FX Quotation, Pricing, and Rate Calculations
Quotation arithmetic and cross rates
Quotations can be direct (domestic currency per unit of foreign currency) or indirect (foreign currency per unit of domestic currency). Market convention often uses a fixed base currency, such as EUR/USD, USD/JPY and GBP/USD. The exam tests bid/ask logic, cross-rate construction, reciprocals and pip values.
- Bid and ask: the bid is where the dealer buys the base currency; the ask is where the dealer sells the base currency. The spread compensates for risk and liquidity.
- Cross rates: to build a cross, multiply the relevant legs. For the cross bid, multiply the bid of the base/quote leg by the bid of the quote/term leg. For the cross ask, multiply the two asks.
- Reciprocals: the reciprocal of a bid becomes the ask, and the reciprocal of an ask becomes the bid.
- Pip value: for a USD-quoted pair, pip value in USD is fixed per unit; for other pairs it depends on the quote currency and position size.
Worked example
EUR/USD is 1.1000/1.1005 and USD/JPY is 110.00/110.05. To build EUR/JPY, the bid = 1.1000 × 110.00 = 121.00. The ask = 1.1005 × 110.05 = 121.110, rounded to 121.11. Reasoning: a client selling EUR receives JPY at the cross bid; the dealer buys EUR at the EUR/USD bid and sells USD at the USD/JPY bid. Using mid-market rates would misprice the client.
Traps
- Multiplying a bid by an ask when constructing a cross rate.
- Inverting the wrong side of a reciprocal quote.
- Treating JPY pips as 0.0001 rather than 0.01.
- Rounding intermediate rates before the final quote.