Advertisements

Exchange Rate

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 nation’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

Therefore BASE/COUNTER

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.

 

Related Topics

Fundamental Analysis

Technical Analysis of Financial Markets

Central Bank’s Monetary Policy

Core Banking

Online Trading Academy

Advertisements

Leave a Reply

%d bloggers like this: