In foreign exchange market, the big banks exchange their currency at a rate for a larger amount of foreign currency. Due to its volume or huge quantities, the rate is reserved by these large banks. Thus its called as the inter-bank exchange rate. This interbank exchange rate is also called as the real exchange rate or the spot rate. As the foreign exchange market is a decentralized market as transactions happen over the counter where the large bank dealers quote their rate to determine the spot rate.
Interbank rate calculation
There is a bid price and an ask price which is involved in determining the spot rate. These are the selling or buying rates which one quotes for converting the currency. Thus a mid-point of these bid and ask prices are arrived at for finding the interbank exchange rate. The selling price is set slightly (fraction of a unit) higher than the buying price.
Now this spot rate isn’t the rate at which currencies would be exchanged now. Rather it is for two trading days after today. So if today is trading day T then T+2 is the spot rate. To get an interbank exchange rate for today, one needs to use the Cash rate, which is generally at a discount. Similarly, there is a Tom rate which is also at a discount but for transaction the next trading day or T+1.
Factors influencing the spot rate
The foreign exchange market is the most volatile financial markets as its open round the clock all 5 week days – making it biggest in volume and in terms of volatility. Due to technological advancement it is easily accessible to many a traders big or small. Thus apart from fundamental factors which generally govern the direction of the currencies, the technical factors also move the financial markets to a large extent. Supply and Demand, economic health of an economy, political stability, inflation and interest rates, forex reserves, trade deficits, debts, etc each play an important role in calculating the value of the interbank exchange rate.
The currency which is being exchanged is also important in determining the rate of exchange. So for example, with currencies which are highly liquid like EUR/USD will not demand that high a spread when compared to low liquidity currency pair like GBP/CHF.
Are the banks offering the ‘real time’ interbank exchange rate?
Many banks tend to markup the exchange rate especially for low volume transactions done mostly by the small and medium enterprises. Even though they add their margin on each transaction by increasing the buying price by few paisa, the enterprise isn’t aware of the actual spot rate prevailing in the market. The banks have found to considerably mark up the spot while buying the currency and mark down while selling making the enterprise lose money. The rate should ideally be sourced from the information provider like Reuters or Bloomberg as they quote the real time rates.
The necessity of sourcing the real rate is important as the currency prices fluctuate almost every second. Sometimes news or event related movements are drastic, warranting immediate actions in order to maximize on the opportunity. For example during the 2019 Indian Lok Sabha elections, the currency moved more on the exit polls day rather than the results or vote counting day. Now if one would have waited for results to trigger any action in the currency then the boat is missed for that individual. Thus small or big events make the currency volatile and its best left to forex experts to manage the forex risk.
Thus it’s important to stay abreast with the forex rates in such volatile foreign exchange markets so that forex doesn’t remain a cost center and can be managed as a profit center instead. Having the right professionals assisting in sourcing the information is equally significant as is receiving their advisory.
Right to Forex information
Forex advisors watch the market through the trading session all days and help them in ascertaining the risk profile of each corporate in order to hedge against the market volatility. Providing the real time rates is the first step towards transparency between the bank and the exporter or importer. Once the IBR spread loop is managed, the corporate can focus on ensuring the benchmark or costing is protected by taking timely action and not wait (like a trader) for maximizing the profits or minimizing the losses as the case may be.
It’s not feasible for small and medium enterprises to subscribe to Reuters or Bloomberg terminal just for receiving the real time foreign exchange rates. While information is of prime importance, the same can be outsourced from forex advisors like Myforexeye, who not only give timely information but also provide with forex advisory, transaction process outsourcing, forex training and many other forex services to their corporate clientele. Their state of the art dealing room with recorded telephone lines ensures that no transaction is delayed or missed.
08 May 2020 05:21 PM
Converting one exchange rate into another at a particular price makes transferring rates. Ideally all nations should be treated as equal and there shouldn’t be any exchange rate applicable which would mean to have a universal currency.
24 Apr 2020 03:08 PM
Managing risk in a financial market is required to keep a check on the adverse movements in the instrument of the market. Particularly in the foreign exchange market.
10 Apr 2020 06:12 PM
So was India’s decision on locking down the country for 21 days required? The implication on the economic growth or rather slowdown has only made many doubt the timing and preparedness of the decision.
24 Feb 2020 05:08 PM
When they say the currency markets are volatile, it is the spot exchange rate, which is being referred to, which fluctuates within seconds.
07 Feb 2020 03:19 PM
Derivatives market enables access to financial assets for trading at a future date and not just at the market trading date. In currency derivatives the trader agrees to buy or sell a fixed amount of a specified currency at the end.
27 Jan 2020 02:13 PM
Well devaluing a currency can give a thrust to the exports and reduce the trade deficit but for any economy which has higher imports, the consequences can be on the negative too.