rate at which a person can sell a currency to the bank and ask rate is the rate at which a person can buy currency from the bank. The action is simple, Bank can buy only when someone sells to the bank - BID RATE. Bank can sell only when someone buys from the bank - ASK RATE. So, we can buy one dollar by giving INR 47.75 and sell a dollar and get INR 47.5. Individual Buys Sells Bank Sells Buys Rate Ask Rate Bid Rate Amount 47.75 47.5

The difference between Bid rate and Ask rate is called as Spread. Therefore it is the benefit that accrues to the bank.

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Understanding Foreign Exchange

In this type of two way quoting, direct quote can be converted into indirect quote by the following formula, Price/ Product = INR/$ = 47.5 47.75 Direct Quote For converting the formula is, Bid rate = 1/ ask rate. Ask rate = 1/ Bid rate. So, $/INR = 1/47.75 1/47.5 $/INR = 0.0209 0.0210 - Indirect quote. So, that about Bid and ask rate, spread and how to convert direct quote into indirect quote by using bid and ask rate. Spread = 47.75 47.5 = 0.25

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Understanding Foreign Exchange