FOREIGN EXCHANGE

Foreign Exchange
 FOREIGN EXCHANGE RATE
Foreign exchange rate
is the price of one
currency expressed in
terms of another
currency.
 Foreign exchange instrument
• SPOT transcation- The exchange of one
currency the second day after the date
on which the transaction is made.
• (spot rate- the rate at quoted for transaction that require delivery within to days)

• OUTRIGHT FORWARD Rate – EXCHANGE OF

CURRENCY AFTER THREE OR MORE DAYS OF TRANSACTION

• Fx Rate- ONE CURRNCY IS SWAPPED FOR ANOTHER

ON ONE DATE THEN SWWAPED BACK ON FUTUER DATE
• OPTION- IS THE RIGHT BUT NOT THE
OBLIGATION TO BUY OR SELL A FORIGEN
CURRENY ON A SPECIFIC DATE AT SPECIFIC
EXCHANGE RATE
 FORIGEN EXCAHNGE
CONVERTIBILTY
• HARD currency-Those currency that are
fully convertible ex us $ doller
• Soft currency- those currency that are nit
fully convertible ex currency of
developing countries.
• ( fully convertible currencies are those
that government allow both resident and
nonresident to purchase at unlimited
amounts)
 QUOTATIONS
• Direct quote
It is a home currency price of a foreign currency unit.

• Indirect quote
It is a foreign currency price of a home currency unit.

• Bid
The exchange rate in one currency at which a dealer (usually bank) will buy
another currency.

• Offer
The exchange rate at which a dealer will sell the other currency.
• Spot rate
The exchange rate for a transaction that requires almost immediate delivery
of foreign exchange..
HOW COMPANIES USE FORIGEN EXCHANGE

ARBITAGE - THE PURCHASE OF FORIGEN CURRENCY ON ONE

MARKET AND RESALE ON ANOTHER MARKET FOR EX- THE
TRADER CONVERT 100 DOLLAR INTO 150 FRANS WHEN
EXCHANGE RATE IS 1.5 PER DOLLER . THE TRADER THE
CONVERT THEM 150 FRANS INTO POUNDS AT EXCHANGE RATE .
467 PER FRANCE AND FINALLY CONVERT THEMMPOUND INTO
125 DOLLER AT AN EAXCHANGE RATE OF .56 POUNDS

SPECULATION – INVERTORS CAN ALSO USE FORRIGN EXCHANGE

TRANSCATION TO SPECULATE FOR PROFIT OR TO PROTECT
AGAINST RISK. IS THE BUYING OF COMMODITIES. THE FORIGRN
EXCHANGE IS ELEMENT OF RISK AND PROFIT
 CONTEMPORARY EXCHANGE RATE
SYSTEMS
• Fixed-Rate system
Govts. (through their central banks) buy or sell their currencies in the foreign
exchange market whenever exchange rates deviate from their stated par
values.

• Crawling peg system

It is an automatic system for revising the exchange rate, establishing a par
value around which the rate can vary up to a given percentage point.

• Target-zone arrangement
It is virtually a joint float system co-operatively arranged by a group of
nations sharing some common interests and goals.
• Managed float system (Dirty float)
It is employed by govts to preserve an orderly pattern of exchange rate
changes and is designed to eliminate excess volatility.

• Independent float system (Clean float)

In this, an exchange rate is allowed to adjust freely to the supply and demand
of this currency for another.
 DETERMINATION OF FOREIGN EXCHANGE
RATES
• Purchasing power parity (PPP)
This principle suggests, the exchange rate should equalize the price of an identical
basket of goods and services in the two countries.
 Absolute PPP: exchange rate is determined by relative prices of similar basket
of goods and services.
 Relative PPP: focuses on the relationship between the change in prices of the
two countries and change in exchange rate over the same period.

• Interest rate parity (IRP)

This principle provides an understanding of the way in which interest rate are
linked between different countries through capital flows.
 Forward rate: it is the rate at which bank is willing to exchange one currency
for another at some specified future date.
• Spot rate
The exchange rate for a transaction that requires almost immediate delivery
of foreign exchange..

• Cross rate
The exchange rate between two infrequently traded currencies, calculated
through a widely traded third currency.
 FOREIGN EXCHANGE MARKET
• The foreign exchange (currency or forex or FX) market exists wherever
one currency is traded for another.
• It is by far the largest financial market in the world, and includes trading
between large banks, central banks, currency speculators, multinational
corporations, governments, and other financial markets and institutions.

STOCK MARKET
• The term 'the stock market' is a concept for the mechanism that enables
the trading of company stocks (collective shares), other securities, and
derivatives.
• The stocks are listed and traded on stock exchanges which are entities (a
corporation or mutual organization) specialized in the business of bringing
buyers and sellers of stocks and securities together.
 Foreign exchange risk and
exposure
Foreign Exchange Risk
The risk of an investment's value changing due to changes in currency exchange
rates. 
2. The risk that an investor will have to close out a long or short position
in a foreign currency at a loss due to an adverse movement in exchange rates.
Also known as "currency risk" or "exchange-rate risk". A firm may not face
foreign exchange risks unless it is “exposed” to foreign exchange fluctuations.

Foreign Exchange Exposure

It refers to the sensitivity of changes in the real domestic-currency value of
assets, liabilities, or operating incomes to unanticipated changes in exchange
rates. The “real” domestic currency value means the value that has been
adjusted by the nation’s inflation.
 Why manage foreign exchange risk?

• Fluctuations in the currency market have an impact on outgoing

import payments and incoming export funds

• Exposure to foreign exchange risk depends on factors such as

currency volatility and contract value

• By managing the risk one may maximise profits or minimize the

risk
 IMPACT OF FOREX ON
INTERNATIONAL BUSINESS
• One of the key risks (or opportunities, depending on how effectively it is managed)
is the exposure to foreign currency fluctuations.
• Involve a foreign currency from the point of view of at least one, and possibly all,
of the parties to a trade deal.
• Most of the deals denominated in US Dollars.
• Example: A trade deal in which a French exporter agrees to ship to a Canadian
importer against a US-Dollar Documentary Letter of Credit.
- FX risk or opportunity for either or both parties,
- Depends upon the fluctuation of the value of the US Dollar (USD)

relative to the Euro (EUR) and the Canadian Dollar (CAD).

 Impact on economy
- Play a key role in the market economy

- Exchange rate distortions damage the

economic structure, while excessive exchange
rate fluctuations may trigger financial turmoil.

- The relationship between the exchange rate and

monetary policy is currently at its closest.
 BASIC CONCEPTS
• International Monetary System
Set of policies, institutions, practices, regulations and mechanisms that
determine foreign exchange rates.

• Foreign exchange
Money of a foreign country such as foreign currency bank balances,
banknotes, cheques and drafts

• Fixed or managed exchange rate system

If the govt. of a country regulates the rate at which the local currency is
exchanged for other currencies
• Pegged exchange rate system
When a country’s currency is tied or fixed to another country’s currency.

• Par value
The rate at which the currency is fixed.

• Floating or flexible exchange rate system

The govt. does not interfere in the valuation of its currency

• Real exchange rate

The exchange rate after deducting an inflation factor.

• Nominal exchange rate

The exchange rate before deducting an inflation factor.

• Devaluation of a currency
Drop in the foreign exchange value of a currency that is pegged to another .
It is associated with fixed or managed exchange rate system.