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WIFE Week in Financial Education (2021-05-03)

David Harper CFA FRM

David Harper CFA FRM
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Hello, welcome to another WIFE! The forum was super busy last week. I wrote a long reply to the question (link below) about the interpretation of foreign exchange (FX) quotes. We have experience here. This is one of many examples of where we (members in this forum) prompted a correction to GARP's imprecise syntax references (in actual questions) to an "USD/EUR exchange rate"; e.g., 2016-P1-Q6. My advice is to disregard the domestic/foreign FX monikers because they are relative to each counterparty (so they don't give you actual guidance). The proper FX quote convention syntax is base/quote, as in EURUSD (aka, EUR/USD) where the pair's first currency is the base and the second currency is the quote (aka, price) currency. This may be initially confusing because EURUSD refers mathematically to the ratio USD/EUR, as in $X.XX US dollars per 1.00 unit of EUR. But it is ultimately convenient: given a quote of $1.21 EURUSD (i.e., EUR is the base), a numerical increase implies appreciation in the base currency (it takes more dollars to purchase one Euro or equivalently, one Euro gets you more dollars). The major currencies already belong to an informal priority ranking, where EUR ranks first (see https://en.wikipedia.org/wiki/Currency_pair), so by convention the preference is EURUSD and USDEUR is unconventional. If you really want to also use direct-versus-indirect, then know that a direct quote refers to a quote when your domestic currency is the quote (aka, price) currency, while an indirect quote refers to when your domestic currency is the base currency. Consequently, a quote of $1.21 EURUSD is direct if you are based in New York, but indirect if you are based in Paris. (Why do I prefer to omit the "/" in the pair? Because it connotes the mathematical ratio. I figure EURUSD is just slightly less susceptible to misinterpretation than EUR/USD. It's the little things).

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