Direct and Indirect Methods of Foreign Exchange Quotations
With the direct method of foreign exchange quotation, the exchange rate is expressed as the number of units of the domestic currency needed to acquire one (1.0) unit of the pertinent foreign currency. Within the U.S., this method is also referred to as quoting exchange rates in American (U.S.) terms.
With the indirect method of foreign exchange quotation, the exchange rate is expressed as the number of units of the pertinent foreign currency needed to acquire one (1.0) unit of the domestic currency. In the U.S., this method is referred to as quoting the exchange rate in foreign terms.
Memorize these definitions! Note that the two methods are reciprocals of one another.
Example: Currency Conversion
Suppose you are given the direct quote, in U.S. terms, between the U.S. dollar and the euro as:
€1.00 = $1.2830
The indirect quote between the U.S. dollar and the euro would then be calculated as the reciprocal (1 / 1.2830), and we get the following indirect quote for the U.S. dollar:
€0.7794 = $1.00
Suppose you have the following indirect foreign exchange quote for the Japanese yen and U.S. dollar, from a Japanese perspective:
¥109.38 = $1.00
The direct exchange quote for the Japanese yen to U.S. dollar, from a Japanese perspective, will be the reciprocal of (1 / 109.38), and we then get:
$0.009142 = ¥1.00
TradingAn indirect quote expresses the amount of foreign currency required to buy or sell one unit of the domestic currency in the foreign exchange markets.
InvestingForeign exchange risk is the chance that an investment’s value will decrease due to changes in currency exchange rates.
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TradingExchange rates have a tremendous influence on the economy. Exchange rates can indirectly affect many of the most important aspects of our lives.
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