Unit-2

International foreign exchange market-1

Introduction to International forex mkt
• The foreign exchange (also known as FX or forex) market is a global
marketplace for exchanging national currencies against one another.
• Because of the worldwide reach of trade, commerce, and finance, forex
markets tend to be the largest and most liquid asset markets in the world.
• Currencies trade against each other as exchange rate pairs. For example,
EUR/USD.
• Forex markets exist as spot (cash) markets as well as derivatives markets
offering forwards, futures, options, and currency swaps.
• Market participants use forex to hedge against international currency and
interest rate risk, to speculate on geopolitical events, and to diversify
portfolios, among several other reasons.
Functions of International forex Market
• 1. Transfer Function:
• The basic function of the foreign exchange market is to facilitate the
conversion of one currency into another, i.e., to accomplish transfers
of purchasing power between two countries. This transfer of
purchasing power is effected through a variety of credit instruments,
such as telegraphic transfers, bank draft and foreign bills.
• In performing the transfer function, the foreign exchange market
carries out payments internationally by clearing debts in both
directions simultaneously, analogous to domestic clearings.
Continue….
• 2. Credit Function:
• Another function of the foreign exchange market is to provide credit,
both national and international, to promote foreign trade. Obviously,
when foreign bills of exchange are used in international payments, a
credit for about 3 months, till their maturity, is required.
Continue….
• 3. Hedging Function:
• A third function of the foreign exchange market is to hedge foreign
exchange risks. Hedging means the avoidance of a foreign exchange risk. In
a free exchange market when exchange rate, i. e., the price of one currency
in terms of another currency, change, there may be a gain or loss to the
party concerned. Under this condition, a person or a firm undertakes a
great exchange risk if there are huge amounts of net claims or net liabilities
which are to be met in foreign money.
• Exchange risk as such should be avoided or reduced. For this the exchange
market provides facilities for hedging anticipated or actual claims or
liabilities through forward contracts in exchange. A forward contract which
is normally for three months is a contract to buy or sell foreign exchange
against another currency at some fixed date in the future at a price agreed
upon now.
History of FX market
Continue….
The Bretton Woods Agreement and System
Explained
• Approximately 730 delegates representing 44 countries met in
Bretton Woods in July 1944 with the principal goals of creating an
efficient foreign exchange system, preventing competitive
devaluations of currencies, and promoting international economic
growth. The Bretton Woods Agreement and System were central to
these goals. The Bretton Woods Agreement also created two
important organizations—the International Monetary Fund (IMF) and
the World Bank. While the Bretton Woods System was dissolved in
the 1970s, both the IMF and World Bank have remained strong pillars
for the exchange of international currencies
Smithsonian Agreement
• The Smithsonian Agreement was a temporary agreement negotiated
in 1971 among the ten leading developed nations in the world,
namely Belgium, Canada, France, Germany, Italy, Japan, the
Netherlands, Sweden, the United Kingdom, and the United States.
The deal made adjustments to the system of fixed exchange rates
established under the Bretton Woods Agreement and effectively
created a new standard for the dollar, as the other industrialized
nations pegged their currencies to the U.S. dollar.
European monetary system
• The European Monetary System (EMS) was an arrangement between
European countries to link their currencies.
• The goal was to stabilize inflation and stop large exchange rate
fluctuations between these neighboring nations, making it easy for
them to trade goods with each other.
• The European Monetary System (EMS) was succeeded by the
European Economic and Monetary Union (EMU), which established a
common currency called the euro.
Major Currencies
Most traded currencies
Rank Currency (Nicknames) Code (Symbol) % daily turnover % daily turnover
(April 2019) (April 2019)
1 United States dollar USD ($) 84.9% 87.6%
(Greenback)
2 Euro (Single) EUR (€) 39.1% 31.4%
3 Japanese Yen (Jappy) JPY (¥) 19.0% 21.6%
4 Pound Sterling (Cable) GBP (£) 12.9% 12.8%
5 Australian Dollar (Aussie) AUD ($) 7.4% 6.9%
6 Swiss Franc (Swissy) CHF (Fr) 6.4% 4.8%
7 Canadian Dollar (Loonie) CAD ($) 5.3% 5.1%
8 Hong Kong Dollar HKD ($) 2.4% 1.7%
15 Indian Rupee INR (`) 0.9% 1.1%
Other 21.7% 27.0%
Total % (100% for buyer and 100% for 200%
seller)
Market Participants

Corporat Bank
es s

Financial Central
Intermediar Banks
y

Hedg Speculato
e rs
Fund
s
Features of Forex Market
• 24-hour trading, 5 days a week with continuous access to global
dealers.
• Increase in international trade.
• An enormous liquid market making it easy to exchange most
currencies.
• Volatile markets offering profit opportunities for speculators
and opportunities for hedgers.
• Recognized instruments (Forwards, Futures, Options and Interest
Rate
Derivatives) for controlling risk exposure.
• The ability to make profit in rising or falling markets.
• Bigger role forBRIC economies and the other emerging markets in
the global trade.
INDIAN FOREX
MARKET
 Indian FX Market
• Market participants
RBI Authorized dealers
Corporates
Brokers
Banks
Foreign Institutional Investors
• Liquidity
Enough two way liquidity for spot transactions upto USD 50 Mio (1 deal)
Average deal size USD 1 Mio.
Swap liquidity declines beyond 6 months
Forward prices actively traded till 1 year
Many banks offer USD hedge for corporate for up to even 7 years
• Market timings
9 a.m. to 5 p.m. (Monday to Friday) for INR transactions.
Offshore Market
Non Deliverable Forwards (NDF) markets are very active and useful in
regards with INR.
USD/INR (1999 to 2020)
Reserve Bank of India
The Reserve Bank is the umbrella network for numerous activities, all related to the nation’s
financial sector, encompassing and extending beyond the functions of a typical central
bank.

Monetary Authority - Formulates, implements and monitors the monetary policy,

announced twice a year.
 Issuer of Currency - Maintaining an adequate supply of currency
 Banker and Debt Manager to Government
 Banker to Banks - Providing liquidity in the markets
 Regulator of the Banking System - Ensuring bank penetration and safety of depositors’
funds
 Manager of Foreign Exchange - Ensuring stability of interest and exchange rates
 Regulator and Supervisor of the Payment and Settlement Systems
 Developmental Role - Development of financial institutions and markets.

RBI intervention in currency markets is solely to deliver low volatility in the exchange
rates, and
not to take a view on the rate or direction of the Indian rupee in relation to other
currencies

The Reserve Bank’s Department of External Investments and Operations (DEIO) invests the
country’s foreign exchange reserves built up by purchase of foreign currency from the market. In
investing its foreign assets, the Reserve Bank is guided by three principles: safety,
Essence of FX market FOREX
MARKET
• The base of international trade
Without the forex market, the exporter won’t be able to trade their goods
and currencies as when a product is exported then the payments from the
importing country are done in their national currency and obviously, that currency
can’t be used by the exporters. Also, it is not possible for the importers to pay in
the currency of foreign countries as all they have is their national currency. These
necessities are fulfilled through the forex market which converts the currencies at a
global rate and conversion value. It not only helps the traders in their global
business efficiently and also common people can send money to their family
members and friends who are living in a foreign country.
Continue….
• Hedging Function –
This is one of the most important functions of the foreign exchange market
for the businessmen and investors who deal on a global level. Many times, when
the payments are made by the services or goods receiver, it might not be the same
when it reaches to the goods or service provider because of the continuous
changes in the values of the currencies and it can also cause loss to any of the
parties. So, in order to eliminate these losses, people use the function of hedging
which is a risk management strategy. It offsets the probability of fluctuations which
might cause losses in the investments, payments, receipts, and other transactions.
Continue….
• Controls inflation –
The management of a foreign exchange market is regulated by
the central bank of that country. For this, central banks have to hold
large reserves to balance the net amount that occurs in the foreign
receipts and payments which eventually help in balancing a healthy
economy of any country.
Forex Arithmetic

 Type of quotes (Tom, Spot,

Forward)
 Spot Rate
 Two way Quote
 Bid-Ask
 Spread
 Currency Pairs
 Quote Style
 Spot Rate Calculations
 Instruments in FX Market
 Forward Contracts
 Interest Rate Parity
 Calculation of Annualized
Premium
 Types of Quotes
• Inter-bank rates are always quoted on spot
basis

•Spot rate is adjusted for value cash and tom

transactions as per prevailing call money rates
(cost of holding USD)
Trade Date Spot
Forward/Futures

Cash Tom

•USD/INR futures are quoted for month end

largely linked to month end premium rates
Spot Rate
Rate of exchange for immediate settlement
It is settled on the “Second” working day
Saturday and Sunday are holidays
Eg: SPOT rate: $ 64.35-64.36 supposing you have
1,00,000 dollar received on Thursday the bank
will settle 1,00,000*64.35 = 64,35,000 on the

following Monday.
Two way quote
BID QUOTE and ASK QUOTE
Ex: $ - 64.00/64.10

64.00 - bid(buying) - (Bank point of view)

64.10 - ask(selling) - (Bank point of view)
If you want to sell $, you will get 64.00
If you want to buy $ you will get 64.10.
Bid and Ask
The bank’s quote of Bid and Ask is from the banker’s
perspective.
Bid = Buy
Ask = Sell

Eg. USD/INR = 64.50-64.55

If the Bid rate for USD is 64.50 it means that the bank is
ready to buy 1$ for 64.50
If the ask rate is for USD is 64.55, it means that the bank is
(asking if someone will buy) selling 1$ for 64.55.
Spread
ASK MINUS BID = SPREAD
Eg. 64-65

SPREAD = 64 - 65 = 1
Factors: a) Stability of the exchange rate
b) Depth of the market - Volume of
transaction
High volume (deep market) - narrow spread
Low volume (thin market) - wider spread
Currency Pairs
Base currency
The first currency quoted in a currency pair on forex. It is
sometimes referred to as the "primary currency".

Quoted currency
It's the second currency quoted in a currency pair. It is
sometimes referred to as the "secondary currency" or
"counter currency".
USD /
Eg. INR
Base Currency
Quoted Currency
1 USD = 64.00 INR
Quote Style
Exchange rate quotes, as the price of one currency in
terms of another, come in two forms:

A “direct” quotation is the amount of domestic currency

(if you are in India or Japan) per unit of foreign
currency and

An “indirect” quotation is the amount of foreign currency

per unit of domestic currency (if you are in Europe or
London).
Spot Rate Calculation
USD/INR 64.30 64.35
EUR/USD 1.2500 1.2510
USD/JPY 105.00 105.20

• Bank’s spot buying rate ( euro exports)

USD = INR 64.30
1
EUR = INR
1 (64.30)*EUR(1.2500)
• Bank’s=spot
INR 80.38
selling rate ( JPYimports)
USD 1 = INR 64.350
JPY = INR (64.35) /
100 JPY(105.20)
= INR 61.17
Problem
An Indian would like to have Travelers Cheques :
GBP - STERLING 90.70-91.25
Explain the quote
Compute the spread
How much would you pay for purchasing 250 pounds?
If you have a balance of pounds 23 in Travelers Cheques ,
how many rupees would you receive if the bank in India
quotes 89.65-91.92?
 Answer
Bank buys at 90.70 and Ask rate is 91.25
Spread = 0.55

250*91.25 = 22812.50( Purchase- Ask price)

23*89.65 = 2061.95 (Sale- Bid price)

Note: In practice all forex transactions are rounded off

to a rupee i.e. 2062
Thank you