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A C Reddi P Yesuthasen
in pursuit of
THE DERIVATIVES GROUP
FINANCIAL ENGINEERING and RISK MANAGEMENT
no part of this publication may be reproduced or distributed in any form or any means. For more information. Except as permitted under Copyright Act. T. 26/1 First Floor. Chennai 600 017 India.in TDG books are available at volume discount for business schools. training institutes and corporate training programs.© A C Reddi 2009. West Mambalam. without the prior written permission of the copyright holder and the publisher. 1957 (as last amended by Act No. Website: www. write to the publisher or email at: contact@tdg. 23/24 Giri Street. All rights reserved. 49 of 1999).tdg. Published by The Derivatives Group. Mangesh Street. Printed in India. Nagar. ISBN-13: 978-81-908834-0-5 ii .in Printed by Pranam Printers & Designers. Chennai 600 033 India.
1 Forex Settlement Risk 3.4 Hierarchy in the Currency Pair 2.5 N Currencies and N1 Currency Pairs 2.2 First Floating-rate Regime 1.4 Mismatch 4.CONTENTS Chapter 1 Forex is International Payments 1.9 Two-way Quote 2.6 Deal Blotter.8 Quotation Styles 2.7 Limits on Position.3 Arithmetic with Two-way Quotes 1 2 4 4 4 5 6 6 7 9 12 13 14 14 15 17 18 18 20 20 22 24 27 28 30 35 41 41 42 45 46 46 49 51 51 55 56 58 58 Chapter 2 Chapter 3 Chapter 4 Chapter 5 iii .3 Gold Exchange Standard 1.1 Currency Pair 2.6 Numeraire Currency 2.2 Forex swap 4.1 Chain Rule 5.3 Exposure 4.10 Abbreviated Offer Quote FX Settlements: Value Dates 3.2 Value Dates Exceptions to Spot Value Date Rule 3.2 Base Currency and Quoting Currency 2.3 Forex Deals: Classification and Risk 4. Position and Gap Statements 4.8 Cross Rate Arithmetic 5.7 Cross Rates 2.4 Controlled Float 1.10 Which Regime is the Best? Forex Basics: the Literacy 2.1 Gold Standard 1.5 Bretton Woods System 1. Gap and Others Forex Swap versus Currency Swap 4.8 Gold and Monetary System 1.3 ISO/SWIFT Codes 2.9 Balance of Payment and Convertibility 1.1 Outright 4.5 Cash Flow Analysis 4.6 Smithsonian Agreement 1.7 Second Floating-rate Regime 1.2 Trader’s Quicker Method 5.
4 Accounting 10.6 Import Bill Transactions 8.4 Clean Instruments/Remittances 8.2 Wash Rates Chapter 7 Chapter 8 Chapter 9 Chapter 10 iv .4 Fixing the Price for Near and Far Legs 7.9 Long-term Forward Exchange Prices 6.5 Export Bill Transactions 8.11 Early and Late Payments of Purchases Trade Life Cycle and Best Practices 9.8 Forward Contracts: Early and Late Delivery 8.12 Non-deliverable Forward (NDF) Forex Swaps 7.2 Process Flow 9.5 Cash Management with Forex Swap Commercial Transactions 8.11 Forward Exchange: Theory versus Practice 6.1 Forex Swap: Recap 7.1 Forward Exchange Arithmetic 6.5 5.2 Swap Points and Forex Swaps 7.2 Classification of Commercial Transactions 8.1 Organization 9.6 Chapter 6 Check on Calculations Mnemonic Aid for Two-way Arithmetic Triangular Arbitrage 60 60 62 67 68 71 73 77 78 79 81 82 83 84 88 90 95 95 96 97 99 103 107 108 108 109 110 112 113 115 117 121 123 126 131 132 133 138 147 155 156 160 Forward Exchange 6.9 Forward Contracts: Cancellation 8.3 Best Practices FX Prime Brokerage 9.5.8 Swap Points for Fwd-to-Fwd and Turn Periods 6.6 Forex Prices for Short Dates 6.10 Forward Contracts: Extension/Rollover 8.7 Swap Points for Broken Dates 6.1 General Flow for Transactions 10.2 Swap Points: Premium.5 Market Conventions on Forward Exchange 6. Par 6.4 5.4 Nature of Swap Points 6. Discount.1 Features of Commercial Transactions 8.3 Arithmetic with Two-way Quotes 6.10 Forward Exchange for Cross Rates 6.3 Market Price and Margin 8.7 Forward Contracts: Optional Delivery Periods 8.3 Anatomy of Two-way Swap Quote 7.
4 Risk Management 11.1 FX-speak 12.10.6 Hedging Operations Countries.4 Trending 12.6 Operations Milestones Front Office: Trading and Hedging 12.3 10.2 Market Practices in Interdealer Market 12. Currencies and ISO Codes Forex Market: Profile Index Chapter 12 Annex I Annex II v .3 Operations 11.5 Trading Operations 12.3 Sample Deal Conversations 12.2 Evolution of Continuous Linked Settlement 11.4 Chapter 11 Position Reconciliation Mark-to-Market/Revaluation 161 162 169 170 171 173 178 179 181 183 183 185 188 191 192 204 207 213 216 Continuous Linked Settlement 11.1 Settlement Risk in FX 11.5 Liquidity Facilities 11.
Mr A C Reddi was himself a forex trader with a leading bank. His rich domain knowledge is exhibited in depth with which each subject is dealt with and at the same time he has ensured that the reader gets a comprehensive view of the subject in as simple a language as possible. Practices peculiar to the Indian forex market are covered. This book is a must for all practitioners as a reference book to be kept part of the library. Mr P Yesuthasen has for many years been associated with the Financial Markets Division of the Reserve Bank of India at a time when new products were introduced in the Indian market. I am sure this book will go a long way in providing domain and practical knowledge to all those associated with foreign exchange business. C. R. All the concepts have been illustrated with practical examples that would aid students and officials to understand the way foreign exchange operations are conducted in the market and inside a dealing bank. derivatives and risk management practices in commercial banks. State Bank of India. Both the authors have been actively involved in providing consultancy services to banks and corporate treasuries where their services are eagerly sought after. and Chief Executive Officer.FOREWORD The authors have taken great pains to bring out in a lucid and clear manner the practical aspects of foreign exchange operations. ROYAPPA Formerly General Manager (Foreign Dept). too. SBI Gilts Ltd . he was actively associated with the supervision of forex operations. As a regulator.
Chapter 8 applies the concepts and arithmetic of the previous six chapters to real-life transactions with plenty of examples and illustrations. Chapter 12 concludes the book with a detailed discussion of forex trader’s language. Together. It is true that there are many textbooks on foreign exchange but they deal with the theory of foreign exchange and multinational finance. The next three chapters deal with the arithmetic: they constitute the “numeracy” of the forex. and practices. Chapter 11 deals with the innovative forex settlement called “continuous linked settlement”. is a modest endeavor to fill this gap. To our knowledge. Chapters 2 through 4 deal with the basic concepts and constitute the “literacy” of the forex. We have spared a whole chapter to discuss in detail the concept.PREFACE From the practitioner’s perspective. Readers can safely skip this chapter: after all. “The art of reading is to skip judiciously” (Philip G Hamerton). all others deal with the practice of forex. . Ours. these six chapters equip the reader to price and hedge any type of transaction from the customer or dealer. customs. no textbook on foreign exchange has discussed it in detail. It also discusses the general principles of speculation and hedging in forex market. the forex market has fewer books than the bond and equity markets. Chapter 9 deals with the trade life cycle. Except the first chapter. including the early and late payments and receipts from the customers and the financing component in forex transactions. industry best practices and the recently emerged business of FX prime brokerage. in 200 pages. process and the critical operational timeline in this innovative settlement. They do not fulfill the requirements of business and operations of a forex dealer. The first chapter chronicles in a dozen pages the history of exchange rates regimes over the last 150 years. Chapter 10 explains the accounting of various forex transactions and accounting problems in revaluation. which is the world’s only cross-border multi-currency settlement system on payment-versus-payment basis with settlement finality characteristic of central bank payment systems.
Acknowledgements We have greatly benefited from discussions with our colleagues and friends in the forex market. we have chosen not to list them here and offer them our silent thanks.com) x . which we sincerely ask you to email to us. updated as of March 2009. their currencies and their ISO codes. bank and corporate treasuries and regulatory bodies. we are sure that the next edition will greatly improve due to readers’ feedback on omissions and commissions.Annex I lists the countries. To manage that risk. Being first-time authors.in) P Yesuthasen (yesuthasen@gmail. Annex II summarizes the profile of global forex market from the latest Triennial Central Bank Survey 2007. They are so many that it is quite possible that our list might miss a name or two. A C Reddi (acreddi@tdg.
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