Following is the equation for forward exchange rate based on relative purchasing power parity:. Where f and S 0 are the forward exchange rate and spot exchange rate quoted with the domestic currency as the price currency, i d and i f are the inflation rates in domestic country and foreign country respectively and t is the time period involved. The interest rate parity attempts to forecast exchange rate based on the difference between the risk-free interest rates in two markets.

The premise is that the currency of the country which offers higher interest rate should appreciate because there will be higher demand for that currency. Following is the formula that can be used to work out forward exchange rate using interest rate parity relationship:. Where f and S 0 are the forward exchange rate and spot exchange rate direct quote , r d and r f are the risk-free interest rates in domestic country and foreign country respectively and t is the time period.

There are three ways in which a company can be exposed to foreign exchange risk: a transaction exposure , b translation exposure and c economic exposure. Transaction exposure arises from the possibility of exchange rate movement between the date on which an asset or liability arises and the date on which it is settled.

Translation exposure arise when a foreign company financial statements are translated from its functional currency to the reporting currency for consolidation purpose. The transaction exposure can be management using either a forward contracts and futures contracts , b money market hedge , c currency options and d currency swaps. You are welcome to learn a range of topics from accounting, economics, finance and more. We hope you like the work that has been done, and if you have any suggestions, your feedback is highly valuable.

Let's connect! Every Forex beginner finds themselves in the position that you are now. They enter the market and start looking at spreads, educational resources and anything they can get their hands on, and find themselves confused and unable to understand anything. Which is why there are so many resources for beginners to start learning. One of the key skills for learning how to read what is going on throughout the market and your screen is to learn the lingo of the industry Unless you learn to understand what people around you are saying, you will not be able to achieve the same rate of success as you potentially could.

Thankfully the Forex community is big and friendly enough to be welcoming of newcomers and to give them chances to learn, which is one of the reasons why the Forex market is one of the best for beginners to go into. Though some concepts might need a little bit more explaining. One such thing is the Forex direct quote vs indirect quote concepts, which a lot of people get easily confused about.

The difference between indirect and direct exchange rates quotes is the notation they are given in. They convey the same meaning but in different forms. It is like two words that are synonyms. You can use them interchangeably, but each one has its own, a more specific context that would be the preferred usage for the word. In this situation too, both try to convey the same thing but are usually used in different contexts as a way of impressing something onto the reader.

To be more precise, both of the notations attempt to convey the value of one currency against the value of the other, simply changing the location of the base currency and the compared currency. Let us get into more detail regarding each of the quote styles and see why they are the way they are.

The direct quote is a way of defining the value of the value of one currency against the value of another. In a situation like this, we have a base currency and a currency that is being compared relative to the base.

With most of the transactions around the world happening relative to the US dollar, it is often accepted that the US dollar is the base currency when creating a Direct Quote. Though, at the same time, this often depends on the location where the currency is being defined. The national currency of the country that the currency comparison is happening in, is usually accepted to the be the base currency.

The difference between the two types of quoting lies within the structure.

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So to get specific in the comparison of FX direct vs indirect quote, the structure is what changes. In a direct quote, the base currency comes first and then comes the compared currency. So for example if we are trying to define the Euro against the US dollar, we are going to write it this way:. There is an exception to the rule through — all of the currencies that are related to the former British empire, such as the Canadian Dollar and the Australian dollar, are always quoted as the base to the US dollar.

This means that the exchange rate of the Great British Pound Sterling would be listed as 1. The same rule applies to the Euro, though on a grander scale: the Euro is always listed as the Base currency even against the USD, GBP or any other currency in the world, when we are dealing with both direct and indirect quotes definition.

The indirect quote is the exact opposite of the direct quote. In that, the compared currency comes before the base currency. So when we would like to compare the value of a certain currency against the base of the United States dollar, this currency would come first and be divided by the US dollar.

This indicates the quantity of the foreign currency required to buy a single US dollar. In this correlation, the lower resulting number shows that the currency is weak against the dollar, while a higher resulting number shows the opposite.

This conversion is most often used to see how well everything is going for a domestic currency against an international one, such as the US dollar. As the US dollar is the dominant currency in global foreign exchange markets, the convention is to generally use direct quotes that have the US dollar as the base currency and other currencies — like the Canadian dollar, Japanese yen and Indian rupee — as the counter currency.

In the direct quote, a lower exchange rate implies that the domestic currency is appreciating or becoming stronger, since the price of the foreign currency is falling.

Language confusion

Conversely, for an indirect quote, a lower exchange rate implies that the domestic currency is depreciating or becoming weaker, since it is worth a smaller amount of foreign currency. What about cross-currency rates, which express the price of one currency in terms of a currency other than the US dollar? A trader or investors should first ascertain which type of quotation is being used — direct or indirect — to price the cross-rate accurately.

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