FOREIGN EXCHANGE
Hedging to avoid loss
Foreign Exchange Market - is a place where
foreign money are bought and sold. It is a
institutional arrangement for buying and selling of
foreign currencies. Exporter sell the Foreign
currencies and importers buy them.
Exporter is the current currency of the US while the Importer is the local
money exchange.
CHARACTERISTICS OF FOREIGN EXCHANGE
1. Electronic Market - through the use of
gadgets and smartphones any means that
would exchange in currency.
2. Geographical Dispersal - separated or
dispersed (kalat).
3. Transfer of purchasing power - the ability of
the currency to purchase.
4. Intermediary - mode of how they are going to
conduct the business or a market. Banks,
Money changer, Central Bank, Financial
Institutions
5. Provision of credit through letter of credit
- given a credit lines for those in the business
6. Minimization of risk - lessen the exposure to
possible increase in currency.
FUNCTIONS OF FOREIGN EXCHANGE
1. Transfer function
2. Credit function
3. Hedging function
STRUCTURE OF FOREIGN EXCHANGE MARKET
R t il Wh l
MAJOR Bank
PARTICIPANTS
and
1. Retail clients
2. Commercial banks
3. Foreign exchange brokers
4. Central banks
FOREIGN EXCHANGE TRANSACTION
● It is an agreement between two parties to
exchange one currency for another at an
agreed exchange rate on an agreed date. It
also provides protection against unfavourable
exchange rates.
NATURE OF FOREIGN
TRANSACTION
1.
2. Arbitrage to purchase currency of two or more
countries
3. Speculation price less purchase high sell
TYPES OF TRANSACTION
1. Spot Transaction - the spot transaction is
when the buyer and seller of different
currencies settle their payments within the
two days of the deal. It is the fastest way to
exchange the currencies. Here, the
currencies are exchanged over a two day
period, which means no contract is signed
between the countries. The exchange rate at
which the currencies are exchanged is called
the Spot Exchange Rate. This rate is often
the prevailing exchange rate. The market in
which the spot sale and purchase of
currencies is facilitated is called as a Spot
Market.
2. Forward Transaction - a forward transaction
is a future transaction where the buyer and
seller enter into an agreement of sale and
purchase of currency after 90 days of the
deal at a fixed exchange rate on a definite
date in the future. The rate at which the
currency is exchanged is called a Forward
Exchange Rate. The market in which the
deals for the sale and purchase of currency at
some future date is made is called a Forward
Market
3. Future Transaction - the future transactions
are also the forward transactions and deals
with the contracts in the same manner as that
of normal forward transactions. But however,
the transactions made in a future contract
differs from the transaction made in the
forward contract on the following grounds:
● The forward contracts can be
Interbank customized on the client’s request,
(bank while the future contracts are
standardized such as the features,
date, and the size of the contracts is
standardized.
● The future contracts can only be
traded on the organized exchanges,
while the forward contracts can be
traded anywhere depending on the
client’s convenience.
● No margin is required in case of the
forward contracts, while the margins
are required of all the participants
and an initial margin is kept as
EXCHANGE collateral so as to establish the future
position.
 4. Swap Transaction - involve a simultaneous
borrowing and lending of two different
currencies between two investors. Here one
investor borrows the currency and lends
another currency to the second investor. The
obligation to repay the currencies is used as
collateral, and the amount is repaid at a
forward rate. The swap contracts allow the
investors to utilize the funds in the currency
held by him/her to pay off the obligations
denominated in a different currency without
suffering a foreign exchange risk.
5. Option Transaction - the foreign exchange
option gives an investor the right, but not
the obligation to exchange the currency in
one denomination to another at an agreed
exchange rate on a predefined date. An
option to buy the currency is called as a Call
Option, while the option to sell the currency
as a Put Option.
SETTLEMENT DATE
● Settlement Date is a securities industry term
describing the date on which a trade (bonds,
equities, foreign exchange, commodities,etc.,)
settles. That is, the actual day on which
transfer of cash or assets is completed and is
usually a few days after the trade was done.
The number of days between trade date and
settlement date depends on the security and
convention in the market it was traded. For
example when settling a share transaction on
the London Stock Exchange this is a set at
trade + 2 business days.
1. Spot transaction - here the transaction takes
place on T+2 basis i.e., in spot exchange
transaction settlement usually takes two working
days.
2. Ready or cash transaction - in these types of
transaction is settled on same day i.e., on the
trade day
3. Tomorrow transaction - in these types of
contract settlement of underlying is to be done
on the day tomorrow
4. Future or forward transaction - these contract
are settled on a specific futures date at a fixed
price.
FOREIGN EXCHANGE RATES
● An exchange rate is the rate at which one
currency will be exchanged for another. It is
also regarded as the value of one country’s
currency in relation to another currency.
● For example, an interbank exchange rate of
114 Japanese yen to the United States dollar
means that ¥114 will be exchanged for each
US$1 or that US$1 will be exchanged for
each ¥114. In this case it is said that the price
of a dollar in relation to yen is ¥114, or
equivalently that the price of a yen in relation
to dollars is $1/114.
FOREIGN EXCHANGE DETERMINATION
Demand for foreign exchange
● When Indian people and business firms want
to make payments to the US nationals for
buying US goods and services or to make
gifts to the US citizens or to buy assets there,
the demand for foreign exchange (here
dollar) is generated. In other words, Indians
demand or buy dollars by paying rupee in the
foreign market
● A country releases its foreign currency for
buying imports. Thus, what appears in the
debit side of the BOP account is the sources
of demand for foreign exchange. The larger
the volume of imports the greater is the
demand for foreign exchange.
Supply function
● We can determine supply of foreign
exchange. Supply of foreign currency comes
from its receipts for its exports. If the foreign
nationals and firms intend to purchase Indian
goods or buy Indian assets or give grants to
the Government of India, the supply of foreign
exchange is generated.
DIRECT RATES / QOUTES
● Direct Rates - a unit of foreign currency is
quoted in term of domestic currency
● Direct quote - bid rate < ask rate
1. Bid rate - it is the rate at which a
buyers is ready to buy the currency
that is constant
2. Ask rate - it is the rate at which an
seller is ready to sell the currency that
is constant
● Indirect rate - it is the price of one unit of
home currency in terms of foreign currency
● A lower exchange rate implies that the
domestic currency is depreciating or
becoming weaker, since it is worth a smaller
amount of foreign currency.
● Example, if the Canadian dollar (direct)
quotation now changes to US$1 = C$1.2700,
the indirect quote would be C$1 =
US$0.07874 = 78.74 US cents
1. Spot Rate - a foreign exchange spot
transaction, also known as FX spot, is an
 agreement between two parties to buy one
currency against selling another currency at
an agreed price for settlement on the spot
date. The exchange rate at which the
transaction is done is called the spot
exchange rate.
2. Forward rates - the forward exchange rate
(also referred to as forward rate or forward
price) is the exchange rate at which a bank
agrees to exchange one currency for another
at a future date when it enters into a forward
contract with an investor.
3. Cross currency rates - a cross rate is the
currency exchange rate between two
currencies when neither are official currencies
of the country in which the exchange rate
quote is given. Foreign exchange traders use
the term to refer to currency quotes that do
not involve the US dollar, regardless of what
country the quote is provided in.

FACTORS INFLUENCING THE FOREIGN

EXCHANGE RATES
● Relative inflation rate
● Income levels
● Relative quality
● Relative interest rate
● International trade
● Capital movements
● Change in prices
● Speculation
● Strength of the economy
● Stock exchange operations
● Political factors