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EconomicsModule 8 of 8

Exchange Rate Calculations

6

Concepts

4

Formulas

1

Decisions

4

Quiz Questions

Key Concepts

6 concepts covered in this module.

Exchange Rate Quotation

Direct: domestic per foreign (e.g., 1.25 USD/EUR). Indirect: foreign per domestic. Price/Base convention: P/B.

Bid-Ask Spread

Dealer buys at bid, sells at ask. Spread = ask - bid. Always buy high (ask) and sell low (bid) from YOUR perspective.

Cross Rates

Exchange rate between two currencies derived through a third. A/C = (A/B) × (B/C).

Forward Exchange Rate

Rate agreed today for exchange in the future. Forward premium: forward > spot. Forward discount: forward < spot.

Covered Interest Rate Parity

Forward premium/discount reflects interest rate differential. Eliminates arbitrage between money markets and FX forwards.

Triangular Arbitrage

Exploiting mispricing among three currency pairs. If cross rate differs from market rate, profit is possible.

Formulas

4 essential formulas for this module.

Cross Rate

A/C = (A/B) × (B/C)

Where: Multiply rates to find the cross rate

Forward Rate (CIP)

F/S = (1 + rprice) / (1 + rbase)

Where: F = forward, S = spot, r = interest rate for the period

Forward Premium/Discount

Forward Premium = (F - S) / S × (360/days)

Where: Annualized forward premium

Bid-Ask with Cross Rates

(A/C)bid = (A/B)bid × (B/C)bid

Where: Take bid of bid, ask of ask for cross

Decision Frameworks

1 decision frameworks to guide your analysis.

How to determine if arbitrage exists?

  • Compare calculated cross rate to market cross rate
  • If different, buy low and sell high through the triangle
  • Forward rate vs spot × interest rate differential for covered interest arbitrage

Mind Map

Visual overview of how concepts connect in this module.

Exchange Rate Calculations
Quotations
Direct vs Indirect
Price/Base convention
Bid-Ask spread
Cross Rates
A/C = (A/B)×(B/C)
Cancel common currency
Triangular arbitrage
Forward Rates
F/S = (1+r_p)/(1+r_b)
Premium vs discount
Covered interest parity
Arbitrage
Triangular: 3 currencies
Covered interest: spot+forward
Profit if mispriced

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Capital Flows and the FX Market