Introduction to Financial

Markets & Institutions

Lecture 8
Foreign Exchange Market
Objectives:

By the end of this class, we will be able to:

 Understand the basics of foreign exchange market

 Identify the currency in foreign exchange

 Discuss the role of central bank in foreign exchange market

What is a Foreign Exchange Market?
Foreign Exchange Market

▪ The Foreign Exchange Market, also known as the

Forex market or the currency market, is an
international marketplace where currencies are traded.

▪ It tends to determine currency exchange rates through

currency pair trading and speculation.

▪ It is the world's largest financial market.

▪ It contributes to international liquidity and preferable

stability.
Basics of Foreign Exchange Market

▪ Buyers, sellers, market intermediaries, and the Indian Monetary

Authority make up the Indian Foreign Exchange Market.

▪ Mumbai is India's key centre for foreign exchange.

▪ The Foreign Exchange Dealers Association is a non-profit

organization that also serves as a watchdog.

▪ Forex trading is open to all residents, HUFs, and qualifying

corporations which fulfil the FEMA or Foreign Exchange
Management Act conditions.
Basics of Foreign Exchange Market

 Forex market have the option of trading spot forex (also known
as spot FX) as well as currency futures, generally referred to as
foreign exchange futures or
FX futures.

 The spot market is where financial items including

commodities, currencies, and securities are exchanged for rapid
delivery.

 The exchange rate is the one in effect at the time of the

transaction.

 Currency derivatives are a legally binding contract to purchase

or sell a currency exchange rate in the future at a predetermined
price.
Currency
3-letter symbols represent currencies. The following are the
standard representations for some of the most often exchanged
economies:

▪ CAD – Canadian Dollar

▪ EUR – Euros
▪ USD – United States Dollar
▪ AUD – Australian Dollar
▪ GBP – British Pound JPY – Japanese Yen CHF – Swiss
Franc
Currency

▪ EUR/USD, GBP/USD, USD/CHF, and USD/JPY are the majors,

accounting for 75% of all Forex market activity.

▪ Because it is featured in all financial pairings, the USD is

regarded a prominent currency pair.

▪ Cross currency pairs or cross prices are those that

do not involve the US dollar.

The following are the most actively traded cross rates:

▪ EUR/CHF stands for euro-franc.
▪ EUR/GBP = euro-pound
▪ EUR/JPY stands for euro-yen.
▪ GBP/JPY stands for sterling-yen.
▪ NZD/JPY = Kiwi-Yen
▪ NZD/JPY = Kiwi-Yen
Central Bank and Foreign Exchange Market

▪ In the foreign exchange markets, central banks like the

RBI play a key part.

▪ They engage in the foreign exchange market to manage

currencies in accordance with their financial needs.

▪ The supply of money, inflation, and/or interest rates are all

controlled by central banks.

▪ In comparison to banks or speculators, commercial

enterprises deal in tiny volumes.

▪ Their transactions have a brief effect on the market rate.

Forex Reserves

Forex reserves consist of the following assets:

 Gold
 SDRs are used as forex reserves (special drawing rights of
the IMF)
 Investments in foreign currencies (capital inflows
to the capital markets FDI and external commercial
borrowings)

India has accumulated them and the Reserve Bank

of India is in charge of them.
Foreign Exchange Market

Where do India's foreign exchange reserves reside?

▪ Within the broad boundaries of currencies, instruments, issuers, and counterparties, the RBI Act of 1934 provides
the overall legal framework for the deployment of reserves in various foreign currency assets and gold.

▪ According to RBI data, 64 percent of foreign currency reserves are stored in assets such as Treasury bills issued by
foreign governments, primarily the United States, 28 percent is placed in foreign central banks, and 7.4 percent is
put in commercial banks overseas.

▪ As of March 2020, India has 653.01 tonnes of gold, with 360.71 tonnes stored in safe custody with the Bank of
England and the Bank for International Settlements, and the rest owned domestically.
Let us reflect

Q: What will happen if there will be no central bank such as RBI to manage
the foreign exchange market in India?

Q: Look for major foreign exchange rates for INR for the following currencies

and mention them:

▪ CAD – Canadian Dollar

▪ EUR – Euros

▪ USD – United States Dollar

▪ AUD – Australian Dollar

▪ GBP – British Pound JPY – Japanese Yen CHF – Swiss Franc