Question

QUESTION 8 A. Define Exchange rate and distinguish between direct and indirect quote. B. Johnson is a US citizen who recently got married to Bridget in New York. Johnson and Bridget plan to spend USD 1,000 each in Spain, New Zealand and Scotland as their honey moon package. At a Bank in New York they were offered the following bid-ask quote USD/EUR 1.304-1.305, USD/NZD 0.67-0.69 and USD/GBP 1.90-1.95. If Johnson and Bridget accept these quote how many EUR, NZD and GBP do they have on departure? If they return after their honeymoon with EUR 300, NZD 1,000 and GBP 75 and the exchange rate remain unchanged, how many USD will they have? C. (0) Draw the rate of return diagram depicting the return on assets for the two separate countries Japan and Germany. Assume that (Currency ) is considered to be domestic and Germany (Currency €) the foreign country. Mention the equilibrium exchange rate between the two countries. (ii). Assume that the Japan Interest rate (i\) and the Germany Interest rate (€) both remain fixed as expected rate of declines. Which of the following will be observed and why? - The RORE line will shift to the right The ROR¥ line will shift to the right • The RORE line will shift to the left - The ROR¥ line will shift to the left

Answer 1

A. Direct Quote : A direct quote is the home currency price for one unit foreign currency.
  Example : 1 GBP = $ 1.25 is a direct-quote for an American.
Indirect Quote : An indirect quote is the foreign currency price of one unit of the home currency.
Example : $ 1 = 0.85 GBP is an indirect quote for an American.

B. Quotes are always given by the bank.

Bid Rate is the Bank Buying Rate, Bank will always buy at low rate.

Ask Rate is the Bank Selling Rate, Bank will always sell at high rate.

Currency	Bid	Ask
EUR	1.304	1.305
NZD	0.67	0.69
GBP	1.90	1.95

The couple is buying Foreign Currency. In other words, Bank is selling foreign currency.

The quotes given in the question are direct quotes.

How to read quotes?

USD/EUR - 1.304-1.305 will be read as US Dollars per Euro or how much dollars will be charged by bank to Buy-Sell 1 Euro.

Answer (i)

Since the couple is buying foreign currency and the bank is selling foreign currency, Ask Rate will be used.

USD	Foreign Currency	Ask Rate	Formula	Calculation	Equivalent Amount	Remarks
1000	EUR	1.305	= USD Amount / Ask Rate for 1 Euro	= 1000 USD / 1.305	766.2835 Euro	The couple will receive less Euros because Euro is a stronger currency than USD.
1000	NZD	0.69	= USD Amount / Ask Rate for 1 NZD	= 1000 USD / 0.69	1449.2754 NZD	The couple will receive more NZD because NZD is a weaker currency than USD.
1000	GBP	1.95	= USD Amount / Ask Rate for 1 GBP	= 1000 USD / 1.95	512.8205 GBP	The couple will receive less GBP because GBP is a stronger currency than USD.

Answer (ii)

Since the couple is selling foreign currency and the bank is buying foreign currency, Bid Rate will be used.

Amount	Foreign Currency	Bid Rate	Formula	Calculation	Equivalent Amount	Remarks
300	EUR	1.304	= EUR Amount * Bid Rate for 1 Euro	= 300 EUR* 1.304	391.2 USD	The couple will receive more USD because Euro is a stronger currency than USD.
1000	NZD	0.67	= NZD Amount * Bid Rate for 1 NZD	= 1000 NZD * 0.67	670 USD	The couple will receive less USD because NZD is a weaker currency than USD.
75	GBP	1.90	= GBP Amount * Bid Rate for 1 GBP	= 75 GBP * 1.90	142.50 USD	The couple will receive more USD because GBP is a stronger currency than USD.

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