Lesson 1

Question 1

Nominal exchange rate

Answer 1

This is the exchange rate quoted in the market

Question 2

Real exchange rate

Answer 2

This is the inflation adjusted exchange rate

Question 3

Spot exhange rate

Answer 3

Current exchange rate

Question 4

Forward exchange rate

Answer 4

This is the exchange rate quoted and traded today for future delivery and payment of the currencies involved

Question 5

Bid exchange rate

Answer 5

For (e.g. USD/GBP) This is the rate at which dealers buy GBP (sell USD)

Question 6

Ask exchange rate

Answer 6

For USD/GBP this is the rate at which dealers sell GBP (buy USD)

Question 7

Mid exchange rate

Answer 7

Average of the bid and ask rates

Question 8

Bid/ask spread

Answer 8

Difference between bid and ask rates

Question 9

Cross exchange rate

Answer 9

The exchange rate between two currencies implied by their exchange rates with a common third currency

Question 10

the FX rate quotations are 1.7799USD/GBP and 1.4160 USD/EUR, what is the cross rate
between GBP and EUR?

Answer 10

Cross rate = (1.4160USD/EUR)/(1.7799USD/GBP) = 0.7956GBP/EUR

Question 11

the FX rate quotations are 0.6000-0.6015 USD/AUD and 10.700-10.720 MXN/USD, what
are the cross rates between AUD and MXN?

Answer 11

Cross country bid rate: 10.700 * 0.600 = 6.42MXN/AUD

Cross country ask rate: 10.720*0.6015 = 6.45MXN/AUD

Cross rates are 6.4200 - 6.481 MXN/AUD

Question 12

Triangle arbitrage:
if the rates offered by the bank are 6.3000 – 6.3025 MXN/AUD, how would a triangle arbitrage be profitable given the cross rates are 6.4200 – 6.4481 MXN/AUD?

Answer 12

The quotes for MXN are too low with respect AUD, so the AUD is undervalued. We buy AUD for
MXN, and then resell through USD until we wind up back with MXN.
Assume we have 1million pesos
Step 1: Buy AUD with MXN at the ask rate of 0.63025 MXN/AUD
1m/6.3025 = 158,667 AUD
Step 2: Sell AUD for USD at the bid
158,667×0.6000 = 95,200 USD
Step 3: Sell USD for MXN at the bid
95,200×10.700 = 1,018,643 MXN
An arbitrage profit of 18,643 pesos