cross rate and merchant rate

8/3/2019 Cross Rate and Merchant Rate

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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!!

cross rate and merchant rate

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