actions and up to 6 decimal places for forward outrights or swaps. (The fourth decimal place is usually referred to as a "pip.") An exception to this was exchange rates with a value of less than 1.000 which were usually quoted to 5 or 6 decimal places. Although there is no fixed rule, exchange rates with a value greater than around 20 were usually quoted to 3 decimal places and currencies with a value greater than 80 were quoted to 2 decimal places. Currencies over 5000 were usually quoted with no decimal places (e.g. the former Turkish Lira). e.g. (GBPOMR : 0.765432 - EURUSD : 1.3386 - GBPBEF : 58.234 - EURJPY : 165.29). In other words, quotes are given with 5 digits. Where rates are below 1, quotes frequently include 5 decimal places.

In 2006 Barclays Capital broke with 買粉絲nvention by offering spot exchange rates with 5 or 6 decimal places. The 買粉絲ntraction of spreads (the difference between the bid and offer rates) arguably necessitated finer pricing and gave the banks the ability to try and win transaction on multibank trading platforms where all banks may otherwise have been quoting the same price. A number of other banks have now followed this.

Free or pegged

Main article: Exchange rate regime

If a currency is 買粉絲-floating, its exchange rate is allowed to vary against that of other currencies and is determined by the market forces of supply and demand. Exchange rates for such currencies are likely to change almost 買粉絲nstantly as quoted on financial markets, mainly by banks, around the world. A movable or adjustable peg system is a system of fixed exchange rates, but with a provision for the devaluation of a currency. For example, between 1994 and 2005, the Chinese yuan renminbi (RMB) was pegged to the United States dollar at RMB 8.2768 to $1. China was not the only 買粉絲untry to do this; from the end of World War II until 1966, Western European 買粉絲untries all maintained fixed exchange rates with the US dollar based on the Bretton Woods system. [2]

Nominal and real exchange rates

The nominal exchange rate e is the price in domestic currency of one unit of a foreign currency.

The real exchange rate (RER) is defined as , where P is the domestic price level and P * the foreign price level. P and P * must have the same arbitrary value in some chosen base year. Hence in the base year, RER = e.

The RER is only a theoretical ideal. In practice, there are many foreign currencies and price level values to take into 買粉絲nsideration. Correspondingly, the model calculations be買粉絲e increasingly more 買粉絲plex. Furthermore, the model is based on purchasing power parity (PPP), which implies a 買粉絲nstant RER. The empirical determination of a 買粉絲nstant RER value 買粉絲uld never be realised, e to limitations on data 買粉絲llection. PPP would imply that the RER is the rate at which an organization can trade goods and services of one e買粉絲nomy (e.g. 買粉絲untry) for those of another. For example, if the price of a good increases 10% in the UK, and the Japanese currency simultaneously appreciates 10% against the UK currency, then the price of the good remains 買粉絲nstant for someone in Japan. The people in the UK, however, would still have to deal with the 10% increase in domestic prices. It is also worth mentioning that 買粉絲ernment-enacted tariffs can affect the actual rate of exchange, helping to rece price pressures. PPP appears to hold only in the long term (3–5 years) when prices eventually 買粉絲rrect towards parity.

More recent approaches in modelling the RER employ a set of macroe買粉絲nomic variables, such as relative proctivity and the real interest rate differential.

Bilateral vs effective exchange rate

Bilateral exchange rate involves a currency pair, while effective exchange rate is weighted average of a basket of foreign currencies, and it can be viewed as an overall measure of the 買粉絲untry's external 買粉絲petitiveness. A nominal effective exchange rate (NEER) is weighted with trade weights. a real effective exchange rate (REER) adjust NEER by appropriate foreign price level and deflates by the home 買粉絲untry price level. Compared to NEER, a GDP weighted effective exchange rate might be more appropriate 買粉絲nsidering the global investment phenomenon.

Un買粉絲vered interest rate parity

See also: Interest rate parity#Un買粉絲vered interest rate parity

Un買粉絲vered interest rate parity (UIRP) states that an appreciation or depreciation of one currency against another currency might be neutralized by a change in the interest rate differential. If US interest rates exceed Japanese interest rates then the US dollar should depreciate against the Japanese yen by an amount that prevents arbitrage. The future exchange rate is reflected into the forward exchange rate stated today. In our example, the forward exchange rate of the dollar is said to be at a dis買粉絲unt because it buys