BBA F&A Year) (3 rd

International Financial Management

COC642B – SEMESTER 6

International Financial Management COC642B – BBA F&A Jan to May 2023

Unit 3

➢ FOREX market - Introduction

➢ Structure of Forex Market

➢ Types of transaction and settlements

International Financial Management COC642B – BBA F&A Jan to May 2023

FOREX Market Introduction
Is a market in which currencies are bought and sold against each other.

➢ Retail Market – Example travellers, tourist

➢ Wholesale or Inter-bank market – Banks, Corporation, central banks etc.

➢ The Spread between buy and sell in retail market will be high
➢ The spread between buy and sell in wholesale market will be less

➢ Retail transactions done by authorised dealers

➢ Whole transaction done through OTC (Over The Counter)

International Financial Management COC642B – BBA F&A Jan to May 2023

Structure of FOREX market
Primary price / market makers or professional dealers or primary
dealers:
➢ Who make two way market.
➢ They will quote two way price (Price to buy and a price to sell)
➢ This include big commercial banks, large investment dealers and few
large corporation
➢ Primarily they play an important role in taking position off the hands
of another dealer or corporate customer, by offsetting the deal with
other customer

International Financial Management COC642B – BBA F&A Jan to May 2023

Structure of FOREX market
Example – Primary Price maker (A) sells USD against INR to one
corporate customer, to carry the position for a while and offset it by
buying USD against INR, During this period if the price has moved
against the dealer, he bears the loss.

Buy INR -----------> Sell USD (1 USD = 65.85 INR) – 1st January 2023
5th January 2023 1 USD = 66.05 INR).
When he acquires the USD he has to bear the loss of INR 200,000 for a
USD 1 Million transaction.

International Financial Management COC642B – BBA F&A Jan to May 2023

Structure of FOREX market
➢ The difference between buy and sell price is called as bid-offer spread
➢ This provides the cushion against such losses.
➢ High volatility the spread is more.
➢ The spread also recovers the cost of the dealing function and makes
profit
➢ There are three tier layers of primary dealers [top tier (Very large banks
and large no of CCY) / second tier(Large bank with limited no of CCY)
and last tier (Small banks)]
➢ SBI / HDFC / ICICI makes the market say around nine to ten currencies
other are less
International Financial Management COC642B – BBA F&A Jan to May 2023
Structure of FOREX market
Secondary price makers

➢ Retail market where entities quote for forex

➢ They do not make two way quote
➢ e.g. Restaurants, hotels, shops etc.
➢ The bid ask price will be high by these makers

International Financial Management COC642B – BBA F&A Jan to May 2023

Structure of FOREX market
Foreign currency brokers
➢ Act as middleman between two market makers
➢ Provide information to market making banks about price
which there are firms who are willing to buy or sell
➢ They collect commission for the service
➢ Until the deal is struck they keep both the side’s identity
anonymous
➢ Electronic brokerage has replaced this traditional brokers
International Financial Management COC642B – BBA F&A Jan to May 2023
Structure of FOREX market
Price takers
➢ Entities that agree or take the price as it is quoted by
primary makers.
➢ These are corporations who use the currencies for
operational purpose such as import export, hedging etc.
➢ Most of these corporations do not take any positions and
hence transfer the risk to primary makers who have the
expertise to manage such risks.
International Financial Management COC642B – BBA F&A Jan to May 2023
Structure of FOREX market
Central Bank
➢ Managing authority
➢ They intervene time to time and stabilise the rate.

Speculators
➢ When the primary makers do not cover their positions and
leave to the market movement.

International Financial Management COC642B – BBA F&A Jan to May 2023

Types of transactions and settlement
➢ Transaction date – The day on which the transaction takes
place
➢ Settlement date or value date – The day on which the
actual movement of cash happens
➢ Settlement location – the location of the currencies
countries
➢ Dealing location – the location of the countries who are
party to the transaction
International Financial Management COC642B – BBA F&A Jan to May 2023
Value / settlement date for spot transaction
➢ For European and Asian currencies traded against dollar is
T +2 (Transaction + 2 business days)
➢ The time gap is required to clear and deal through
communication network such as Society for worldwide
inter-bank financial telecommunication (SWIFT)
➢ For USD to Canadian dollar or Mexican peso T + 1
(Transaction + 1 business days)

International Financial Management COC642B – BBA F&A Jan to May 2023

Value / settlement date for spot transaction
Example:
➢ E.g 1 London bank sells Yen against dollar to Paris bank on Wednesday –
Settlement date is ______
➢ E.g 2 SBI India sells USD to HDFC against rupee on Tuesday – Settlement date is
______________
➢ In E.g 2 example the transaction date is Thursday – Settlement date is ________
➢ In E.g 1 transaction day is Monday and following Wednesday is holiday in Japan
or US then _________

International Financial Management COC642B – BBA F&A Jan to May 2023

Value / settlement date for spot transaction
Example (cont..):
➢ E.g 1 London bank sells Yen against dollar to Paris bank on Monday

Tuesday is holiday in UK but not in France then

If Paris bank “made the market” means London bank “called for a quote” then the
settlement date is Wednesday.
If Paris bank “called for a quote” means London bank “made the market” then the
settlement date is Thursday

International Financial Management COC642B – BBA F&A Jan to May 2023

Value / settlement date for Forward transaction
➢ The rate of exchange is fixed on the transaction date itself.
➢ Calculation of settlement date is two step process
➢ A. Find the “Valued date for a spot transaction” for the same currency on same day.
➢ B. Add one calendar month to arrive at Value for forward

Example

1 month (30 days) forward purchase of GBP against INR made in June 20

International Financial Management COC642B – BBA F&A Jan to May 2023

Value / settlement date for Forward transaction
➢ The rate of exchange is as on June 20th
➢ Calculation of settlement date is two step process
➢ A. “Valued date for a spot transaction” is _____________________
➢ B. Add one calendar month is ______________________________

➢ Standard forward contract maturities are 1 week, 2 weeks, 1,2,3,6,9,12 months

Example 2
➢ 2 months forward deal entered on December 28, 2022
Date of Settlement is ____________________

International Financial Management COC642B – BBA F&A Jan to May 2023

Spot Contracts
Spot rate quotation:
➢ European terms and American terms:
➢ European terms – quotes given as number of units of a currency per USD
➢ American terms – quotes given as number of units of USD per unit of currency

E.g Interbank quotes in European terms

EUR 0.772 per USD INR 62.50 per USD

E.g Interbank quotes in American terms

USD 1.2953 per EUR USD 0.0160 per INR

International Financial Management COC642B – BBA F&A Jan to May 2023

Spot Contracts
Direct quotes and Indirect quotes:
➢ In any country “direct quote” gives amount of the currency of that country
against per unit of foreign currency (e.g. INR 80 per USD)
➢ “Indirect quote” is reciprocal of above (e.g. USD 1.25 per 100 INR) (Generally we
use the unit as 100 for currencies such as INR, Yen, Indonesian rupiah)
Direct Quote
1 unit of FCY is equivalent to X units of Local CCY

Indirect Quote
1 unit of Local CCY is equivalent to X unit of FCY

International Financial Management COC642B – BBA F&A Jan to May 2023

Spot Contracts

1 CHF = 1.2 USD

80 INR = 1 USD

104 GBP = 1 INR

International Financial Management COC642B – BBA F&A Jan to May 2023

Spot Contracts
Quotation convention:

USD/CHF – US Dollar-Swiss franc

USD-INR – US Dollar – Indian Rupee

The first currency is the “Base currency”. USD is base currency and Swiss franc and
Indian rupee are quoted currency. USD/INR quotation will be given as amount of
rupee per USD.

International Financial Management COC642B – BBA F&A Jan to May 2023

Spot Contracts
Rate convention:
➢ Bid / offer or ask price
➢ Bid price is the price at which the dealer is wiling to “buy” or ‘bidding for” one
unit of a base currency against the quoted currency
➢ The offer or ask price is the price at which the dealer is willing to “sell” or
“offering” for one unit of base currency against the quoted currency
Example:
USD/CHF Spot: 1.1550/1.1560
GBP/EUR Spot: 1.3025/1.3035
The difference between offer and bid price is called bid-offer spread or bid-ask
spread
International Financial Management COC642B – BBA F&A Jan to May 2023
Cross Rate Determination
Currencies – INR – USD – ZAR
Step 1: Find the spot exchange rate between INR and USD (if
exchange rate quote is given directly)
Step 2: Find the spot exchange rate between ZAR and USD (if
exchange rate quote is given directly)
Step 3: Work out the exchange rate between ZAR and INR
(known as cross-rate) based on the above 2 given spot-
exchange rates.

International Financial Management COC642B – BBA F&A Jan to May 2023

Cross Rate Determination
Example 1:
Determine the cross-rate between INR and ZAR based on the
following information:
INR/USD: 75.37 (one -way spot exchange rate between INR
and USD as on 31.03.2020)
ZAR/USD: 17.73 (one-way spot exchange rate between ZAR
and USD as on 31.03.2020)

International Financial Management COC642B – BBA F&A Jan to May 2023

Cross Rate Determination
Example 2:
Determine the cross-rate between INR and ZAR based on the
following information:
INR/USD: 74.85 – 75.37 (two -way spot exchange rate
between INR and USD)
ZAR/USD: 17.25 – 17.73 (two-way spot exchange rate between
ZAR and USD)

International Financial Management COC642B – BBA F&A Jan to May 2023

Cross Rate Determination
Example 3:
Find the cross-rates between Pound Sterling and Arab Emirate
Dinar based on the following exchange rate quotations:
(i) CAD/GBP: 1.823/36
(ii) AED/CAD: 0.8334/48

International Financial Management COC642B – BBA F&A Jan to May 2023

Arbitrage
Meaning
➢ Set of transaction – Selling-Buying or lending – borrowing
➢ The same asset or equivalent groups of assets
➢ Equivalent means identical cash flows and risk
characteristics
➢ To profit from price discrepancies
➢ Within the market or across the market
➢ No risk involved and no capital committed
International Financial Management COC642B – BBA F&A Jan to May 2023
Arbitrage
One-point or direct arbitrage or arbitrage between banks
Example
GBP/USD – Two quotes Bank A (1.4550/1.4560) and Bank B (1.4538/1.4548)
Arbitrage opportunity
This situation is very rare
Market will adjust automatically

GBP/USD – Two quotes Bank A (1.4550/1.4560) and Bank B (1.4543/1.4553)

Arbitrage opportunity

International Financial Management COC642B – BBA F&A Jan to May 2023

Arbitrage
Inverse quote and two point arbitrage
Means buying currency in one market and selling in another market
Example
Spot quote from a bank in Zurich USD/CHF – 1.4955/1.4962
Spot quote from a bank in New York CHF/USD – 0.6695/0.6699
Arbitrage opportunity?

International Financial Management COC642B – BBA F&A Jan to May 2023

Arbitrage
Inverse quote and two point arbitrage
ABC Bank in India purchase USD from Bank Melon NY for USD 1,000,000 in US and
sell to SBI India for same amount in India
Assuming Spot quotes
USD/INR in US = 78.40/79.10
INR/USD in India = 0.01278/0.01281

International Financial Management COC642B – BBA F&A Jan to May 2023

Arbitrage
Cross rate and three point arbitrage
Example
New York Bank quoting USD/JPY – 110.25/111.10 USD/AUD – 1.6520/1.6530
Quote from a bank in Sydney AUD/JPY – 68.30/69.00
Dealer has 100 M Japanese Yen

International Financial Management COC642B – BBA F&A Jan to May 2023

Arbitrage
Cross rate and three point arbitrage
Example 1
Aditya Birla Fashion, an established exporter of silk materials, has a surplus of US$ 20 million as on
31st May 2022.
The banker of the company informs the following exchange rates that are quoted at three different
forex markets:
GBP/ INR 99.10 at London
USD/ INR 64.10 at Mumbai
GBP/ USD 1.5530 at New York
Assuming that there are no transaction costs, advice the company how to avail the arbitrage gain
from the above quoted spot exchange rates.

International Financial Management COC642B – BBA F&A Jan to May 2023

Arbitrage
Cross rate and three point arbitrage
Example 2
A Bank in New York Spot rate quote:
USD/GBP : 0.645/0.655
USD/AUD : 1.6520/1.6530
Same time Bank in Sydney Spot rate quote:
AUD/GBP : 0.397/0.407

The dealer is having 1,000,000 GBP in hand.

Explain the arbitrage possibility.

International Financial Management COC642B – BBA F&A Jan to May 2023

Forward contracts
Between a bank and customer (can be another bank)
Calls for delivery at a future date
Specified amount of one currency to USD
Exchange rate fixed at the time of the contract
Example
US Company buys textiles from UK for a value of GBP 1 Million payable after 90
days
Spot rate 1 GBP = 1.4 USD (the rate is expected to increase in future – strong GBP)
US Company enters a forward contract with bank agreed to pay 1.5 USD for 1 GBP
after 90 days

International Financial Management COC642B – BBA F&A Jan to May 2023

Forward contracts
Discount & Premium:
If forward rate expressed against US dollar is higher than Spot rate then Premium.
If forward rate expressed against US dollar is lower than Spot rate then Discount.

Forward premium or Forward rate – spot rate 360

discount of foreign = Spot rate X No of days forward
currency (LHC)

Forward premium or 360

Spot rate – Forward rate
discount of foreign = X No of days forward
Forward rate
currency (RHC)

International Financial Management COC642B – BBA F&A Jan to May 2023

Forward contracts
Discount & Premium:
Today SR $ 1 = Rs.46
Today FR of 6 months $1 = Rs.51 or Rs.44
Calculate Premium/Discount for 6 months and p.a

E.g. 2 RIL has purchased machinery worth US$5,00,000 from the US which is
payable in 3 months time. RIL expects that the frame will weaken over a period. He
has asked his banker for forward exchange cover. The rates existing at the time are:

International Financial Management COC642B – BBA F&A Jan to May 2023

Forward contracts
E.g.3
The spot rate of exchange is 2.5 Northland dollars to the pound. If, at the end of the
six months the Northland dollar has (i) gained 4%, (ii) lost 2%. What will be the 6
months forward rate.

E.g.4
B Ltd, has shipped goods to an USA importer for $ 10000 due in 90 days.
Today Spot Rate $ 1 = Rs.45 If Rs. will depreciate by 10% in 90 days, calculate gain or
loss due to foreign exchange fluctuation.

International Financial Management COC642B – BBA F&A Jan to May 2023

Swaps
Transaction between currencies A and B, consist of a spot purchase (sale) of
currency A coupled with a forward Sale (purchase) of currency A both against
currency B
Spot-Forward Swap:
One leg is spot transaction and other is forward transaction
E.g. A Bank buys pounds one month forward against dollar. It has created a long
position against dollar and short against pound.
If it wants to square this off………
a. Enter into swap by purchasing pounds at spot and sell forward 1 month and
b. Also Sell Pound at spot

International Financial Management COC642B – BBA F&A Jan to May 2023

Swap Margin
Since there will be a forward premium or discount on currency A vis-à-vis currency
B, the rate applicable to forward will be different from spot.
These two differences is called “Spot margin”
A pair of “Swap points” have to be added or deducted from Spot price to obtain
forward price
How to determine whether the “Swap points” have to be added or deducted:
Condition 1 – Bank must always make profit, means the Ask price have to be always
more than the Bid price.
Condition 2 - The bid-ask spread is narrow at spot and have to increase as the
forwards days increase.

International Financial Management COC642B – BBA F&A Jan to May 2023

Swap Margin
Example:
USD/CHF Spot: 1.4265/1.4275 1 month swap: 0.0015/0.0008
If swap points added:
USD/CHF forward = (1.4265+0.0015)/(1.4275+0.0008) = 1.4280/1.4283
Condition 1 – ?
Condition 2 - ?
If swap points Subtracted:
USD/CHF forward = (1.4265-0.0015)/(1.4275-0.0008) = 1.4250/1.4267
Condition 1 – ?
Condition 2 - ?

International Financial Management COC642B – BBA F&A Jan to May 2023