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the exchange rate is always quoted per unit of the base currency • e. all currency pairs traded against the Euro are quote per EUR 2 . one Euro buys 1.30 US Dollars • Currency Hierarchy: • • • • • • • • Euro British Pound (Sterling) Australian Dollar New Zealand Dollar United States Dollar Canadian Dollar Swiss Franc Japanese Yen Note: Euro is the world’s dominant base currency. the Euro is the base currency… if the pair is trading at 1. for EUR/USD.g..FX Market Convention • Base Currency (Primary Currency) • The base currency is the first currency in a currency pair.30.

months. or Forward yearsPricing: Forward price = Spot price + Forward (or swap) points 3 .FX Forward • What if you want to lock in an FX rate to satisfy a future obligation? • A forward contract in the FX market locks in the price at which an entity can buy or sell a currency on a future date: • Both parties agree on an exchange rate for a specific date in the future • Money does not change hands until the future maturity date • Length of the contract can be a couple of days.

FX Forward • The forward rate is determined by the interest rate differentials between two currencies. so no arbitrage is possible: • One of the most important mathematical concepts in FX: understanding the basic relationship between FX forwards and Interest Rates • This prevents speculators from investing funds in the country with higher rates and locking in a risk-free profit 4 .

75% USD 10.0327 Receive CAD 10. 2010 Deposit USD for 12 months at rate of 0.404.0200 Receive CAD 10.200. 2011 Two paths.000.000 USD 10.000 October 14.075.000 Spot rate 1.FX Forward October 14. both end up with the same CAD amount…no arbitrage! “Forward” All-In Rate 1.00% 5 .000 Deposit CAD for 12 months at rate of 2.

• The ability of a country to attract capital investments will also impact the movement of its currency.Factors Affecting FX Movements • Economic policies by central banks affect FX movements. More Reserves Current account financing is easy The home currency appreciates Capital flows overseas. A strong economy And/or Tight monetary policy A weak economy And/or Expansionary monetary policy Attracts capital from overseas. Fewer Reserves Current account financing is difficult The home currency depreciates 6 .

•Interest rates are tools to affect the money supply in the market and consequently the economic activity .

in repo rate – increases currency flow in the market (increases inflation) • Lower rates increase the money supply and boost economic activity •Reverse repo rate – • Rate at which RBI borrows from other banks • Inc.•Cash Reserve Ration (CRR) – • Minimum ratio of bank deposits that banks have to maintain with the RBI • Increase or decrease can alter the money flow in the market •Repo rate – • Rate at which the RBI lends money to other banks • Dec. in reverse repo – decreases currency flow in the market (inflation control measure) .

Interest rates trend 2010-15 INDIA EU US JAPAN .