cross rate and merchant rate
TRANSCRIPT
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PRESENTATION ON CROSS
RATES AND MERCHANT RATESBy
K.N.Divya
MBA BT II year
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Cross rate
Many currency pairs are inactively traded, so their exchangerate is determined through their relationship to a widely tradedthird currency.
For example, an Australian importer needs Danish
currency to pay for purchases in Copenhagen.
The Australian dollar (symbol A$) is not widely quotedagainst the Danish kroner (symbol DKr).
However, both currencies are quoted against the U.S.dollar. Assume the following quotes:
Australian dollar A$1.5431/US$
Danish kroner DKr7.0575/US$
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We have the following rates:
US$1.441936 / GBP
US$0.625067 / CHF
Calculate the CHF / GBP rate!
= CHF 2.300898 / GBP.
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Cross Rates Example
First: How do I get CHF/GBP from the two rates?
CHF/GBP = (US$/GBP)/(US$/CHF)
Second: Bid = go from bottom (GBP) to top (CHF)
(use GBP to buy US$, then US$ to buy CHF)
Third: Ask = go from top (CHF) to bottom (GBP) (use CHF tobuy US$, then US$ to buy GBP)
Fourth: Apply rule from part one to currency rate pairs.
Therefore, CHF 2.300898 / GBP.
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Cross rate tips
As you do more cross rate questions you will start tosee patterns emerging.
For example if both rates are something per USD orUSD per something then you will have to divide therates somehow and you will be matching bids withasks.
Or if the rates are in different forms (USD is indifferent places) then you will be multiplying andyou will match bid with bid and ask with ask.
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Merchant Rates
The bases on which some margins are added or deducted
are interbank rates or base rates
Bank add or deduct some margin with interbank rate
The rates that are ultimately quoted by banks to theircustomers are called merchant rates.
The margin is depends upon:
Size of the transaction
Customer Relationship
Customer Awareness
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Types of Merchant Rates
TT Rates (Telegraphic Transfer)
OD Rates (On Demand)
Bill Rates
Bill Buying Rates
Bill selling rates
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TT RatesTelegraphic Transfer Rates
The bank undertakes only currency transfers and does not have toperform any other function such as handling documents.
It may be TT buying rate or TT selling Rate
TT buying rates are applicable for immediate and clean inwardremittances, when the bank sells foreign currency drafts.
TT selling rate is applicable for clean outward remittance and when thebank sells foreign currency drafts.
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OD Rates
On Demand Rates
When cashing a personal cheque payable overseas, the bank willnot give a TT rate but use on demand rates because it has to sendit overseas for collection. This means a delay, which is calledtransit period.
The bank will further subtract an exchange margin from TTbuying rate and also recover interest from the customer for thetransit period.
The purpose of exchange margin is to recover costs involvedand provide a profit margin to the bank.
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Bill Rates
When there is some delay between the bank paying
the customer and itself getting paid, as when the bank
discounts export bills, various margins are subtractedfrom the TT buying rates.
Similarly, when the bank has to handle documents
apart from effecting payments, margins are added tothe TT selling rate.
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Bill Buying Rate
Exporters draw bills of exchange on their foreign customers. They can sellthese bills to an AD for immediate payment. The AD buys the bill andcollects payment by the drawee on presentation. The delay involved is onlythe transit period.
Time or usance bills give time to the importer to settle the payment, i.e., theexporter agrees to give credit to the importer.
In such cases, the delay involved is transit period the usance or creditperiod.
In addition to the exchange margin to cover the cost and provide profit, theAD will also adjust the rate for forward discount or premium.
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Bill Selling Rate
When an importer requests the bank to make a payment to a
foreign supplier against a bill drawn on the transaction. For this
the bank adds another margin over the TT selling rate to arrive at
the bill selling rate.
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Exercises
Currencypairs
Spot 1-Month 2-Month 6-Month
USD/INR 43.70/80 10/11 20/25 35/45
EUR/USD 1.2850/55 2/7 16/21 48/53
GBP/USD 1.8670/80 -34/-27 -100/-80 -180/-150
USD/JPY 105.70/80 -23/-18 -75/-65 -160/-145Calculate TT buying and TT selling rate for USD, EUR, GBP and
JPY against INR keeping middle of the market as base and
keeping 1% spread between TT buying and TT selling on USD and
2% on other currencies on either side of the base rate.
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Solution
Currency MiddleRate
BaseRate VsRupee
Maximum
Spread
TTBuying
TTSelling
USD
EUR
GBP
JPY
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Solution
Currency MiddleRate
BaseRate VsRupee
Maximum
Spread
TTBuying
TTSelling
USD 43.75
EUR 1.28525
GBP 1.8675
JPY 105.75
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Solution
Currency MiddleRate
BaseRate VsRupee
Maximum
Spread
TTBuying
TTSelling
USD 43.75 43.75
EUR 1.28525 56.23
GBP 1.8675 81.70
JPY 105.75 0.4137
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Solution
Currency MiddleRate
BaseRate VsRupee
Maximum
Spread
TTBuying
TTSelling
USD 43.75 43.75 0.44
EUR 1.28525 56.23 1.12
GBP 1.8675 81.70 1.63
JPY 105.75 0.4137 .0082
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Solution
Currency MiddleRate
BaseRate VsRupee
Maximum
Spread
TTBuying
TTSelling
USD 43.75 43.75 0.44 43.53
EUR 1.28525 56.23 1.12 55.67
GBP 1.8675 81.70 1.63 80.89
JPY 105.75 0.4137 .0082 0.4096
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Solution
Currency MiddleRate
BaseRate VsRupee
Maximum
Spread
TTBuying
TTSelling
USD 43.75 43.75 0.44 43.53 43.97
EUR 1.28525 56.23 1.12 55.67 56.79
GBP 1.8675 81.70 1.63 80.89 82.52
JPY 105.75 0.4137 .0082 0.4096 0.4178
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Problem 2
A client gives a USD bill for discounting to the bank. The bill
has a transit period of one month and usance period of two
months. If the bank charges only 0.25% margin on the market
rates, what is the rate quoted to the client?
USD buying Rate = 43.70 Forward premium = 0.20
(3 Month forward points)
Break even rate = 43.90
Margin @ 0.25% = 0.11
Rate for client = 43.79
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Problem 3
Is the GBP at discount or premium against USD?
What is the outright USD / GBP 182-day six month forward rate forthe client to buy GBP assuming 0.15% margin?
Solution
The GBP is at a forward discount
Calculation is as follows:
GBP spot bank selling / Client buying rate = 1.868
Six-month forward points = 0.0150
Six-month forward break even rate = 1.8530
Margin @ 0.15% Client rate = 1.8558
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Problem 4
What is the one month forward outright rate forJPY/INR for an importer assuming a margin of 0.20?
Which currency is at premium?
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Solution
Importer would be buying JPY against INR. This would be the cross of buy
LPY / sell USD rate and buy USD / sell INR rate.
His rate for buying JPY against USD spot = 105.70 (Take less JPY as facing theprice)
One month forward points are = 23
One month forward JPY/USD outright rate = 105.47 His rate for buy USD / Sell INR = 43.80
Forward points one month = 011
USD/INR outright forward rate = 43.91
JPY/INR outright forward rate = 4391/105.47 = 04163 Margin @ 0.20 = 0.0008
Client rate = 0.4171
Spot JPY = 43.80/105.70 = 04143. as the JPY is more expensive in forwards
(0.4163) the JPY is in premium against the rupee.
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Solution
The company should enter into a swap where it sells spot and buys threemonth forward. In this way its position remains covered at all times and itfurther saves the spread on spot leg. As it is doing a sell / buy swap inpremium currency it will pay the swap points.
Rates for three month swap = 20/25
Therefore the breakeven rate is = 25 paise
Margin (@ 0.12% 43.75)
The swap can be written with a difference of 30 points. If spot rate weretaken as 43.75 the three month forward rate would be 44.05.
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Thank you!!