📚 JAIIB 2026 • AFM • Module C • Chapter 5 of 10 • Unit 23

Financial Mathematics — Forex Arithmetic
(Converting Currencies — Direct Quotes, Cross Rates & Forward Points!)

When an exporter sends goods abroad, the importer pays in foreign currency. Banks convert currencies using exchange rates. This chapter covers direct vs indirect quotes, cross rates, chain rule, value dates (Cash/TOM/SPOT/Forward), and how forward premium/discount works.

⏱ 20 min read🎯 Forex Basics⚡ 12 Flash Cards

Banky Enters the World of FOREX! 🌍💱

An NRI customer wants to send $5,000 to India. “How many rupees will I get?” Banky needs to know: what’s the exchange rate, is it direct or indirect, what’s the bid/offer spread, and is it spot or forward?

“Sir, $1 = ₹75 — is that a direct or indirect quote? And what’s a ‘cross rate’?” 🤔

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Section 1 of 9

Forex — Complete Guide

📖 Part 1 — Direct vs Indirect Quote

Foreign Exchange = Converting one country’s currency into another. Arises from international trade. Banks buy and sell forex.

Direct Quote: Home currency price of 1 unit of foreign currency. For Indians: $1 = ₹75 is DIRECT. How many RUPEES for 1 DOLLAR? India uses DIRECT quotes since August 2, 1993 (before that, indirect was used).

Indirect Quote: Foreign currency price of 1 unit of home currency. ₹1 = $0.0133 is INDIRECT for Indians.

Direct Quote = 1 / Indirect Quote (reciprocals of each other)

Bid/Ask Spread: Bank quotes TWO rates: Bid (buying rate — lower) and Ask/Offer (selling rate — higher). The spread is the bank’s profit. Example: $1 = ₹74.8450/74.8545. Bank BUYS $ at 74.8450, SELLS $ at 74.8545.

🧑‍💼 Banky: “Direct = how many RUPEES for 1 DOLLAR 🇮🇳💰. Indirect = how many DOLLARS for 1 RUPEE 🇺🇸💰. India uses DIRECT since Aug 1993!” 🌍

📋 Part 2 — Cross Rate, Chain Rule & Value Dates

Cross Rate: When direct ₹/Euro rate isn’t available, use a THIRD currency (usually USD) as bridge. Buy USD with rupees, then buy Euros with USD. Chain Rule calculation.

Example: $1 = ₹74.8545 and $1 = €0.9027 → 1 Euro = ₹74.8545 ÷ 0.9027 = ₹82.92

Value Dates (when currencies actually exchange):

CASH/READY: Same day as deal. TOM: Next working day (tomorrow). SPOT: 2nd working day after deal (MOST common!). Forward: Any date beyond spot.

🧑‍💼 Banky: “TOM = tomorrow! SPOT = day after tomorrow (2nd working day)! CASH = today! Forward = future! SPOT is the DEFAULT rate in forex!” 📅

💱 Part 3 — Forward Rates: Premium & Discount

Forward Rate = Spot Rate ± Forward Points. Forward points reflect INTEREST RATE DIFFERENTIAL between two countries.

Forward Points = Spot × Interest Differential × Forward Period / (100 × Days in Year)

Premium (Direct quote): Forward rate > Spot rate → base currency is COSTLIER in future → ADD premium to both bid and ask.

Discount (Direct quote): Forward rate < Spot rate → base currency is CHEAPER in future → SUBTRACT discount from both bid and ask.

How to identify from forward differentials: First figure < Second figure (e.g., 15-18) → Base currency at PREMIUM → ADD. First figure > Second figure (e.g., 24-19) → Base currency at DISCOUNT → SUBTRACT.

At Par: Spot = Forward rate (no difference). Arbitrage: Risk-free profit from interest rate differentials between currencies — market forces eliminate this quickly.

Interest rate differential determines forward points (most dominant factor when capital flows are free).

🧑‍💼 Banky: “Premium = ADD (costlier in future). Discount = SUBTRACT (cheaper in future). First < Second = Premium. First > Second = Discount!” ➕➖

🎯

Section 2 of 9

Exam-Ready Points

🎯 Must Remember!

India uses DIRECT quotes since August 2, 1993 (before that: indirect).
Direct = Home currency price of 1 unit foreign. $1 = ₹75 is direct for India.
Direct = 1/Indirect (reciprocals).
CASH = same day. TOM = next working day. SPOT = 2nd working day. Forward = beyond spot.
Cross rate: Use third currency when direct rate unavailable. Chain rule calculation.
Forward rate = Spot ± Forward points. Forward points = interest rate differential effect.
Direct quote: Premium → ADD. Discount → SUBTRACT. From BOTH bid and ask.
Forward differentials: First < Second = Premium (ADD). First > Second = Discount (SUBTRACT).
Interest rate differential is the MOST dominant factor determining forward points.
3 factors for forward points: Supply/demand, Market expectations, Interest rate differential.
Arbitrage: Risk-free profit from rate differentials. Market eliminates it quickly.

📝 Past Exam Questions

Q: Exchange on next working day is called?

A: TOM (tomorrow)

Q: Exchange on 2nd working day is called?

A: SPOT

Q: Which about forward rate is correct?

A: All — premium if forward > spot (direct), discount if forward < spot, forward points = basis points.

Q: Factors determining forward points?

A: All — supply/demand, market view, interest rate differential.

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Section 3 of 9

Last-Minute Flash Cards

Direct Quote

Home currency per 1 unit foreign | $1 = ₹75

India uses DIRECT since Aug 2, 1993. Direct = 1/Indirect.

Indirect Quote

Foreign currency per 1 unit home | ₹1 = $0.0133

Used before 1993 in India. Reciprocal of direct.

CASH

Same day exchange

Also called READY rate.

TOM

Next working day

Tomorrow. One day after deal.

SPOT

2nd working day after deal

MOST common default rate in forex market.

Forward

Any date beyond SPOT

Spot ± Forward points. Based on interest rate differential.

Cross Rate

Via third currency when direct rate unavailable

₹→$→€ chain. Chain rule calculation.

Premium (Direct)

Forward > Spot → ADD to both bid & ask

Forward differentials: First < Second = Premium.

Discount (Direct)

Forward < Spot → SUBTRACT from both

Forward differentials: First > Second = Discount.

Forward Points Formula

Spot × Int Diff × Period / (100 × Days/Year)

Interest rate differential = MOST dominant factor.

Bid vs Ask

Bid = bank buys (lower) | Ask = bank sells (higher)

Spread = bank’s profit on forex transaction.

Arbitrage

Risk-free profit from rate differentials

Market forces eliminate arbitrage opportunities quickly.

⚡ Module C • Chapter 5 (Unit 23) Done!

Direct Quote: Home currency per 1 foreign unit. India uses direct since Aug 1993.
Value Dates: Cash (same day), TOM (next day), SPOT (2nd day — default), Forward (beyond spot).
Cross Rate: Via third currency. Chain rule calculation.
Forward: Spot ± Points. Premium → ADD. Discount → SUBTRACT. Interest differential = key factor.
First < Second = Premium. First > Second = Discount. At Par = equal.

Banky says: “Direct = rupees per dollar! TOM = tomorrow! SPOT = 2nd day! Premium = ADD! Discount = SUBTRACT! Now I can handle forex!” 🎉🌍💱

Next: Chapter 24 — Capital Structure & Cost of Capital! 💪

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