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How currencies are quoted or priced?

We already discussed in our earlier blog that in foreign exchange the currencies are commodities and one currency is bought against another currency.

But how is one currency priced against another?

Any price is nothing but a ratio of quantities. Let's think in a different way.

Suppose a burger costs $ 5. That means if we give USD 5 we can get in return 1 burger. So we can write it as -
1 burger / USD 5 

Or

USD/Burger = 5/1

Can we put this in a different way? 

Can we say that we buy 1 burger and in return we actually sell USD 5 and this price notation shows the relative quantities of the two items bought and sold? 

Currencies are priced in exactly the same way. Every forex transaction involves a currency pair where one currency is sold and another currency is bought and the foreign exchange rate or quote shows the relative quantities of the two currencies bought or sold.

Direct and Indirect Quotation

In any currency quote the currency stated in the left is called the base currency and the currency on the right is called the quoting currency. 

When the price is quoted in such a way it denotes the number of units of home currency required to purchase fixed units (usually 1 unit) of a foreign currency, then it's called direct quotation or home currency quotation. 

For example if you see a buying quote -
USD/INR = 75.50
It means 1 USD = INR 75.50. 

To put it more simply, if you want to buy a dollar in India, you have to give up Rs 75.50 or we can also say if you sell Rs 75.50, you can buy 1 USD in return.

Indirect quotation is just the opposite. Here a fixed unit of home currency is quoted against units of foreign currency.

For example in the London market the quote of GBP is given as -

Whether it's direct or indirect quotation, always keep in mind what is quoted in the market as forex price (or exchange rate) is the price of base currency, in units of quoting currency. 

Also, almost always the unit of the base currency is 1 unit. There are some exceptions where the base currency is not taken as 1 unit, for example in JPY/INR instead of 1 JPY, 100 units of JPY is taken. The market practice for the notation of a currency pair is to write the base currency first, followed by the quoting currency. 

For example,

When we write EUR/USD, the base currency is euro, the quoting currency is USD and it means the price of Euro in terms USD. Again in USD/JPY, USD becomes the base currency and it means the price of USD in terms of JPY.

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