In this section we shall first examine how exchange rates are quoted in international markets and then we shall see how these rates are used for quoting rates for currencies other than US dollar in India.
Exchange Quotations in International Markets
In international markets, barring few exceptions, all rates are quoted in terms of US dollar. For instance, at Singapore Sweets may be quoted at 1.5425/5440 and Japanese Yen at 104.67/70. This should be understood as:
USD 1 = CHF 1.5425 - 1.5440
USD 1 = JPY 104.67 – 104.70
In interpreting an international market quotation, we may approach from either the variable currency or the base currency, viz., the dollar. For instance, we may take a transaction in which Swiss francs are received in exchange for dollars as: (a) purchase of Swiss francs against Dollar or (b) sale of Dollar against Swiss francs. For the sake of uniformity we will assume the base currency as the currency being bought of sold.
The quotation for Swiss franc is CHF 1.5425 and CHF 1.5440 per Dollar. While buying dollar the quoting bank would part with fewer francs per dollar and while selling dollars would require as many francs as possible. Thus, CHF 1.5425 is the dollar buying rate and DEM 1.5440 is the dollar selling rate. It may be observed that when viewed from dollar, the exchange quotation partakes the character of a direct quotation and the maxim ‘Buy low; Sell high’ is applicable. We will denote such rates as ‘Dollar/Foreign Currency Rates’, implying that dollar is being bought or sold against foreign currency. Few currencies such as pound-sterling and Euro are quoted in variable units of US dollar. They are quoted as so many US dollars per unit of foreign currency concerned. Examples are:
GBP 1 = USD 1.4326/4348
EUR 1 = USD 0.9525/9548
The base currency here is the foreign currency. Taking Euro as example, the quoting bank will buy that currency at USD 0.9525 and sell at USD 0.9548. We will indicate such quotation as ‘Foreign Currency/Dollar Rate’, the quotation being for purchase or sale of foreign currency against dollars.
Cross Rates and Chain Rule
Let us now see how exchange rates are calculated in India based on quotations in international markets.
In India, buying rates are calculated on the assumption that the foreign exchange acquired is disposed of abroad in the international market and the proceeds realized in US dollars. The US dollars thus acquired would be sold in the local interbank market to realize the rupee. For example, if the bank purchased a CHF 10,000 bill it is assumed that it will sell the Swiss francs at the Singapore market and acquire US dollars there. The US dollars are then sold in the interbank market against Indian rupee.
The bank would get the rate for US dollars in terms of Indian rupees in India. This would be the interbank rate for US dollars. It would also get the rate for US dollars in terms of Swiss francs at the Singapore market. The bank has to quote the rate to the customer for Swiss franc in terms of Indian rupees.
The fixing of rate of exchange between the foreign currency and Indian rupee through the medium of some other currency is done by a method known as ‘Chain Rule’. The rate thus obtained is the ‘cross rate’ between these currencies.
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