Reading a quote the right way
An exchange rate is a price with two currencies and no fixed direction. 118 taka per dollar and 0.00847 dollars per taka are the same fact written two ways, and mixing them up is the most common error in the topic.
Always write the units down. If a rate is quoted in taka per dollar, a rise means the taka has weakened, because each dollar now costs more taka.
Banks quote a bid and an ask. The gap, or spread, is the price of liquidity, and it is why converting out and back always costs something.
Key points
- An exchange rate is always a ratio of two currencies.
- Write the units before you calculate anything.
- Bid-ask spreads make round trips expensive.
Covered interest parity
F = S × (1 + i_domestic) ÷ (1 + i_foreign)
The forward rate that removes any riskless gain from borrowing one currency and lending the other.
Suppose the spot rate is 118 taka per dollar, the taka rate is 9%, and the dollar rate is 4%. Investing one taka locally grows it to 1.09. Converting to dollars, investing at 4%, and converting back must give the same answer, so the forward rate has to be 118 × 1.09 ÷ 1.04 = 123.67.
That is covered interest parity: the currency with the higher interest rate trades at a forward discount, because the extra interest is exactly offset by a weaker forward rate.
The parity is enforced by arbitrage, and it holds closely whenever money can move freely. Where capital controls or credit limits bind, the gap between the quoted forward and parity is a measure of that friction.
Key points
- Higher interest rates come with a weaker forward rate.
- The parity is a no-arbitrage condition, not a forecast.
- Real markets deviate when capital cannot move freely.
Purchasing power parity
Expected change in spot ≈ Inflation differential
The currency of the higher-inflation country is expected to depreciate.
If prices rise 7% a year at home and 3% abroad, the difference of 4% should show up as a depreciation of the home currency, all else equal. From a spot of 118, that points to about 122.72 over the year.
Relative parity is a long-run anchor, not a trading signal. It says nothing about next week, and it can be wrong for years when capital flows, productivity, or policy dominate.
Use it the way you would use a trend line on a chart: as context for whether a rate looks stretched, never as a precise target.
Key points
- Higher inflation points to a weaker currency over time.
- Parity is a long-run tendency, not a forecast.
- Big deviations can persist for a long time.
Living with currency exposure
A firm that invoices in dollars but pays costs in taka has a real exposure. If the taka weakens, the taka value of the receivable rises, which helps; if it strengthens, the same receivable is worth less.
The firm can do nothing, hedge with a forward, borrow in the matching currency, or pass the risk to customers through pricing. Each choice trades certainty against flexibility and cost.
Translation exposure, where a foreign subsidiary's results are converted for reporting, is a different problem from transaction exposure, where actual cash flows change value. They are often confused, and they are hedged differently.
Key points
- Transaction exposure affects cash; translation exposure affects reported numbers.
- Natural hedges match assets and liabilities in the same currency.
- Pricing can shift currency risk to the customer, or lose the sale.
02 / Calculate
Watch value compound.
Change the starting amount, the rate, or the horizon. A negative rate models inflation and shows the loss of buying power.
An annual ৳100,000 grows at 8% for 15 years with no extra contributions.
Future value
৳317,216.91
After 15 years the balance is ৳3.17 L. You contributed ৳100,000.00 and earned ৳217,216.91 in growth.
Total interest earned
৳217,216.91
Compounding vs simple interest
+৳97,216.91
Year by year
| Year | Opening | Added | Growth | Closing |
|---|---|---|---|---|
| 1 | ৳100,000.00 | ৳0.00 | ৳8,000.00 | ৳108,000.00 |
| 2 | ৳108,000.00 | ৳0.00 | ৳8,640.00 | ৳116,640.00 |
| 3 | ৳116,640.00 | ৳0.00 | ৳9,331.20 | ৳125,971.20 |
| 4 | ৳125,971.20 | ৳0.00 | ৳10,077.70 | ৳136,048.90 |
| 5 | ৳136,048.90 | ৳0.00 | ৳10,883.91 | ৳146,932.81 |
| 6 | ৳146,932.81 | ৳0.00 | ৳11,754.62 | ৳158,687.43 |
| 7 | ৳158,687.43 | ৳0.00 | ৳12,694.99 | ৳171,382.43 |
| 8 | ৳171,382.43 | ৳0.00 | ৳13,710.59 | ৳185,093.02 |
| 9 | ৳185,093.02 | ৳0.00 | ৳14,807.44 | ৳199,900.46 |
| 10 | ৳199,900.46 | ৳0.00 | ৳15,992.04 | ৳215,892.50 |
| 11 | ৳215,892.50 | ৳0.00 | ৳17,271.40 | ৳233,163.90 |
| 12 | ৳233,163.90 | ৳0.00 | ৳18,653.11 | ৳251,817.01 |
| 13 | ৳251,817.01 | ৳0.00 | ৳20,145.36 | ৳271,962.37 |
| 14 | ৳271,962.37 | ৳0.00 | ৳21,756.99 | ৳293,719.36 |
| 15 | ৳293,719.36 | ৳0.00 | ৳23,497.55 | ৳317,216.91 |
Test the assumption
What if the rate changes?
The same inputs, compared across nearby rates.
6.0% rate
৳239,655.82
Comparison scenario
8.0% rate
৳317,216.91
Your current assumption
10.0% rate
৳417,724.82
Comparison scenario
Growth uses a constant annual rate with interest added once a year. Contributions are added at each year-end. Real products compound more often and carry fees, taxes, and risk.
03 / Apply
An exporter prices a dollar contract
A garment exporter signs a contract worth one million dollars, payable in six months, with costs in taka. The finance team must decide whether to hedge, and at what rate the deal still makes sense.
The assumptions
- The spot rate is 118 taka per dollar and the six-month forward is quoted at 121.
- Parity implies a forward of about 120.9 over six months.
- The contract margin is thin enough that a 3% currency move matters.
What to take away
01
Compare the quoted forward with parity to see the cost of certainty.
02
A margin that survives only at the spot rate is not a margin.
03
Hedging decisions belong before the contract is signed.
Your turn
0 of 4 answered
01Question
The spot rate is 118 taka per dollar, the taka rate is 9%, and the dollar rate is 4%. What is the one-year parity forward rate?
02Question
Home inflation is 7% and foreign inflation is 3%. From a spot rate of 118, what spot rate does relative purchasing power parity suggest after one year?
03Question
You convert ৳1,00,000 at a spot rate of 118 taka per dollar. How many dollars do you receive, to two decimals?
04Question
Which parity links spot rates, forward rates, and interest rates?
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Open the playgroundSources & further reading
CFA Institute · Currency exchange rates ↗OpenStax · Principles of Finance (free textbook) ↗Educational sample content. Worked examples use hypothetical figures. Dates refer to the note's latest content update.