## Sunday, October 02, 2011

### Foreign Exchange

CFA Level 1 - Global Economic Analysis

Direct and Indirect Methods of Foreign Exchange Quotations

With the direct method of foreign exchange quotation, the exchange rate is expressed as the number of units of the domestic currency needed to acquire one (1.0) unit of the pertinent foreign currency. Within the U.S., this method is also referred to as quoting exchange rates in American (U.S.) terms.

With the indirect method of foreign exchange quotation, the exchange rate is expressed as the number of units of the pertinent foreign currency needed to acquire one (1.0) unit of the domestic currency. In the U.S., this method is referred to as quoting the exchange rate in foreign terms.

 Look Out! Memorize these definitions! Note that the two methods are reciprocals of one another.

Example: Currency Conversion
Suppose you are given the direct quote, in U.S. terms, between the U.S. dollar and the euro as:

¬1.00 = \$1.2830

The indirect quote between the U.S. dollar and the euro would then be calculated as the reciprocal (1 / 1.2830), and we get the following indirect quote for the U.S. dollar:

\$0.7794 = ¬1.00

Suppose you have the following indirect foreign exchange quote for the Japanese yen and U.S. dollar, from a Japanese perspective:

\$0.009142 = ¥1.00

The direct exchange quote for the Japanese yen to U.S. dollar, from a Japanese perspective, will be the reciprocal of (1 / 109.38), and we then get

:
¥109.38 = \$1.00
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