This article provides a popular introduction to common currencies, types of exchange rates, methods of exchange rate quotation, and exchange rate systems.
Concepts#
Foreign Exchange: Usually refers to various payment methods that can be used for international settlements, expressed in foreign currencies. It includes foreign currencies, foreign currency deposits, foreign currency securities (government bonds, treasury bills, corporate bonds, stocks, etc.), and foreign currency payment vouchers (bills, bank deposit vouchers, postal savings vouchers, etc.). Foreign exchange is an abbreviation for international exchange.
Exchange Rate: The exchange price between two different currencies. If foreign exchange is also considered as a commodity, then the exchange rate is the price of purchasing one currency with another currency in the foreign exchange market.
Common Currencies#
Common names and standard codes for commonly used freely convertible currencies:
| Currency Symbol | Currency Name | Translation | Common Usage |
|---|---|---|---|
| USD | US Dollar | 美元 | $ /US$ |
| EUR | EURO | 欧元 | € |
| GBP | Pound Sterling | 英镑 | £ |
| JPY | YEN | 日元 | JP¥ |
| CHF | Swiss France | 瑞士法郎 | SF |
| SEK | Swedish Krona | 瑞典克朗 | SKr |
| NOK | Norwegian Krone | 挪威克朗 | NKr |
| CAD | Canadian Dollar | 加拿大元 | Can$ |
| AUD | Australia Dollar | 澳大利亚元 | A$ |
| SGD | Singapore Dollar | 新加坡元 | S$ |
| HKD | Hong Kong Dollar | 香港元 | HK$ |
| MOP | Pataca | 澳门元 | P /Pat |
| MYR | Malaysian Ringgit | 马米西亚林吉特 | M$ |
| THB | Thai Baht | 泰国铢 | B |
| KRW | Korea Won | 韩国元 | W |
| SDR | Special Drawing Right | 特别提款权 | SDRs |
The Australian dollar is commonly referred to as the "Aussie dollar".
The Macau pataca is commonly referred to as the "pataca" (Portugal uses the euro).
The New Taiwan dollar is represented by the currency symbols TWD or NTD, and is commonly written as NT$.
The "Renminbi" (RMB/CNY) is represented by the symbol ¥ and is a non-freely convertible currency. It is referred to as "onshore renminbi" within China and "offshore renminbi" outside of China (symbol CNH, CNY in Hong Kong, as Hong Kong is the largest offshore renminbi market). If you carry a bundle of ¥100 to Hong Kong, that bundle of "onshore renminbi" becomes "offshore renminbi".
Types of Exchange Rates#
- Bid Rate: The exchange rate used by banks when buying foreign exchange from customers.
- Offer Rate: The exchange rate used by banks when selling foreign exchange.
- Middle Rate: The average of the bid rate and offer rate.
In China, foreign exchange is divided into cash and spot rates, and exchange rates are also divided into cash rates and spot rates. Cash refers to foreign currency cash or funds deposited in a bank in foreign currency, which is physically held and cannot be directly remitted across borders. Spot refers to foreign exchange that can be freely bought and sold in the international financial market, can be paid internationally, and can be freely exchanged for other currencies. It can be remitted across borders and is the foreign currency on the books. Due to the loss and management costs of physical money, it is not cost-effective to purchase cash. There is a handling fee for cash conversion.
Exchange Rate Quotation#
First determine the domestic currency and foreign currency (all exchange rate quotation methods are defined based on the concept of "domestic currency"). In a designated foreign exchange market, the domestic currency is the legal currency of that region and is used for quotation.
Consider: Which is the domestic currency and which is the foreign currency between CNY, HKD, MOP, and TWD?
In Hong Kong, how much JPY can be exchanged for USD?
(When we hold a certain currency and want to enter the foreign exchange market, regardless of where the transaction takes place, we can analyze the quotation by considering the held currency as the base currency.)
Direct Quotation Method#
The direct quotation method, also known as the payable quotation method or price quotation method, is a method of expressing the exchange rate of a certain unit of foreign currency in terms of the domestic currency. Generally, it indicates how much of the domestic currency can be exchanged for 1 unit or 100 units of foreign currency.
For example, CNH/HKD, with HKD as the base currency, the selling rate for CNH is 1.08363 and the buying rate for CNH is 1.09606. The unit here is 1.
The more valuable the domestic currency, the less of the domestic currency can be obtained for a unit of foreign currency, and the smaller the exchange rate value. Conversely, the less valuable the domestic currency, the more of the domestic currency can be obtained for a unit of foreign currency, and the larger the exchange rate value.
Under the direct quotation method, the rise and fall of the exchange rate are inversely related to the change in the value of the domestic currency: when the domestic currency appreciates, the exchange rate decreases; when the domestic currency depreciates, the exchange rate increases.
Most countries adopt the direct quotation method. Most exchange rates in the market are also based on the direct quotation method. Examples include the exchange rates between the US dollar and the Japanese yen, the US dollar and the Hong Kong dollar, and the US dollar and the Chinese yuan.
Indirect Quotation Method#
The indirect quotation method, also known as the receivable quotation method or quantity quotation method, is a method of expressing the exchange rate of a certain unit of the domestic currency in terms of foreign currency. Generally, it indicates how much of the foreign currency can be exchanged for 1 unit or 100 units of the domestic currency.
For example, CNH/JPY, with CNH as the base currency, the selling rate for CNH is 19.1464 and the buying rate for CNH is 19.4799.
The more valuable the domestic currency, the more of the foreign currency can be obtained for a unit of the domestic currency, and the larger the exchange rate value. Conversely, the less valuable the domestic currency, the less of the foreign currency can be obtained for a unit of the domestic currency, and the smaller the exchange rate value.
Former Commonwealth countries mostly use the indirect quotation method, such as the UK, Australia, New Zealand, etc. Examples of exchange rates in the market that use the indirect quotation method include the pound sterling to US dollar and the Australian dollar to US dollar.
Exchange Rate Systems#
The Impossible Trinity, also known as the Trilemma or Mundell's Triangle, is a principle in international finance that states that a country cannot simultaneously achieve the following three objectives:
- Capital mobility
- Fixed exchange rate, stable currency value
- Independent monetary policy
Hong Kong and Macau have chosen capital mobility and fixed exchange rates, giving up independent monetary policy. China controls capital mobility and has an independent monetary policy.
Hong Kong Linked Exchange Rate System#
The Hong Kong Linked Exchange Rate System is a fixed exchange rate system of the currency issuing authority, guaranteed by 100% foreign exchange reserves. The Hong Kong dollar is pegged to the US dollar at a rate of 7.75 to 7.85 Hong Kong dollars per US dollar. Hong Kong Linked Exchange Rate System - Wikipedia
Macau adopts a currency board system, and the issuance of the Macau pataca is supported by 100% foreign exchange reserves. The Macau pataca is pegged to the Hong Kong dollar at a fixed exchange rate of 1 Hong Kong dollar to 1.03 Macau pataca, indirectly pegging it to the US dollar.
Managed Floating Exchange Rate System#
CNY: Currently, the USD/CNY exchange rate fluctuates around 7. Towards a More Market-Based RMB Exchange Rate Formation Mechanism - People's Bank of China
TWD:
The Central Bank does not adopt a policy of deliberately weakening or strengthening the New Taiwan dollar exchange rate. The New Taiwan dollar exchange rate has always maintained dynamic stability. The Central Bank only adjusts the foreign exchange market when necessary to slow down excessive exchange rate fluctuations, but it does not have the ability to reverse the trend of exchange rates.
Theories of Exchange Rate Determination#
- International lending theory
- Purchasing power parity theory
- Interest rate parity theory
- Balance of payments theory
- Asset market theory
Exchange rate - Factors affecting the change of exchange rate - Wikipedia
References#
Basic Knowledge of Personal Foreign Exchange Trading - Bank of China
Impossible Trinity - Wikipedia
Pataca - Monetary Authority of Macao
Renminbi Exchange Rate - Wikipedia