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Hello Sir!
Eg: The base currency is sterling pounds.
If I’ve dollars and would like to convert it to sterling pounds, I will use the ask rate,isn’t it?However the examiner in Kenduri co qn used the bid rate to convert the premium in $ to sterling pounds.
Why is it so?
Thank you.
I never think it terms of Ask and Bid rates because it depends which way round the currency is quoted and which way round we are converting, and I find it unnecessarily confusing.
Essentially you convert at whichever rate is worse for the company (because it is the bank that makes the profit from the spread – not the company 🙂 )
The premium is payable and is calculated in $’s. Because the quote is $’s per Pound, we divide by the relevant rate to convert to Pounds. Dividing by the smaller rate gives the higher payment. What the examiner has done is perfectly correct.
In my first lecture on foreign exchange risk management I spend time (with several examples) on deciding which rate to use when, and the ‘rule’ that I use (that always works 🙂 )
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