Detailed Explanation of Foreign Exchange Rate Pricing

The exchange rate, also known as the exchange rate, is a problem with foreign exchange rates when different currencies trade goods. The so-called foreign exchange rate is a predetermined exchange rate between different currencies based on their different gold contents. The gold content of a currency is the basis for determining the exchange rates of different currencies. The foreign exchange rate is expressed in terms of the price of one country's currency and the amount that can be exchanged for another country's currency. When determining the foreign exchange rate of various currencies, the first step is to determine which country's currency to use as the standard. Due to different standards, several different methods of foreign exchange rate pricing have emerged. The commonly used pricing methods include direct pricing, indirect pricing, US dollar pricing, and bidirectional pricing.

Direct pricing method

The direct pricing method, also known as the payable pricing method, refers to calculating the amount of domestic currency payable based on a certain unit of foreign currency. The vast majority of countries in the world, including China, currently adopt the direct pricing method. Under the direct pricing method, the higher the exchange rate, the more domestic currency can be exchanged per unit of foreign currency, indicating that the foreign currency appreciates while the domestic currency depreciates. On the contrary, if one wants to exchange the same amount of foreign currency with a smaller amount of local currency than before, it indicates a decrease in the value of the foreign currency or an increase in the value of the local currency, which is called a decrease in the foreign exchange rate. That is, the value of the foreign currency is directly proportional to the rise or fall of the exchange rate.

Under the direct pricing method, the smaller amount is the foreign exchange buying price, while the larger amount is the foreign exchange selling price, with a difference of 2–5 points during the period. Some prices only include the middle price. In China, the direct pricing method for the RMB exchange rate is: 1 US dollar = 6.1822 RMB yuan.

The more valuable the domestic currency is, the less domestic currency can be exchanged per unit of foreign currency and the smaller the exchange rate value. On the contrary, the less valuable the domestic currency is, the more local currencies can be exchanged per unit of foreign currency, and the exchange rate value is greater. Under the direct pricing method, the rise and fall of foreign exchange rates are inversely proportional to the changes in the value of the domestic currency: the appreciation of the domestic currency leads to a decrease in the exchange rate; the local currency depreciates, and the exchange rate rises. Most countries adopt the direct pricing method. Most exchange rates in the market are also directly priced. For example, USD to JPY, USD to HKD, USD to RMB, etc.

Indirect pricing method

The indirect pricing method is also known as the receivable pricing method. It calculates the amount of foreign currency receivable based on a certain unit of domestic currency (such as one unit). In the international foreign exchange market, the euro, pound sterling, Australian dollar, etc. are all indirectly priced. For example, 1 pound = 1.6025 US dollars; 1 euro = 1.5680 Canadian dollars; 1 euro = 1.0562 US dollars; 1 Australian dollar = 0.5922 US dollars, etc.

In the indirect pricing method, the amount of domestic currency remains unchanged, while the amount of foreign currency changes with the comparison of the value of domestic currency. If a certain amount of local currency can be exchanged for less foreign currency than in the previous period, it indicates that the value of the foreign currency increases and the value of the local currency decreases, that is, the foreign exchange rate increases. On the contrary, if a certain amount of local currency can be exchanged for more foreign currencies than in the previous period, it indicates a decrease in the value of the foreign currency and an increase in the value of the local currency, that is, a decrease in the foreign exchange rate, that is, the value of the foreign currency is inversely proportional to the rise and fall of the exchange rate.

The quotation in the foreign exchange market is generally a two-way quotation, where the quoting party simultaneously quotes their own buying and selling prices and the customer decides the buying and selling direction on their own. The smaller the difference between the buying price and the selling price, the smaller the cost for investors.

The characteristic of the indirect marking method is that the quantity of local currency is fixed and unchanged, while the amount converted into foreign currency changes with changes in the value of local currency and foreign currency. The rise and fall of exchange rates are represented by changes in relative foreign currency amounts. If a certain unit of local currency is converted into more foreign currency than before, it indicates an increase in the exchange rate of local currency and a decrease in the exchange rate of foreign currency.

The meanings of exchange rate fluctuations represented by indirect and direct pricing methods are exactly opposite. Therefore, when quoting the exchange rate of a certain currency and explaining its exchange rate fluctuations, it is necessary to clearly determine which pricing method to use to avoid confusion.

Bidirectional pricing

The quotation in the foreign exchange market is generally a two-way quotation, where the quoting party simultaneously quotes their own buying and selling prices and the customer decides the buying and selling direction on their own. The quoting party bank or broker simultaneously quotes the bid rate and offer rate to the customer. Due to the two methods of currency quotation, direct and indirect quotation, in order to facilitate and clearly indicate the "target currency" of buying or selling.

The smaller the difference between the buying price and the selling price, the smaller the cost for investors. The normal price difference for interbank transactions is 2–3 points. The price difference between banks (or traders) and customers varies greatly depending on the individual situation. Currently, the price difference for foreign margin trading is basically 3-5 points, Hong Kong is 6–8 points, and domestic bank firm trading ranges from 10–40 points.

USD list price

The US dollar pricing method, also known as the New York pricing method, refers to the indirect pricing method used for other foreign currencies in the New York international financial market, in addition to the direct pricing method for the pound sterling. The US dollar pricing method was formulated and implemented by the United States on September 1, 1978, and is currently the prevailing pricing method in the international financial market. The purpose of the US dollar pricing method is to simplify quotations and widely compare the exchange rates of various currencies.

When buying and selling foreign exchange in non-US dollars, the exchange rate of the currencies of the buyer and seller is calculated based on their respective ratios to the US dollar. It should be noted that except for the pound sterling, euro, Australian dollar, and New Zealand dollar, the US dollar pricing method is already widely used in the international foreign exchange market.

Its characteristic is that the unit of the US dollar remains unchanged, and the ratio of the US dollar to other currencies is reflected through changes in the quantity of other currencies. With the rapid increase in foreign exchange trading volume between international financial markets, an exchange rate representation is used when quoting prices between banks to facilitate international transactions.

People refer to currencies with fixed quantities under various pricing methods as base currencies and currencies with varying quantities as quoted currencies. Obviously, under the direct pricing method, the benchmark currency is foreign currency and the pricing currency is local currency; under the indirect pricing method, the base currency is the local currency and the pricing currency is the foreign currency; Under the US dollar pricing method, the benchmark currency is the US dollar, and the pricing currency is the currencies of other countries.

Disclaimer: Investment involves risk. The content of this article is not an investment advice and does not constitute any offer or solicitation to offer or recommendation of any investment product.