Cross Rates: Folder PDF Cross rates

Derivative 2 page 448/639

The exchange rate between two currencies calculated on the basis of the rate of these two currencies in terms of a
third currency is known as a cross rate.

Cross-rates
The direct/indirect quote system is related to the domestic currency. The European/American
quote
system involves the USD. But if a Malayan trader calls a Hong Kong bank and asks for the
JPY/CHF quote, the Hong Kong bank will quote a rate that does not fit under either quote
system.
The Hong Kong bank will quote a cross rate. Most currencies are quoted against the USD, so
that
cross-rates are calculated from USD quotations. For example, the JPY/GBP is calculated using
the
USD/JPY and USD/GBP rates. This usually implies a larger bid-ask spread on cross exchange
rates. The cross-rates are calculated in such a way that arbitrageurs cannot take advantage of the
quoted prices. Otherwise, triangular arbitrage strategies would be possible and banks would soon
notice imbalances in their buy/sell orders.
Cross Rates:
A cross rate may be defined as an exchange rate which is calculated from two (or more) other rates.
Thus the rate for the Deutschmark to the Swedish crone will be derived as the cross rate from the US
dollar to the Deutschmark and the US dollar to the crone. The practice in world foreign exchange
market is that currencies are quoted against the US dollar. If one bank asks another bank for its
Deutschmark rate, that rate will be quoted against the US dollar unless otherwise specified. Most
dealings are done against the US dollar hence it follows that the market rate for a currency at any
moment is most accurately reflected in its exchange rate against the US dollar. A bank that was asked
to quote sterling against the Swiss franc would normally do so by calculating this rate from the
sterling/dollar rate and the dollar/Swiss franc rate. Thus, the cross rates would be used to determine
the quotations.
Cross rates and Chain rule:
The fixing of rate of exchange between the foreign currency and Indian rupee through the medium of
some other currency is done by what it is known as Chain rule. The rate thus obtained is the Cross
rate between these currencies. For example, let us assume that in the inter bank market dollar is
quoted at Rs.42.50 and at Singapore market dollar is quoted at CHF 1.8000. From this information
the rate of exchange of Swiss Franc in terms of rupees may be calculated as follows:
? RS =CHF 1 .. (1)
If CHF 1.8000 =USD 1 .. (2)
And USD 1 =Rs.42.50 (3)

It should be noted that the currency which appears as the second item (right hand side) in the first
equation appears as first item (left hand side) in the next equation. Thus franc appears on the right
hand side in the first equation left hand side in the second equation. US dollar which appears on the
right hand side in the second equation appears on the left hand side in the third equation. The rate of
exchange between Indian rupee and Swiss franc can be calculated by dividing the product of the right
hand side by the product of the left hand side.
42.50 x 1 x 1 = Rs.26.5620
1.8000
Ready Rates Based on Cross Rates: international foreign exchange market, the
exchange rates for other currencies are quoted in the basis of the rates for the
currency in terms of US dollar. They have to be converted into rupee terms
before quoting to the customers.