What Is the Middle Rate?
- The middle rate is the exchange rate that is halfway between a currency's bid and ask rates.
- The middle rate is calculated using the midpoint of the bid and ask (offer) rates.
- A transaction at the middle rate benefits both parties in that they do not have to cross the entire bid-ask spread.
- Trading at the middle rate is most important in markets that are illiquid or have a wide bid-ask spread.
- With the advent of online trading and increased liquidity, bid-ask spreads have tightened to a point where counterparts meeting at a middle rate is less of a real concern since the bid and offer are so close to one another, to begin with.
Understanding the Middle Rate
A bid-ask spread (informally referred to as the buy-sell spread) is the difference between the highest price that a buyer (the bid) is willing to pay for an asset and the lowest price that a seller is willing to accept (the ask or offer). An individual looking to sell will receive the bid price while one looking to buy will pay the ask price.
When faced with a standard bid and ask price for a currency, the higher price is what you would pay to buy the currency, while the lower price is what you would receive if you were to sell the currency. The bid price is what someone is willing to pay for a currency, while the ask price is the rate at which someone will sell the same currency. For example, an American traveler is visiting Europe, and the cost of purchasing euros at the airport is displayed as follows:
- EUR 1 = USD 1.30 / USD 1.40
The higher price (USD 1.40) is the cost to buy each euro. To buy EUR 5,000, someone would have to pay the dealer USD $7,000. Suppose also that the next traveler in line has just returned from a European vacation and wants to sell the euros that are leftover. They have EUR 5,000 to sell, and would the deal would trade at the bid price of USD 1.30 (the lower price), receiving USD $6,500 in exchange for the euros. The middle rate here would be EUR/USD 1.35.
The middle rate is thus the term used to describe the midpoint rate when conducting a foreign exchange transaction.
Calculating the Middle Rate
Middle rate = (bid rate + ask rate) ÷ 2
A transaction executed at the middle rate requires two parties willing to transact in opposite directions (i.e., a buyer and a seller) at the same time. Trading at the middle rate is most important in markets that are illiquid or have a wide bid-ask spread.
Example of the Middle Rate
For example, say the market for the EUR/USD currency pair is trading with a bid price of $1.1920 and an offer price of $1.1930. A buyer and seller wish to transact with each other, and both are seeking price improvement so that they do not have to lift the offer or hit the bid, respectively.
They could agree to execute the trade at the middle rate, which would be $1.1925. Both parties benefit by not crossing the entire spread to execute their transaction.
With the advent of online trading and increased liquidity, bid-ask spreads have tightened to a point where counterparts meeting at a middle rate is less of a real concern since the bid and offer are so close to one another, to begin with. Additionally, with fewer foreign exchange transactions happening via brokers, middle rate transactions are less prevalent.