Academic journal article Atlantic Economic Journal

On Misquoting Bilateral Exchange Rates

Academic journal article Atlantic Economic Journal

On Misquoting Bilateral Exchange Rates

Article excerpt

A bilateral exchange rate is the price of one currency in terms of another. For two currencies, such as x and y, the bilateral exchange rate can be expressed as x/y or y/x. However, there seems to be no consensus view on what these expressions mean. That is, is x/y the price of one unit of x in terms of y or the price of one unit of y in terms of x? This is not a trivial issue but rather a serious problem. Apart from the confusion it causes, expressing exchange rates the right way around is essential for correct calculations in some financial operations, such as arbitrage and hedging. It is also essential for the correct measurement of variables, such as the real exchange rate and the interest parity forward rate.

The absence of a general agreement on what these expressions mean becomes obvious by skimming through some books on the subject. For example, McGrath and Viney [Financial Institutions, Instruments and Markets, 1997, p. 367] define the dollar/mark exchange rate as the price of one dollar in terms of the mark. Conversely, Levi [International Finance, 1990, p. 41] defines the exchange rate i/j as "the number of units of currency i per unit of currency j." Contradictions can be found even in the same book. For example, Giddy [Global Financial Markets, 1994, p. 16] defines the pound/mark exchange rate as implying the price of one pound. On page 28, however, the author implies that the mark/dollar exchange rate is the price of one dollar. …

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