PRESENTATION ON CROSS RATES AND MERCHANT RATES

By K.N.Divya MBA BT II year

Cross rate
Many currency pairs are inactively traded, so their exchange rate is determined through their relationship to a widely traded third currency. For example, an Australian importer needs Danish currency to pay for purchases in Copenhagen. The Australian dollar (symbol A$) is not widely quoted against 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$

We have the following rates: US$1.4419 36 / GBP US$0.6250 67 / CHF

Calculate the CHF / GBP rate! = CHF 2.3008 98 / GBP.

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 to buy US$, then US$ to buy GBP) Fourth: Apply rule from part one to currency rate pairs. Therefore, CHF 2.3008 98 / GBP.

Cross rate tips

As you do more cross rate questions you will start to see patterns emerging. For example if both rates are something per USD or USD per something then you will have to divide the rates somehow and you will be matching bids with asks. Or if the rates are in different forms (USD is in different places) then you will be multiplying and you will match bid with bid and ask with ask.

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 their customers are called merchant rates.

The margin is depends upon:

Size of the transaction Customer Relationship Customer Awareness

Types of Merchant Rates

TT Rates (Telegraphic Transfer) OD Rates (On Demand) Bill Rates Bill Buying Rates Bill selling rates

TT Rates Telegraphic Transfer Rates

The bank undertakes only currency transfers and does not have to perform 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 inward remittances, when the bank sells foreign currency drafts. TT selling rate is applicable for clean outward remittance and when the bank sells foreign currency drafts.

OD Rates On Demand Rates

When cashing a personal cheque payable overseas, the bank will not give a TT rate but use on demand rates because it has to send it overseas for collection. This means a delay, which is called transit period. The bank will further subtract an exchange margin from TT buying rate and also recover interest from the customer for the transit period. The purpose of exchange margin is to recover costs involved and provide a profit margin to the bank.

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 subtracted from the TT buying rates. Similarly, when the bank has to handle documents apart from effecting payments, margins are added to the TT selling rate.

Bill Buying Rate

Exporters draw bills of exchange on their foreign customers. They can sell these bills to an AD for immediate payment. The AD buys the bill and collects payment by the drawee on presentation. The delay involved is only the transit period. Time or usance bills give time to the importer to settle the payment, i.e., the exporter agrees to give credit to the importer. In such cases, the delay involved is transit period the usance or credit period. In addition to the exchange margin to cover the cost and provide profit, the AD will also adjust the rate for forward discount or premium.

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.

Exercises
Currency pairs
USD/INR EUR/USD GBP/USD USD/JPY

Spot

1-Month

2-Month

6-Month

43.70/80 1.2850/55 1.8670/80 105.70/80

10/11 2/7 -34/-27 -23/-18

20/25 16/21 -100/-80 -75/-65

35/45 48/53 -180/-150 -160/-145

Calculate 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.

Solution
Currency Middle Rate Base Rate Vs Rupee Maximu m Spread TT Buying TT Selling

USD EUR GBP JPY

Solution
Currency Middle Rate 43.75 1.28525 1.8675 105.75 Base Rate Vs Rupee Maximu m Spread TT Buying TT Selling

USD EUR GBP JPY

Solution
Currency Middle Rate 43.75 1.28525 1.8675 105.75 Base Rate Vs Rupee 43.75 56.23 81.70 0.4137 Maximu m Spread TT Buying TT Selling

USD EUR GBP JPY

Solution
Currency Middle Rate 43.75 1.28525 1.8675 105.75 Base Rate Vs Rupee 43.75 56.23 81.70 0.4137 Maximu m Spread 0.44 1.12 1.63 .0082 TT Buying TT Selling

USD EUR GBP JPY

Solution
Currency Middle Rate 43.75 1.28525 1.8675 105.75 Base Rate Vs Rupee 43.75 56.23 81.70 0.4137 Maximu m Spread 0.44 1.12 1.63 .0082 TT Buying 43.53 55.67 80.89 0.4096 TT Selling

USD EUR GBP JPY

Solution
Currency Middle Rate 43.75 1.28525 1.8675 105.75 Base Rate Vs Rupee 43.75 56.23 81.70 0.4137 Maximu m Spread 0.44 1.12 1.63 .0082 TT Buying 43.53 55.67 80.89 0.4096 TT Selling 43.97 56.79 82.52 0.4178

USD EUR GBP JPY

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

Problem 3
Is the GBP at discount or premium against USD? What is the outright USD / GBP 182-day six month forward rate for the 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

Problem 4

What is the one month forward outright rate for JPY/INR for an importer assuming a margin of 0.20?

Which currency is at premium?

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 the price) 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.

Problem - 5

A company has an inward remittance of USD 1 million value spot. It also has an import payment due after three months for USD 1 million. Till now the payable and receivable had a natural hedge but the company fears that this will no longer remain after the inward remittance is converted. It wants to keep its position hedged. What kind of transaction should the company do? At what rate should the bank execute the transaction to get a margin of 0.12%?

Solution
The company should enter into a swap where it sells spot and buys three month forward. In this way its position remains covered at all times and it further saves the spread on spot leg. As it is doing a sell / buy swap in premium 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 were taken as 43.75 the three month forward rate would be 44.05.

Thank you!!