Foreign Exchange Quotations: Spot Market

11.1: Introduction

Many standards have evolved overtime to standardize foreign exchange quotations.  Forex quotations can be expressed as “Direct/Indirect”, “American/European”, “Base  and Variable/term/Quote currency”. It is important to understand these differences as this forms the fundamental of any forex trading.

Though regularly we here “today’s exchange rate is  INR 45.75”, but this can be termed  as layman’s expression as foreign quotations have two rates associated i.e, bid rate and ask rate. Forex dealers keep changing bid-ask spread depending upon their requirement. Hence in the subsequent these aspects are discussed in greater details. The focus of this module is to understand these concepts in relation to spot rates.

11.2. ISO and 3-letter currency code:

It is interesting to note that, each currency is represented as 3-letter code as  prescribed by International Organization of Standardization (ISO). The way ISO 9000 deals with quality standards, ISO 4217 deals with standardization of currency  codes. ISO 4217 specifies a 3- letter alphabetic code as well as 3-digit numeric code.

The first two letters represent the country while the last letter represents the Currency.  For example, USD, INR and AUD are currency of USA, India and Australia respectively. As it can be seen that the first two letters represent the country name while the last letter indicates the currency name. In “INR”, “IN” stands for India while “R” stands for “Rupee”.  Similarly, even though, in common parlance, Peso is the currency of Mexico,  as per the ISO standard, Mexico’s currency is represented as “MXN”. Table 11.1 lists these details for four countries.

Table 11.1: ISO 3-letter currency code http://www.currency-iso.org/iso_index/iso_tables/iso_tables_a1.htm

Appendix 11.1 lists the currency codes for countries as given by ISO. In the 2008, the  list was updated by the ISO. It is interesting to note that, from time to time the currency code changes for a given country. Table 11.2 shows some of the currencies to have been abandoned and the date of withdrawal.

Table 11.2: Historic currency codes to have been dropped http://www.currency-iso.org/iso_index/iso_tables/iso_tables_a3.htm

11.3: American/European, Direct/Indirect Methods of Spot Quotations:
Spot foreign exchange quotations can be given in variety of ways i.e, direct/indirect American/European, base/variable quotations. Understanding difference in foreign exchange quotations is the fundamental to understanding forex market. Also, it is to be noted that a forex quotation will always have one-pair of currency. Forex quotations are slightly  different in interbank market and retail market. In the interbank market, USD is the most traded currency pair. In other words, for majority trades one leg of the currency is USD. Banks & professional dealers normally quote in one of the two ways i.e, a) foreign currency price per one USD, also known as “European Terms” b) USD price per unit of foreign currency also known as “American Terms”. For example, Brazilian Real 2.43937/USD is an example of “European Terms” while USD 0.40994/Brazilian Real is an example of “American Terms”. In the same token INR 48.25/USD is in “European Terms” while USD0.0207/INR is in “American Terms”. 
Most of the interbank quotations are in European terms except four currencies. For Australian Dollar, New Zealand Dollar, Euro and Pound Sterling, interbank transactions are in the from of American Terms. Most banks quote price of USD per one unit Pound Sterling or USD per unit of Euro/ AUD/ NZD. Reason -- a piece of history is associated with this exception!

Pound Sterling consisted of 20 shillings and with 12 pence of each Shilling, While USD followed a decimal system with one hundred pennies in a USD. This lead to difficulties  in quoting a non-decimal currency with a decimal based currency. Hence, for reasons of convenience, banks started quoting USD price per one unit of Pound Sterling. This practice continues till date even though Pound Sterling changed to decimals in 1971. But what about Euro/AUD/NZD!!! Readers have to find out the common thread!!

Foreign exchange quotations can also be in “direct” or “indirect”. A direct quote is the home currency price of one unit of foreign currency. An indirect quote is foreign  currency price of one unit of domestic currency. A forex quotation becomes direct/indirect quotations depending on who is using this quote. For example, INR 48.45/USD is a direct quotation for resident Indian while it is indirect quotation for American.  Similarly, USD0.020673/ INR is a direct quotation for American person  while it is an indirect quotation for Indian. INR 70.25/Pound is direct quotation for a resident Indian while Pound 0.01423/INR is an indirect quotation.

Normally, Banks and foreign exchange dealers use direct quotations while dealing with retail customers. Most of the times when we enter into a shop/hotel accepting foreign currency give the quotations in “direct terms”. So also in case of banks – prominently display the home currency price of foreign currency.

Each forex quotation has a “base” currency and a “variable/quote/term” currency.
Any exchange rate quotation shows how many units of variable/quote/term currency for unit of base currency. For example a forex exchange dealer is quoting USD/HKD as 7.7756. In his case, USD is the base currency while HKD 7.7756 variable/quote/term currency.

Almost all forex quotations have the base currency as the first currency to be listed and are always equal to one. The second currency is the variable/quote/term currency.
For example, the quote USD/HKD of 7.7756 means one USD costs 7.7756 HKD. In this USD is the base currency and HKD is the variable/quote/term currency.

The forex trader always purchases and sells a fixed amount of the ‘base’ currency and exchange the amount of the variable/quote/term currency.
When the quoted price increases, it means that the base currency is appreciating or becoming stronger. This indicates one unit of the base currency can purchase more of the variable/quote/term currency. For example, USD/HKD rate changes to 7.7820 from 7.7756. This means one USD is equivalent to HKD 7.7820 compared to the earlier price of HKD 7.7756. Also it is to be noted here that when the base currency is appreciating  the variable/quote currency is depreciating. However, it is very important to note here that percentage appreciation of base currency is not equal to percentage depreciation of variable/quote currency. This aspect is discussed in detail in later sessions.

Similarly, if the quote currency price decreases, the base currency is depreciating or weakening. This means that one unit of the base currency can buy less of the quote currency. For example, from USD/HKD 7.7756, the rate changes to USD/HKD 7.7690.  In this case the base currency, USD is depreciating as it is worth lesser HKD.

Forex quotation in interbank market is normally expressed upto 4 points after decimal while for retail quotations it is given upto 2 points after decimal. As the ticket size for each trade in interbank market is big, even a 1 point difference in the 4th point after decimal makes a substantial difference. For example, let us compare two quotations: USD/INR 45.7097 vis-à-vis USD/INR 45.70. Suppose a trader wants to sell 70,000 USD and receive INR. Using the first quote, the trader would receive INR 3,199,679 while in second quote, the trader would receive INR 3,199,000 – a difference of INR 679.

All the examples given above are without any bid-ask rate. In real life all forex quotations are expressed in term of bid and ask rates. In the next section, we discuss this aspect in detail.

11.4: What is RBI reference rate?
Everyday Reserve bank of India publishes reference rate for spot USD/INR and spot EUR/INR. The methodology of calculation of these reference rates is given in Text Box.11.1. RBI reference rate is an indicative rate – what is the average foreign exchange rate prevailing on a given date. This rate is also used by companies to convert their foreign currency import payment and export receipt to INR for financial reporting.

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