1. What you will learn
By the end of this lesson you will be able to read any exchange rate correctly by naming its base and quote currency, describe a move as appreciation or depreciation without ambiguity, invert a quote including its two sides, and build a cross rate from two other rates with spreads included. You will also know which Indian authorities govern foreign exchange and exchange-traded currency derivatives. This is education about currency arithmetic and is not advice about any currency, platform or transaction.
2. The idea explained
An exchange rate is a price like any other, but it has two currencies in it and almost every error in the subject comes from losing track of which is which. In the quotation eighty rupees per dollar, the dollar is the base currency, the thing being priced, and the rupee is the quote currency, the thing it is priced in. Read every rate aloud in that form, so many of these per one of those, and half the confusion disappears.
Now direction. If the number rises from eighty to eighty-four, it takes more rupees to buy one dollar, so the dollar has appreciated and the rupee has depreciated. Both statements describe the same event, but their percentages differ because the denominators differ. The dollar rose by four rupees on a base of eighty, which is five per cent. The rupee fell from one-eightieth of a dollar to one-eighty-fourth, a fall of about four point seven six per cent.
Inversion is not linear, and this matters most for the two sides of a quote. A dealer quotes a bid, the price at which the dealer buys the base currency, and an ask, the price at which the dealer sells it, with the ask higher. When you invert the quote to express the other currency as the base, the bid and the ask swap places, because buying dollars is selling rupees. An inverted bid comes from the original ask, and an inverted ask from the original bid.
Cross rates follow from chaining. If one dollar costs eighty rupees and one euro costs one point one zero dollars, then one euro costs eighty multiplied by one point one zero, which is eighty-eight rupees. Once spreads enter, chain the sides that a customer would actually face, and the cross spread becomes wider than either original spread, because you cross two of them.
Finally, a caution that belongs in this lesson rather than a later one. Arithmetic being valid does not make a transaction permitted. Whether an Indian resident may deal in a particular currency product, on a particular venue, for a particular purpose, is a legal question decided by Indian law, and a great many online platforms soliciting Indian residents are not permitted venues.
3. The market, the regulator and the rulebook
Foreign exchange in India is governed by the Foreign Exchange Management Act, administered by the Reserve Bank of India. The Reserve Bank authorises the dealers through whom residents may transact, and its regulations and circulars determine what purposes, instruments and venues are permitted. For any question beginning with may I, the Reserve Bank's own publications are the authority.
Exchange-traded currency derivatives in India trade on stock exchanges under the Securities and Exchange Board of India, the statutory securities regulator, within a framework agreed with the Reserve Bank. The exchanges publish the contract specifications, the permitted currency pairs, the expiry calendar and the settlement methodology; the clearing corporations handle novation, margins and settlement.
Read both regulators for anything real. The Reserve Bank's circulars and frequently asked questions cover permissibility and purpose, and the Securities and Exchange Board's circulars and the exchanges' pages cover contract mechanics. Never quote an eligibility threshold, a permitted amount, a margin rate or a charge from memory; these change, and the current figure is published.
Worked example
4. Worked example
All figures are invented for teaching. Suppose the market quotes eighty rupees per dollar and one point one zero dollars per euro.
The cross rate is eighty multiplied by one point one zero, which is eighty-eight rupees per euro. Check the units: rupees per dollar times dollars per euro gives rupees per euro.
Now direction. The rupee-dollar rate moves from eighty to eighty-four. The dollar has appreciated by four on eighty, which is five per cent. The rupee has depreciated from one divided by eighty, which is zero point zero one two five dollars, to one divided by eighty-four, which is about zero point zero one one nine dollars, a fall of four divided by eighty-four, or about four point seven six per cent.
Now two-sided quotes. A dealer shows rupees per dollar at seventy-nine point nine zero bid and eighty point one zero ask, and dollars per euro at one point zero nine nine zero bid and one point one zero one zero ask. A customer buying euros with rupees faces the ask on both legs, so the rate is one point one zero one zero multiplied by eighty point one zero, which is eighty-eight point one nine rupees per euro. A customer selling euros faces the bids: one point zero nine nine zero multiplied by seventy-nine point nine zero, which is eighty-seven point eight one rupees per euro.
The cross spread is therefore thirty-eight paise per euro, while each original spread was only twenty paise per dollar or twenty pips. Crossing two markets means paying two spreads.
5. Common mistakes and how to fix them
The first mistake is saying a currency rose without naming the pair. Always speak in the form so many of these per one of those.
The second is quoting one currency's percentage move as the other's. Compute each from its own denominator and state which you are reporting.
The third is inverting a bid into a bid. When you flip a quote, the sides swap, so the inverted bid comes from the original ask.
The fourth is chaining mid-rates and then calling the result a price. A customer pays the crossed sides, and the resulting spread is wider than either original.
The fifth is assuming that being able to compute a rate means being allowed to trade it. Permissibility is decided by the Reserve Bank's rules, many platforms soliciting Indian residents are not permitted venues, most active traders lose money, leverage magnifies losses as much as gains, past performance does not indicate future results, and a SEBI-registered investment adviser is the person to consult about an individual's own money.
Key takeaways
6. Board summary
Every rate is so many quote-currency units per one base-currency unit, and must be read that way aloud. A rise in rupees per dollar is a dollar appreciation and a rupee depreciation, with different percentages from different denominators. Inverting a quote swaps bid and ask, because buying one currency is selling the other. A cross rate is built by chaining so the units cancel, and a crossed spread is wider than either original spread. Correct arithmetic says nothing about whether a transaction or venue is legally permitted.
Check your understanding
7. Practice and self-check
One. At eighty-two rupees per dollar and one point two zero dollars per pound, what is the rupee-pound cross? Ninety-eight point four rupees per pound.
Two. The rupee-dollar rate moves from fifty to fifty-five. By how much has the dollar appreciated? Five on fifty, which is ten per cent.
Three. By how much has the rupee depreciated in dollar terms? Five divided by fifty-five, which is about nine point zero nine per cent.
Four. Why are those different? Because each percentage uses its own starting denominator.
Five. A quote is seventy-nine point eight zero bid and eighty point two zero ask in rupees per dollar. What is the ask when inverted into dollars per rupee? One divided by seventy-nine point eight zero, since the sides swap.
Six. A customer buys euros with rupees at a euro-dollar ask of one point one zero and a dollar-rupee ask of eighty point five zero. Rate paid? Eighty-eight point five five rupees per euro.
Seven. Selling at bids of one point zero nine and eighty point one zero gives what? Eighty-seven point three one rupees per euro.
Eight. What is the crossed spread there? One point two four rupees per euro.
Nine. Which authority decides whether a resident may use a particular offshore currency platform? The Reserve Bank of India, under the Foreign Exchange Management Act, read with the date.