Foreign Exchange

What is ForEx ?
Definition-
• Foreign exchange is the mechanism by which
the currency of one country gets converted into
the currency of another country.

• Foreign Exchange is a methods and

instruments used to adjust the payment of debts
between two nations that employ different
currency systems. A nation’s balance of payments
has an important effect on the exchange rate of its
currency.
 administration of foreign
exchange
FOREIGN EXCHANGE MANAGEMENT ACT

CENTRAL GOVERNMENT

RESERVE BANK OF INDIA

FEDAI
AUTHORISED PEARSONS

AUTHORISED MONEY CHANGER AUTHORISED DEALERS

FULL FLEDGED RESTRICTED

 DETERMINTION OF
FOREIGN EXCHANGE RATE

• BALANCE OF PAYMENT
• INFLATION
• MONEY SUPPLY
• INTEREST RATE
• NATIONAL INCOME
• RESOURCE DISCOVERIES
• POLITICAL FACTORS
 Foreign Currency Accounts

FOREIGN
CURRENCY
ACCOUNT

NOSTRO VOSTRO LORO

ACCOUNT ACCOUNT ACCOUNT
 ForEx A/c’s Continued
• NOSTRO ACCOUNT :
OUR ACCOUNT WITH YOU.

• VOSTRO ACCOUNT :
YOUR ACCOUNT WITH US.

• LORO ACCOUNT :
THEIR ACCOUNT WITH YOU.
 ForEx Transactions
FOREX
TRANSACTION

PURCHASE SALE

BANK BANK

PART WITH
ACQUIRE FOREIGN PART WITH HOME ACQUIRE HOME FOREIGN
CURRENCY CURRENCY CURRENCY
CURRENCY
Foreign Exchange Market
 Foreign Exchange Market
Features-
•Market where foreign currencies are traded
•Round the clock market
•Global market
•Large volume of transactions
 Participants
•Individuals: tourists, migrants
•Firms: importers and exporters
•Banks: short position, long position, square
position
•Governments/ monetary authorities: market
intervention
• International agencies: lending
Two tier market:
First tier: ultimate customer and banker
Second tier: between banks
KINDS OF FOREIGN EXCHANGE
MARKETS
From the point of view of foreign exchange
Market Transactions there are following types
of Markets-
•Spot market
•Forward market
•Derivatives markets: currency futures and
options
 SPOT MARKETS
•Currencies traded for immediate delivery at
rates prevailing at the time of transaction
•Actual delivery (electronic transfer) may take
two working days
•Currency arbitrage: buying a currency at
cheaper rate in one market and selling at a
higher rate in another market
-Two point arbitrage
-Triangular (three point) arbitrage – three
currencies
•Currency speculation: buying and holding a
currency for sale at a higher rate in the near
future
FORWARD MARKETS

•Contract for future delivery

•Hedging:
-Currencies are bought or sold for forward
delivery
-Reduces foreign exchange risk
•Speculation:
-Reap profit from changes in exchange rates
in future (difference between forward rates
and future spot rates)
•Arbitrage:
-Reaping profit from disparity between
forward differential and interest rate
differential
FUTURES MARKETS
•It is a derivatives market
•Currency futures market is of recent origin (1972)
•Currencies can be bought and sold in the futures
market
•Size and maturity of contracts are standardised
•Transactions made with the help of brokers through
the clearing house
•Margin deposit and daily marking to the market
•Hedging: to reduce risk
•Futures may not provide a perfect hedge ( mismatch
in size and maturity)
•Speculation: to reap short term profit
 Foreign Currency Exchange
Risk Management
There are several types of forex risks-

•Exchange rate risk

•Interest rate risk

•Credit risk
-Replacement risk
-Settlement risk

•Country Risk
Thank you