Nominal Exchange Rate – Market Quotation
When you go to a bank, you see two rates: one for buying and one for selling. You also hear terms like "Direct Quote". Let's decode them.
1. Methods of Quotation
A. Direct Quote (Home Currency Price)
- Definition: Price of 1 unit of foreign currency in terms of home currency.
- Perspective: How much Rupees to buy 1 Dollar?
- Example (India):
1 USD = ₹ 83.50. - Rule: "Buy Low, Sell High". Bank buys $ at 83, sells at 84.
B. Indirect Quote (Foreign Currency Price)
- Definition: Price of 1 unit of home currency in terms of foreign currency.
- Perspective: How much Dollars to buy 100 Rupees?
- Example (India):
₹ 100 = $ 1.20. - Rule: Used mostly in London (GBP) and Eurozone.
2. Comparison: Direct vs Indirect
Direct Quote
- Variable: Home Currency amounts vary.
- Fixed: Foreign Currency is fixed (1 Unit).
- Formula: 1 FC = x HC.
- Usage: Most countries (including India).
VS
Indirect Quote
- Variable: Foreign Currency amounts vary.
- Fixed: Home Currency is fixed.
- Formula: 1 HC = x FC.
- Usage: UK (GBP), Euro, Australia.
Mathematical Relationship: Direct Quote = 1 / Indirect Quote.
3. Bid-Ask Spread
Banks never trade for free.
-
Bid Rate: The rate at which Bank Buys (You sell).
-
Ask (Offer) Rate: The rate at which Bank Sells (You buy).
-
Spread:
Ask - Bid. This is the bank's profit margin. -
Example: Quote
USD/INR = 83.10 / 83.30.- Bank Buys $ at 83.10.
- Bank Sells $ at 83.30.
- Spread = ₹ 0.20.
4. Exam Notes: Writing the Answer
Question: "Explain Direct and Indirect Quote with examples." (5 Marks)
Answering Strategy:
- Direct: "Price of 1 Unit of Foreign...". Example: 1$ = Rs 80.
- Indirect: "Price of 1 Unit of Home...". Example: Rs 100 = $1.25.
- Reciprocal: Mention they are reciprocals of each other.
- Note: In India, Banks mandate Direct Quotes.
Quiz Time! 🎯
Test Your Knowledge
Question 1 of 5
1. In India, '1 USD = ₹ 83' is an example of: