Exchange Rate Calculations
Learn how the FX exchange rate is calculated. The important terms used in the FX markets including concepts such as bid, ask, bid-ask spreads, cross rate calculations, carry trades and much more.
Foreign Exchange Rate Definition
The price of one nationâ€™s currency in terms of another nations currency.
eg USDJPY or simply Yen USD is the base ccy and JPY is the counter/terms/other ccy
A USDJPY rate of 113.36 means For 1 USD you get 113.36 JPY
Direct vs Indirect Quotes
In direct quotes the foreign ccy is the base ccy and the domestic ccy is the counter currency
so in Japan USDJPY = 104.20 is direct quotation since USD is base currency ie for 1 USD you get 113.36 yen
An indirect quote would be JPYUSD = 0.0088
Most currencies are expressed as the USD as the base except for EUR and GBP.
EUR is expressed as EURUSD and GBP as GBPUSD
Bid, Ask, Bid-Ask Spreads, PIPs
Traders also need to understand the bid, ask and bid-ask spread
Bid is the rate at which the price maker or market maker buys.
Ask is the rate at which the price maker or market maker sells.
So if USDJPY is quoted 113.32-34 then 113.32 is the rate the market maker buys and price taker sells. Similarly 113.34 is the rate at which the price maker sells and taker buys. Obviously the taker buys higher and sells lower.
The difference between 113.32 and 113.34 is 0.02 and is the spread that the market maker earns for quoting prices. The more liquid a currency market the lower the spread and less liquid markets experience higher spreads.
Spreads also tend to increase with volatility. In highly volatile markets the bid-ask spread increases from say 2 pips to 3-4 pips.
A pip or a percentage in point is a smallest price move that a currency pair makes. Most currency pairs are quoted upto four decimal places so a pip would be 0.0001 which is 1/00th of 1% or 1 basis point.
Examples of pips
USDJPY a pip is 2 decimal places 0.01
most currencies a pip is 4 decimal places 0.0001
Spreads increase with smaller quantities. Lot sizes of 0.25 million or less may see spreads of 3-5 pips or more.