I have a question about Question 13 from Reading 34 in the CFAI text. The question is about the cost of shares between different parts of the world. The part I’m confused about is the exchange rate part - let me explain. The question asks to simply calculate the cost of shares and adjust for the exchange rate. In the question the following bids/asks are given for the FX rate: £:= 1.4575-1.4580 E: = 0.9691-0.9695 The answer (for the British pound part) is simply this: 10,000*67.17*1.4580=979,338.60 but I think this is wrong. Why are we using the ASK side of the price for the FX conversion? Surely we must be using the BID? Think of it this way - imagine you go to buy foreign currency from your bank. Why would they EVER give you the better rate? In ordinary security purchases the dealer would always make you pay more (and force you to lose out). In the context of FX translation surely this would mean forcing you to buy at the bid, and then selling back at the ask. So why has CFA text got it the wrong way around? I’ve checked the errata and it’s not mentioned in there. Any thoughts on this?
if someone sells you something, you buy at their asking price. when you sell back, they will buy back from you at their bidding price.
Ask is always the higher number : Bid - Ask. Bank offers to buy at Ask . Bank offers to sell at Bid. They always make money = Ask - Bid
No, sorry guys you’re wrong. Your interpretation of the bid-ask spread is incorrect in this context. Remember, the bank will ALWAYS screw you over and that means it sells to you (in this case) at the BID. I can even prove this! Let’s go to Reuter’s website: http://www.reuters.com/finance/currencies And when you get there scroll down the page and look at the bid/ask spreads matrix. Then, once you have noted the spread, enter 1GBP = USD and press the red colored GO button. You’ll notice how the calculator gives the BID rate, not the ASK. That’s because if you got the ASK rate you’d be beating the currency seller. So he sells to you at the BID and buys back at the ASK and makes money that way. Remember, for a buyer of £ with $, a LOWER fx rate is more advantageous for you. Let’s do a really simple example. Cast your mind back to November 2007 when the exchange rate was £1=$2. Americans were not holidaying in the UK because it was too expensive. Why? Because $1000 only got them £500. Then the dollar massively appreciated and now the exchange rate is about £1=$1.55. This means that 1000 = £645.16 - you get more more pounds for the same amount of dollars! You can apply this demonstration to my example: As a result when the investor buys with £ the seller wants the lowest fx rate possible to get the HIGHEST number of pounds and hence sells at the BID. When the investor then has too many dollars, he needs pounds again and he buys back his pounds and the seller gives him the highest rate possible and sells back at he ASK. I think it’s done this way because the legacy currencies have the indirect quote convention - that is the base currency is not the USD but GBP. In any case, I think I’m right and the textbook is wrong. The textbook should have converted the currency at the BID, not the ASK, and the author made the same mistake as you guys! What say you?
My post was wrong , Bid is lower than Ask , and quote is made like Bid - Ask. Banks always buy at Bid and Sell at Ask. They make money byuying Low and Selling High.
Ok, yes I see that your post was a typo, but what do you have to say about what I’ve written? Forget about the traditional concept of bid/ask. We’re not talking about a stock or bond here.
It is a US Investor. So to invest in Pounds - he will have to Buy Pounds, – which can only happen at the Ask Price.
Ahh ok, I conveniently forgot about that. I get a bit London centric over here sometimes. But if the investor was from the perspective of a British investor, would I then be correct?