FOREIGN

EXCHANGE
MANAGEMENT
FOREIGN EXCHANGE
&
ESSENTIAL FINANCIAL
ARITHMATIC
MODULE:1
I. Foreign exchange management begins with trading currencies to exchange
goods and services overseas.
II. It is associated with currency transactions designed to meet and receive
overseas payments.
III. It requires to understand the relevant factors that influence currency values.
Significance of Foreign Exchange Management
1. For better Planning of Forex
2. For Creating Forex Reserve
3. For Controlling the Risk of Forex
 Forex Forward & Future Contracts
 Options
 Forex Swap
4. For Maximizing the Consolidated Earning of International Business
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INTERNATIONAL/FOREIGN TRADE refers to trade between the residents of two
different countries (Sovereign State).
I. Different countries have different monetary units
II. Restrictions imposed by countries on import and export of goods
III. Restrictions imposed by nations on payments from and into their countries
IV. Differences in legal practices in different countries
FOREIGN EXCHANGE
1) Existence of National Monetary Units
2) Resident would like to get payment/pay bill in the currency of his own country.
3) Need arises for the conversion of the currency while transacting with other country.
4) Foreign Exchange is the mechanism by which the currency of one country gets
converted into the currency of another country.
5) The conversion of currencies is done by banks who deal in foreign exchange.
EXCHANGE RATE
The rate at which one currency is converted into another currency is the rate of exchange
between the currencies concerned. DO NOT SHARE THE SLIDES WITH ANYBODY OUTSIDE THE CAMPUS
Foreign Exchange is the conversion of one country's currency into another. In a
free economy, a country's currency is valued according to the laws of supply and
demand which keeps them in continuous fluctuation.
Foreign Exchange as Stock
As per the Foreign Exchange Management Act 1999,Foreign Exchange as stock
means foreign currency and includes
I. Deposits ,Credits, and balances payable in any foreign currency.
II. Drafts, Travelers Cheques, Letters of Credits or Bills of Exchange, expressed
or drawn in Indian Currency but payable in any foreign currency.
III. Drafts, Travelers Cheques, Letter of Credit or Bills of exchange drawn by
banks , institutions or persons outside India but payable in Indian Currency.
Thus foreign exchange includes foreign currency, balances kept abroad,
instruments payable in foreign currency and instrument drawn abroad but payable
in Indian Currency.
DO NOT SHARE THE SLIDES WITH ANYBODY OUTSIDE THE CAMPUS
Present value: Formula DO NOT SHARE THE SLIDES WITH ANYBODY OUTSIDE THE CAMPUS
Yield on an investment or the cost of a borrowing DO NOT SHARE THE SLIDES WITH ANYBODY OUTSIDE THE CAMPUS
Compounding two or more interest rates together (a strip)
Suppose that I borrow EUR 1
million for 73 days at 4.7%. At
maturity,I borrow the whole
amount again principal and the
interest for another 124 days at
4.9%. What is my simple interest
rate over the combined period of
197 days?

DO NOT SHARE THE SLIDES WITH ANYBODY OUTSIDE THE CAMPUS

 DO NOT SHARE THE SLIDES WITH ANYBODY OUTSIDE THE CAMPUS
In the money market and foreign exchange market, prices are generally quoted for
standard periods such as 1 month, 2 months etc. If a dealer needs to quote a price for an
odd date (or broken date) between these periods, he needs to interpolate. Formula as under

Suppose, for example, that the 1-month rate (30 days) is 8.0% and that the 2-month rate
(61 days) is 8.5%. The rate for 39 days assumes that interest rates increase steadily (i.e. in
a straight line) from the 1- month rate to the 2-month rate. The increase from 30 days to
39 days will therefore be a 9/31 proportion of the increase from 30 days to
61 days. The 39-day rate is therefore:
 DO NOT SHARE THE SLIDES WITH ANYBODY OUTSIDE THE CAMPUS
 A dealer lends GBP 1 million to a customer at 5.3% for 182 days and if the customer
agrees to pay the same interest rate but to pay the interest in two instalments i.e. after
91 days and 182 days, the dealer will be better off.
 Because, when he receives the first interest instalment after 91 days, he can reinvest it
until the end of 182 days. This will earn him extra money, as interest on interest.
 If we assume that the rate is still 5.3%, the total proceeds achieved by the end of 182
days will be GBP 1,026,602.00 as under:
 After 91 days, receive first interest:GBP 1,000,000 × 0.053 × 91/365= GBP 13,213.70
 Reinvest at 5.3% for 91 days, to earn:GBP 13,213.70 × 0.053 × 91/365= GBP
174.60At the end of 182 days, total proceeds :GBP 13,213.70 + GBP 174.60 + GBP
1,013,213.70= GBP 1,026,602.00.
The total interest which the dealer has
achieved is therefore GBP 26,602.00, on a
principal of GBP 1 million. The dealer would
have achieved if he had quoted a rate of
5.335% with all the interest paid at the end,
can be calculated with the formula
 DO NOT SHARE THE SLIDES WITH ANYBODY OUTSIDE THE CAMPUS
The equivalent yield with interest paid only once per year is known as the annual
equivalent rate, or the effective rate.
Formula used:

A dealer is trying to compare two different US dollar investments. The first is for
153 days at a yield of 9.1% and the second is for 87 days at a yield of 9.05%.
Assuming that there are no other significant differences between the two
investments, which is better?
First Investment

Second Investment

The first has an effective rate of 9.475% and the second 9.501%, so on this basis,
the shorter investment has a lower nominal rate but a higher effective rate:
GOOD
WISHES
TO
ALL