Quotations on Spot Exchange Market

Quotations on Spot Exchange Market

The exchange rate is the price of one currency expressed in another currency. Each quotation, naturally, involves two cur­rencies. There is always one rate for buying (bid rate) and another for selling (ask or offered rate) for a currency. Unlike the markets of other commodities, this is a unique feature of exchange markets. The bid rate is the rate at which the quoting bank is ready to buy a currency. Selling rate is the rate at which it is ready to sell a currency. The bank is a market maker. It should be noted that when the bank sells dollars against rupees, one can say that it buys rupees against dollars. In order to separate buying and selling rates, a small dash or an oblique line is drawn between the two. Often, only two or four digits are written after the dash indicating a fractional amount by which the selling rate is different from buying rate. For exam­ple, if dollar is quoted as Rs 42.3004-3120, it means that the bank is ready to buy dollar at Rs 42.3004 and ready to sell dol­lar at Rs 42.3120. Dealers do not quote the entire figure. They may quote, for example, 3004-3120 for dollar. It is these four digits that vary the most during the day. Here, the operators understand because of their experience that a quote of 3004­-3120 means Rs 42.3004-42.3120.

The banks buy at a rate lower than that at which they sell a currency. The difference between the two constitutes the profit made by the bank. When an enterprise or client wants to buy a currency from the bank, it buys at the selling rate of the bank. Likewise, when the enterprise wants to sell a currency to the bank, it sells at the buying rate of the bank. Table gives typical quotations. As is clear from the rates in the table, the buying rate is lower than selling rate.

TABLE: Currency Quotations given by a Bank

CURRENCY	BUYING RATE	SELLING RATE
Rupee/US $	42.3004	42.3120
Rupee /DM	22.2025	22.2080

The prices, as we see quoted in the newspapers, are for the interbank market involving trade among dealers. These rates may be direct or European. The direct quote or European type takes the value of the foreign currency as one unit. In India, price is quoted as so many rupees per unit of foreign currency. It is a direct quote or European quote. If we say forty-two rupees are needed to buy one dollar, it is an example of direct quote. There are a few countries, which follow the system of indirect quote or American quote. This way of quoting is prevalent, mainly, in the UK, Ireland and South Africa. In UK, for example, the quote would be one unit of pound ster­ling equal to seventy rupees. This is indirect or American type of quote.

Examples of direct quotes in India are Rs 42 per dollar, Rs 22 per DM and Rs 7 per French franc, etc. Similarly the examples of direct quote in USA are $ 1.6 per pound, $ 0.67 per DM and $ 0.2 per French franc, etc. One can easily transform a direct quote into an indirect quote and vice versa. For example, a rupee-dollar direct quote of Rs 42.3004-42.3120 can be trans­formed into indirect quote as $ 1/(42.3120)-1/(42.3004) (or $ 0.02363-0.02364). It is important to note that selling rate is always higher than buying rate.

Financial newspapers daily publish the rates of different currencies as quoted at a certain point of time during the day. Financial Times, for example, indicates closing mid-point (mid­dle of buying and selling rate), change on the day bid-offer spread and the day's high and low mid-point. Table gives a typical quotation. These quotations relate to transactions, which have taken place on the interbank markets and are of the order of millions of dollars. These rates are not the ones used for enterprises or clients. The rates for the latter will be close to the ones quoted for interbank transactions. The varia­tion from interbank rates will depend on the magnitude of the transaction entered into by the enterprise.

Traders in the major banks that deal in two-way prices, for both buying and selling, are called market-makers. They create the market by quoting bid and ask prices.

The Wall Street Journal gives quotations for selling rates on the interbank market for a minimum sum of 1 million dollars at 3 p.m.

The difference between buying and selling rate is called spread. The spread varies depending on market conditions and the currency concerned. When market is highly liquid, the spread has a tendency to diminish and vice versa.

The spread is generally expressed in percentage by the equa­tion:

Spread = Selling Rate – Buying Rate x 100

Buying Rate

            For example, if the quotation for dollar is Rs 42.3004/3120, the spread is given by

Spread = 42.3120 – 42.3004 x 100 or 0.0274 %

                                                42.3004

Currencies which are least quoted have wider spread than others. Similarly, currencies with greater volatility have higher spread and vice-versa. The average amount of transactions on spot market is about 5 million dollars or equivalent in other currencies.

Banks do not charge commission on their currency transac­tions but rather profit from the spread between buying and selling rates. Spreads are very narrow between leading curren­cies because of the large volume of transactions. Width, of spread depends on transaction costs and risks, which in turn are influenced by the size and frequency of transactions. Size affects the transaction costs per unit of currency traded while frequency or turnover rate affects both costs and risks by spreading fixed costs of currency trading.

In the interbank market, spreads depend upon the depth of a market of a particular currency as well as its volatility. Cur­rencies with greater volatility and higher trade have larger spreads. Spreads may also widen during financial and eco­nomic uncertainty. It may be noted that spreads charged from customers are bigger than interbank spreads.