Generally, a dealer in the Interbank Market will not reveal whether he is going to buy or sell the foreign exchange. Hence, in the market the quotation made will be a two-way quotation. This means the market maker will indicate two prices. One price for buying the currency and the other price for selling the currency. For example a Mumbai bank may quote the rate of dollar as follows;
USD 1 = 49.1625/1750
What does this mean? The market maker is willing to buy foreign exchange US dollar at the rate of 49.1625 rupees; and he is willing to sell at the rate of 49.1750 rupees per dollar. In actual practice, while quoting, they will not give the whole number Rs.49 as every operator will be knowing the ‘big number’. Hence the quotation will be as follows;
USD 1 = 1625/1750
From this, it is evident that the market maker wants to make a profit of Rs.0.0125 in the deal of buying and selling one dollar. This quotation is a direct quotations, and the bank will apply the rule “Buy Low; Sell High”.
In indirect quotation the Mumbai market maker will quote the rate of dollars as follows:
Rs.100 = USD 2.0762/0767
In indirect quotation, the quantity of foreign currency is stated in terms of per unit of home currency. In this case the market maker will receive 2.0767 USD per Rs.100/- while buying dollars and give away 2.0762 USD per Rs.100/- while selling dollar. Therefore he will apply the principle in indirection quotation, Buy High; Sell Low.
The banker, while dealing with the customer will apply the same principle, as noted earlier, by adding exchange margin. The buying rate is generally known as bid rate; and the selling rate is known as the ‘Offer rate’. The difference between these two rates are the gross profit for the bank and is known as the ‘Spread’.
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