To avoid confusion, the Foreign Exchange markets observe conventions about the way
in which any particular pair of currencies is quoted. Any currency rate always gives the
number of units of the second-named currency equal to one unit of the first-named
currency.
For example, the rate for the US dollar against the Deutschemark rate is quoted as
$/DM (number of Deutschemarks per dollar). This rate might be trading at, say, 1.7500.
This rate gives you the value of one dollar in terms of Deutschemarks; it tells you that
one dollar (the first-named currency) is worth 1.7500 Deutschemarks (the second-named
currency).
The first-named currency is sometimes called the ‘base’. In most cases the first
named currency, or base, is more valuable than the second-named currency. As a result,
most currency rates are numbers greater than one.
For example, the dollar is quoted against the yen as $/Y. This rate might be quoted
at 120.00, which means that one dollar is worth 120.00 yen. Similarly, sterling is quoted
against the dollar as £/$. This rate might be quoted at 1.6000, which means that one
pound is worth 1.6000 dollars.
There are some exceptions to this rule; the Australian and New Zealand dollar are
examples. For historic reasons both are usually quoted as the base against the US dollar
although both are now less valuable than the US dollar.
Which way is up?
It is not always obvious what someone means when they say that a particular currency
rate is ‘rising’ or ‘falling’ or ‘strengthening’ or ‘weakening’. For
example, if the Deutschemark is falling in value, the $/DM rate, which represents ‘number
of Deutschemarks per dollar’, will rise. The best way to think about it is this: A rise
in the rate between a pair of currencies means that the first-named currency has
strengthened against the second-named currency.
A fall in the rate between a pair of currencies means that the first-named currency
has weakened against the second-named currency.
Here are a couple of examples:
$/FF moves from 5.9500 to 5.9700. Here the dollar has risen in value against the
French franc, because one dollar can now buy more francs (5.97) than previously (5.95).
The franc has fallen in value against the dollar.
£/$ moves from 1.5800 to 1.5700. Here the pound has fallen in value against the
dollar, because one pound can now buy fewer dollars (1.57) than previously (1.58). The
dollar has risen in value against the pound.
Pips and decimal points
The smallest unit in which a currency price is normally quoted is called a pip. For
example, £/$ might be quoted at 1.5700; if this price moved to 1.5701, the price would
have moved by one pip.
The value of a pip depends on the currency rate concerned. Many of the most commonly
traded currency rates trade at values between one and ten, quoted to four decimal places.
Dollar/Deutschemark ($/DM), dollar/Swiss franc ($/SF), dollar/French franc ($/FF),
sterling/dollar (£/$) and sterling/Deutschemark (£/DM) all fall into this category. In
these cases the value of one pip is 0.0001 of a unit of the second-named currency.
Dollar/yen ($/Y) and sterling/yen (£/Y) both currently trade at values between 100 and
300 and are quoted to two decimal places. In these two cases the value of one pip is 0.01
yen.
Some currency rates are quoted as four-figure or six-figure rather then five-figure
numbers. DM/Y is quoted as a four-figure number, for example 70.65. Here the value of one
pip is 0.01 yen. Dollar/Italian lira ($/LIT) is quoted as a six-figure number, for example
1591.50. Here the value of one pip is 0.01 lira.
