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‫Welcome back.
‫As we move on to currency exchange in this first lesson, we begin with a definition and conventions
‫of foreign exchange rates.
‫Next, we shall learn the distinction between direct and indirect quotes, the distinction between nominal
‫and real exchange rates and how to make a cross rate calculation.
‫Let's get rolling.
‫An exchange rate is simply the price of one currency in terms of another, the CFA curriculum uses this
‫convention where the currency on top is known as the price currency, and the one below is the base
‫currency.
‫So the exchange rate is the price of one unit of the base currency in terms of the price currency.
‫So if the exchange rate of U.S. dollar per British pound is one point three, it means that the price
‫of one great British pound is one U.S. dollar and 30 cents.
‫Do know that there are alternative conventions for foreign exchange quotes, so don't be surprised to
‫see the same quote expressed in the opposite way.
‫Just be clear that the CFA Institute's convention is more intuitive, where the slash is red as per
‫so we say that the exchange rate is one point three dollars per pound.
‫Another point to note is that a direct quote is from the point of view of an investor in the price currency
‫country, and an indirect quote is from the point of view of an investor in the base currency country.
‫So this U.S. dollar per great British pound quotes of one point three would be a direct exchange rate
‫quote or a USD based investor and an indirect quote for a GBP based investor.
‫For instance, if an American wants to buy a British made clock that retails at 100 pounds, he would
‫use the direct quote of one point three multiplied by a hundred pounds to calculate the price in U.S.
‫dollars.
‫Conversely, a quota of zero point seven six nine two pounds per dollar would be a direct exchange rate,
‫quote, for a GBP based investor and an indirect quote for a USD based investor.
‫So a British person who wishes to buy a 100 dollar pair of sunglasses in the U.S. will also use his
‫direct quote for the calculation.
‫When calculating the percentage change in one currency relative to another, you should be aware that
‫the calculated change is only in terms of the base currency and should not be reciprocated to the price
‫currency.
‫For example, if the U.S. dollar per great British pound rate falls from one point three to one point
‫one, the percentage change in the dollar price of one GBP is simply minus fifteen point four percent
‫because one GBP now buys fifteen point four percent less dollars.
‫It's correct to say that the GBP has depreciated fifteen point four percent relative to USD.
‫However, it's not correct to say that the dollar has appreciated by fifteen point four percent to calculate
‫the percentage change in USD relative to GDP.
‫We need to set USD as the base currency.
‫So our beginning quote is zero point seven six nine two GBP USD an hour ending quote become a zero point
‫nine zero nine one GBP per USD.
‫Using these exchange rates, we can calculate the change in the price of a dollar as eighteen point
‫two percent.
‫In this case, it's correct to say that the dollar has appreciated eighteen point two percent with respect
‫to the great British pound.
‫So to reiterate, be sure that the percentage change you calculate is valid for the base currency only.
‫Another key distinction for exchange rates is between the nominal exchange rate and the real exchange
‫rate, nominal exchange rate is what we've been talking about so far, which is the quoted exchange
‫rate at a point in time.
‫The real exchange rate, however, takes into account the relative price changes between the two countries
‫from a base period, you may wonder why would the relative price changes be important?
‫Let's say you're a U.S. based businessman who regularly imports clerks from the U.K. that sell at 100
‫pounds to sell in the U.S..
‫Assuming that the nominal exchange rate is unchanged for the period, but the price levels in the UK
‫have gone up by 15 percent, but only by three percent in the US, you would be very worried if the
‫GBP price of the clocks go up by 15 percent while U.S. inflation is only three percent for the period.
‫It probably means that your clocks wouldn't sell that well if American income only went up by three
‫percent.
‫So as you can see, even though the nominal interest rate is unchanged, the real cost of import has
‫increased for the U.S. importer.
‫Let's see how the real exchange rate differs to calculate the real exchange rate, we multiply it by
‫the factor of the CPI of the base currency against the CPI of the price currency.
‫Do note that the base is on top in this case, even though the nominal exchange rate remains unchanged,
‫at one point three, the real exchange rate has increased to one point four five one five.
‫A higher real exchange rate means that the relative cost to import from the UK is higher.
‫It also means the relative purchasing power of Americans versus British has declined.
‫Let's pause for an exercise.
‫The AOG per CNY rate was zero point two two one five a year ago.
‫Currently, the rate is zero point two three five six.
‫What is the change in AWADI against CNI for the past year?
‫Pulls the video now and work out your answer.
‫And we're back.
‫I hope you remember when we calculate change in an exchange rate, it's always in terms of a base currency.
‫So we have to invert the rates to set Awadi as the base.
‫So the CNY give her a cut rate was 4.5, 147, and the current rate is four point two 445.
‫Calculate the change and we have minus six percent, therefore, the Australian dollar has depreciated
‫by six percent against the Chinese yuan.
‫Continuing with this example, if the inflation rate for Australia was one point eight percent in the
‫past year and five point four percent in China, what is the change in real rate in CNI per AWADI rate
‫for the year?
‫Pulls the video now and work out your answer.
‫And we're back.
‫Here, we're not given the real rate, nor the CPI, but given the change in prices and we know the
‫change in nominal exchange rate, we can calculate the change in real exchange rate.
‫Plug the figures in and we get minus nine point two percent, so in real terms, the Australian dollar
‫has depreciated by nine point two per cent against the Chinese yuan.
‫And to conclude this lesson, let's learn how to make cross rate calculations.
‫In the foreign exchange market, currencies are traded in currency pairs, most currencies will have
‫an active market against major currencies like the US dollar.
‫So these market quotes are the most relevant.
‫For a pair of relatively less traded currencies like the Malaysian ringgit and the New Zealand dollar,
‫there may not be an active trade in the pair, so the exchange rate may not be that current.
‫If we want to have a more current exchange rate between the two, we can calculate the cross rate between
‫them.
‫Getting the cross rate is simple, for example, if we want to get the cross rate for Malaysian ringgit
‫per New Zealand dollar, we multiply Moyar per USD with USD per NZD.
‫This is just like simple algebra, the USDA cancels out and we get the cross rate for my art per NZD.
‫So if Moyar per USD is four point two and USD per NZD is zero point sixty five, then the cross rate
‫for Moir per NZD is two point seventy three.
‫And let's end with an exercise.
‫The nominal exchange rate between Mexican peso and the U.S. dollar is twenty one point twenty five and
‫the nominal exchange rate between the Thai baht and the U.S. dollar is twenty nine point seventy seven.
‫What's the growth rate for Thai baht per Mexican peso?
‫Pose a video now and work out your answer.
‫And we're back, you should find this quite easy, the growth rate is Thai baht per USD multiplied by
‫USD per cent.
‫Do you remember that?
‫You have to invert Megson per USD.
‫Punch the numbers in and we get across rate of one point four zero zero nine.
‫And that concludes this lesson on foreign exchange rates.
‫There is another distinction between quoted exchange rates that you need to know, that's between the
‫spot rate and the forward rate.
‫We shall address this in the next lesson.
‫See you again.