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Calculating the implied exchange rate between two currencies involves using the exchange rates of those currencies with a common third currency. This is especially useful in triangular arbitrage or hedging strategies. Here's how you can calculate it:
### Formula
To calculate the implied exchange rate between two currencies, say Currency A and Currency B, using their exchange rates with a common Currency C, you can use the following formula:
\[ \text{Implied Rate} (A/B) = \left( \frac{\text{Exchange Rate} (A/C)}{\text{Exchange Rate} (B/C)} \right) \]
### Example
Let's use an example with EUR, USD, and JPY:
- Exchange Rate (EUR/USD) = 1.10
- Exchange Rate (USD/JPY) = 110
- We want to find the implied Exchange Rate (EUR/JPY)
#### Step-by-Step Calculation:
1. *Identify the given rates
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- EUR/USD = 1.10
- USD/JPY = 110
2. *Apply the formula
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\[ \text{Implied Rate} (EUR/JPY) = \left( \frac{\text{Exchange Rate} (EUR/USD)}{\text{Exchange Rate} (USD/JPY)} \right) \]
3. *Substitute the values
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\[ \text{Implied Rate} (EUR/JPY) = \left( \frac{1.10}{110} \right) \]
4. *Calculate the implied rate
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\[ \text{Implied Rate} (EUR/JPY) = 0.01 \]
This means that the implied exchange rate for EUR/JPY, based on the given EUR/USD and USD/JPY rates, is 0.01.
### Verification
You can verify this by converting EUR to JPY through USD:
1. *Convert EUR to USD
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- 1 EUR = 1.10 USD
2. *Convert USD to JPY
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- 1.10 USD = 1.10 * 110 = 121 JPY
Therefore, 1 EUR = 121 JPY, which matches the calculation.
### Real-World Application
In practice, you would compare this implied rate with the actual market rate of EUR/JPY. If there's a significant difference, it might indicate an arbitrage opportunity or a potential for hedge adjustments.
### Summary
To calculate the implied exchange rate:
1. Identify the exchange rates between the currencies and a common third currency.
2. Use the formula to compute the implied rate.
3. Compare the implied rate with the actual market rate to identify opportunities.
It is possible to create any ea on this formula. If possible Please reply. Thanks.