Global Economic Analysis - Spot Market Calculations

Calculating Currency Cross Rates When Given Two Spot Exchange Quotes Involving Three Currencies
A currency dealer located in a particular country will usually provide a set of exchange rate quotations between the country's currency and various foreign currencies. The cross-rate between two currencies not explicitly quoted is obtained by getting quotes for each currency in terms of the exchange rate with a third nation's currency. Suppose you are told that the exchange rate of the U.S. dollar per euro is 1.2440 and that the exchange rate for U.S. dollar per British pound is 1.8146. The euro-to-pound cross rate can be calculated as the euro-to-dollar rate multiplied by the dollar-to-pound rate, which is equal to (1/1.2440) × 1.8146 = 1.4587, or ¬1.4587 per British pound. Note that this result is an indirect quote from the viewpoint of a British entity, or a direct quote from the viewpoint of a business whose domestic currency is the euro.

In general, in calculating cross-rates, bid and ask prices will need to be dealt with.

This makes the calculation only slightly more difficult. The following equations should be kept in mind:

Formula 5.2

(FCa / FCb)ask = (FCa / DC)ask ×(DC/FCb)ask

(FCa / FCb)bid = (FCa / DC)bid ×(DC/FCb)bid

Where FCa and FCb are the two foreign currencies and DC is the domestic currency.

Similar equations are used when calculating FCb to FCa exchange rates.

Example: Currency Cross Rates and Ask Quotations
Verifications can be made by checking that (FCb/FCa)ask is equal to the reciprocal of (FCa/FCb)bid, and by checking that (FCb/FCa)bid is equal to the reciprocal of (FCa/FCb)ask.

Suppose you are given the following bid/ask quotations for two foreign currencies against the domestic currency, the U.S. dollar:

Bid Ask
¬ / $ 0.9002 0.9023
¥ / $ 109.38 109.40

We want to calculate what the ¥ / ¬ bid and ask quotations will be.

Answer:
The ¥ / ¬ bid price will be the number of yen the dealer is willing to pay in order to buy one euro. This transaction would be the equivalent of selling yen to purchase dollars (at the bid rate of 109.38), and simultaneously reselling the dollars to purchase euros (at the ask rate of 0.9023). The bid ¥ / ¬ would be calculated as 109.38/0.9023 = 121.22.

The ¥ / ¬ ask price would be the number of yen the dealer wants to receive in exchange for selling one euro. This transaction would be the equivalent of buying yen with dollars (at the 109.40 ask rate) and at the same time buying those dollars with euros, at the 0.9002 bid rate. The transaction could be expressed mathematically as:

Ask ¥ / ¬ = 109.40 / 0.9002 = 121.53

So the resulting dealer quotation would be:

¥ / ¬ = 121.22 - 121.53

Exam Tip!
You can count on getting questions like these on the exam, so make sure that you are comfortable with these types of questions.

Spot vs Forward Markets Within Foreign Exchange
There are two types of markets for setting currency exchange rates:

  1. The Spot Currency Exchange Market - This market involves trades of currencies for immediate delivery. Settlement usually occurs two days after the trade date. Participants in this market want to convert to the other currency relatively quickly. Transactions in the spot market are often used for investments, or to settle commercial purchases of goods.
  2. The Forward Currency Exchange Market - This market involves contracts for currency exchange in which settlement will take place more than two days after the trade date. While settlement dates are negotiable, standard foreign currency forward contracts usually settle 30, 90 or 180 days after the trade date. If a dealer quotes the 90-day ¥ / $ exchange rate at 109.80-109.83, that means the dealer is willing to commit today to buying dollars for 109.80 yen in 90 days, or to selling dollars at 109.83 yen per dollar 90 days from today.
Forward Market Calculations
Related Articles
  1. Professionals

    Chinese Slowdown Affects Iron Ore Market

    The Chinese economy's ongoing slowdown is having a major impact on iron ore demand.
  2. Personal Finance

    Invest in Costco? First Understand Its Balance Sheet

    A strong balance sheet sets a company apart and boosts investor confidence. How healthy is Costco based on an analysis of its balance sheets from the last two years?
  3. Investing Basics

    Brokers and RIAs: One and the Same?

    Brokers and registered investment advisors have some key differences. Here's what you need to know.
  4. Professionals

    DCF Vs. Comparables: Which One To Use

    DCF and Comparables models are widely used in equity valuation. We explain the pros and cons of each method.
  5. Professionals

    How To Make Money Using Tobin's Q Ratio

    Although it seems simple, Tobin's Q Ratio is more complex than it appears. We explore some of its main strengths and weaknesses.
  6. Taxes

    3 Secrets You Didn't Know About Estate Planning

    Every advisor and saver needs to know these three estate planning secrets.
  7. Professionals

    Cash Flow Is King: How to Keep it Running

    Why is cash flow so important, and what steps can a business take to improve it?
  8. Entrepreneurship

    10 Ways to Nurse Cash Flow in Healthcare

    Running a business in healthcare? You might want to rethink cash flow management practices.
  9. Professionals

    How to Help Clients with Cash Flow Issues

    Sometimes your spending gets out of hand or income has a hiccup. Here's how financial advisors can help clients who have cash flow issues.
  10. Professionals

    How to Improve Your Cash Flow in Manufacturing

    Here are 10 ways to to improve a manufacturer's cash flow.
RELATED TERMS
  1. Personal Financial Advisor

    Professionals who help individuals manage their finances by providing ...
  2. CFA Institute

    Formerly known as the Association for Investment Management and ...
  3. Chartered Financial Analyst - CFA

    A professional designation given by the CFA Institute (formerly ...
  4. Security Analyst

    A financial professional who studies various industries and companies, ...
RELATED FAQS
  1. What are the differences between a Chartered Financial Analyst (CFA) and a Certified ...

    The differences between a Chartered Financial Analyst (CFA) and a Certified Financial Planner (CFP) are many, but comes down ... Read Full Answer >>
  2. How do I become a Chartered Financial Analyst (CFA)?

    According to the CFA Institute, a person who holds a CFA charter is not a chartered financial analyst. The CFA Institute ... Read Full Answer >>
  3. What types of positions might a Chartered Financial Analyst (CFA) hold?

    The types of positions that a Chartered Financial Analyst (CFA) is likely to hold include any position that deals with large ... Read Full Answer >>
  4. Who benefits the most from prepaid expenses?

    Prepaid expenses benefit both businesses and individuals. Prepaid expenses are the types of expenses that are bought or paid ... Read Full Answer >>
  5. If I am looking to get an Investment Banking job. What education do employers prefer? ...

    If you are looking specifically for an investment banking position, an MBA may be marginally preferable over the CFA. The ... Read Full Answer >>
  6. Can I still pass the CFA Level I if I do poorly in the ethics section?

    You may still pass the Chartered Financial Analysis (CFA) Level I even if you fare poorly in the ethics section, but don't ... Read Full Answer >>
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!