Foreign Exchange Simulation Account Opening - Foreign Exchange Rates - Financial ACFX

by acfx0001 on 2011-08-17 12:09:01

Exchange rate, namely the exchange rate of designated foreign exchange banks, refers to the buying and selling prices set by various banks (headquarters, branch rates are the same as headquarters) based on the RMB market mid-price announced by the People's Bank of China and the international foreign exchange market conditions, for various foreign currencies against RMB. This price remains unchanged within the same day but can vary on different dates.

RMB Exchange Rate

Since its inception, the RMB has always been a non-convertible currency, with its exchange rate determined by the central bank, the People's Bank of China, serving only as a policy tool for regulating import-export trade and improving the balance of international payments. The RMB exchange rate roughly went through two phases: the exchange rate before the reform and opening-up, and the rate after. Before the reform and opening-up in 1978, from 1949 to 1952 during the period of national economic recovery, the RMB exchange rate was not based on gold but adopted a managed floating system, with prices being the basis for determining the exchange rate; from March 1955 to November 1971, during the stable period of the Bretton Woods system, the RMB exchange rate remained at 2.4618 yuan level (1 US dollar exchanged); from 1973 to 1979, the RMB exchange rate was adjusted several times, reaching 1.684 yuan (1 US dollar exchanged) in 1978 [1]. After the reform and opening-up, the RMB exchange rate went through stages including the dual-track system of posted rates and adjustment rates, the flexible pegged dollar system after the unification of exchange rates, the rigidly pegged dollar system after the Asian financial crisis, and the exchange rate system reform on July 21, 2005. The period from 1979 to 1994, when the dual-track exchange rate system was in place, saw the largest depreciation of the RMB, depreciating from 1.555 yuan in 1979 (1 US dollar exchanged) to 8.619 yuan (annual average price) in 1994, a depreciation of 4.5 times. During the dual-track exchange rate system, there also existed foreign exchange certificates that were nominally equivalent to RMB. During this time, there was a government-prohibited black market for foreign exchange, initially focusing on the trading of foreign exchange certificates, then directly on foreign currencies, with black market prices for foreign exchange (foreign exchange certificates and foreign currencies) much higher than the officially set rates, peaking at nearly double the official rate early on and gradually declining until approaching the official posted rate; entering the 1990s, off-market (black market) foreign exchange prices turned weaker than the official posted rates, while foreign exchange certificates gradually faded out of the market. From 1994 to the exchange rate system reform in 2005, the RMB to USD remained above 8.27 yuan (1 US dollar exchanged). After the exchange rate system reform in 2005, the RMB gradually entered an appreciation phase, appreciating from 8.2765 yuan (1 US dollar exchanged) before the reform to 7.3046 yuan at the end of 2007 [2], an appreciation of 11.74%.

Basic Concepts of Foreign Exchange Rates

1. Benchmark rates apply to major currencies such as USD, GBP, EUR, JPY, HKD, etc.

2. Spot exchange is more advantageous than cash because banks save certain costs associated with cash management and overseas transportation, so its price can be higher. Both spot and cash selling prices refer to the bank selling foreign exchange, whether it’s cash or spot, neither can be used directly within mainland China, hence the customer potentially incurs overseas payment fees, and the bank should offer the same price.

The buying price refers to the bank buying foreign exchange, the selling price refers to the bank selling foreign exchange, and the difference between the two is the bank's income.

The spot buying price refers to foreign currency recovered domestically from abroad into your account, where the bank will convert your foreign currency into RMB at a fixed spot buying price;

The cash buying price refers to you directly exchanging foreign currency for RMB at the bank;

The selling price refers to when you need to send foreign currency, the bank exchanges the RMB in your account into foreign currency at the exchange rate.

Cash refers to paper money in circulation in the market, while spot refers to securities representing monetary value.

What are the mid-price, buying price, and selling price of the exchange rate?

A bank's foreign exchange rate usually includes four types: the spot buying price of foreign exchange, the spot selling price of foreign exchange, the cash buying price of foreign exchange, and the cash selling price of foreign exchange. Adding these prices together and averaging them gives the mid-price for both spot and cash foreign exchange.

The mid-price, also known as the mid-exchange rate, is the average of the buying and selling rates. Its calculation formula is: Mid-exchange rate = (Buying rate + Selling rate) ÷ 2.

The buying and selling prices are viewed from the bank's perspective. When you sell foreign exchange to the bank, it is a buy for the bank, called the buying price; when you exchange foreign currency with the bank, it is a sell for the bank, called the selling price; when calculating the foreign exchange rate, taking the average of the two is called the mid-price. Another term is the cash buying price (also called the cash price), which is the price at which you sell foreign currency cash to the bank. Because the cost of turning around foreign currency cash is higher than foreign exchange, the cash buying price is much lower than the spot buying price. Banks earn money not only through loans but also through the difference between the selling and buying prices of foreign exchange.

Buying price: The bank's quote for buying the benchmark currency.

Selling price: The bank's quote for selling the benchmark currency.

Content Entries of Foreign Exchange Rates

Buying and selling prices: Both are from the bank's perspective, referring to the price at which the bank buys and sells the first currency mentioned in the quote.

Spot cash buying price: Refers to the price at which the bank buys foreign currency cash, and the client sells foreign currency cash.

Spot exchange buying price: Refers to the price at which the bank buys spot foreign exchange, and the client sells spot foreign exchange.

Spot exchange: Refers to foreign currency instruments remitted from abroad or brought in from abroad, transferred into the personal account in the bank.

Cash: Refers to foreign currency cash or deposits made in foreign currency cash at the bank.

Mid-price: Not for individuals, it refers to the standard set by the bank based on the benchmark price set by the Foreign Exchange Administration, generally the average of the bank's spot buying and selling prices.

Formation Mechanism of Foreign Exchange Rates

The formation of foreign exchange rates is closely related to the management of floating intervals in the inter-bank foreign exchange market, the arrangement of the bank's settlement and sale system, and the management of the bank's settlement and sale turnover position, and these links are key components of the RMB exchange rate system arrangement. Since 1994, China has implemented a single, managed floating exchange rate system based on market supply and demand. This system specifically manifests in the formation process of bank foreign exchange rates as follows: the mid-price of several major currencies such as the US dollar and Japanese yen is obtained by the weighted average of the transaction prices in the inter-bank foreign exchange market, reflecting the basis of market supply and demand; the weighted average transaction price serves as the sole benchmark exchange rate within the country, thereby demonstrating its singularity; the central bank often needs to intervene in the market to balance foreign exchange supply and demand and maintain basic exchange rate stability, thus making the RMB exchange rate managed; and there is a certain fluctuation range in the exchange rates between the inter-bank foreign exchange trading market and the clients and banks, indicating that the exchange rate is not completely fixed but rather has a certain degree of floating.

Direct Quotes and Cross Rates in Foreign Exchange Rates

In the foreign exchange market, there are terms called direct quotes and cross rates. These are general terms referring to the exchange rate method of a particular currency pair, namely the direct exchange rate and the cross exchange rate.

Direct Quote

Direct quotes correspond to cross rates. A direct quote refers to in the international foreign exchange market, a country's currency directly exchanges with the US dollar.

It can be simply understood as:

Any currency directly linked to the US dollar is a direct quote.

For example: EUR/USD AUD/USD USD/JPY USD/CAD all have the US dollar appearing, this is a direct quote.

Those not linked to the US dollar are cross rates.

For example, EUR/GBP AUD/JPY AUD/CAD etc., none of these have the US dollar directly involved, these are cross rates.

Cross Rate

In the foreign exchange market, the US dollar is the base currency. The relative exchange rate between two currencies other than the US dollar is the cross rate, such as the euro against the British pound, the Australian dollar against the Japanese yen.

Using cross rates is a commonly used method for real-time investors in the foreign exchange market to free themselves from being stuck in direct quotes transactions. Many investors who are stuck do not want to stop losses and choose cross-rate operations to free themselves. It can be said that if used well, cross-rate operations can effectively reduce our holding costs and free the already stuck positions faster. If not used well, it will have the opposite effect. We will discuss how to use cross-rate operations and how to avoid risks brought by cross rates. Advantages of cross-rate transactions: 1. Through cross-rates, one can use the stuck currency as the domestic currency and buy the strongest currency in the current market. This allows through cross-rate segment operations, increasing the amount of domestic currency held, naturally reducing the holding cost further, ultimately achieving freedom or even profit. 2. The volatility space of cross-rate trends is relatively large, any currency pair can be freely traded, as long as grasped well, there are many opportunities to make money. After earning from cross-rates, one can choose to return to the original domestic currency or directly back to the US dollar, very flexible. 3. Cross-rate operations involve direct buying and selling between two non-US dollar currencies without going through the US dollar, reducing spreads and lowering transaction costs. Any matter has two sides, cross-rates also have unavoidable disadvantages, improper use can cause new losses. Risks of cross-rate transactions include: 1. The biggest risk in cross-rate transactions is a sharp rise in the US dollar. The linkage characteristics between non-US dollar currencies are very obvious, once the US dollar rises strongly, all currencies will inevitably fall, making cross-rate operations very difficult, and depreciating synchronously with the rise of the US dollar. The final result is that the stuck position becomes deeper. 2. Due to investors' unfamiliarity with cross-rates, the possibility of operational errors is greater, leading to further losses in cross-rate operations and increased stuck positions. Based on the above analysis, we believe that investors doing cross-rates should adhere to two principles: one is to avoid cross-rates under strong US dollar conditions, stopping losses immediately minimizes losses; second is to firmly stop cross-rate transactions when the US dollar fluctuates significantly, using direct-rate segment transactions for self-rescue is better than cross-rates; third, only when the US dollar exchange rate is relatively stable and narrow, is it the best time to do cross-rates. Cross-rates are not the best remedy for freeing stuck positions, if not fully confident, investors should be cautious.