1615456387-8 Foreign Exchange Rate

International Finance & Banking
Foreign Exchange Rate Mechanism
Arun Kumar
Foreign Exchange Market
• International transaction in cash requires two

distinct purchases
– Purchase of foreign currency
– Purchase of good/service with the FC
• Term foreign exchange is used to denote foreign
currency
• Foreign exchange market exists to cater to the
demand for foreign currency/currencies
Foreign Exchange Market
• Organisational setting within which
individuals, governments and banks buy and
sell foreign currencies
• Only a small fraction of daily transactions in
foreign exchange involve trading of currency
• Most foreign exchange transactions involve
transfer of bank deposits
Definition of Foreign Exchange
• In terms of FEMA (1999) definition
– Deposits, credits and balances payable in foreign
currency
– Drafts, travellers’ cheques, letter of credit or bill of
exchange expressed or drawn in Indian currency
but payable in foreign currency
– Drafts, travellers’ cheques, L/Cs, etc. drawn by
banks, institutions or persons outside India but
payable in Indian currency
Exchange Rate
• Denotes the price or the ratio or the value at which
one currency is exchanged for another
• Exchange rate is very dynamic
• The foreign exchange market is round-the-clock
market due to different time zones
• Major participants-
– central banks,
– commercial banks,
– forex brokers,
– corporations,
– individuals
Exchange Rate Mechanism - What it is ?
• Bank buys currency from Customers at buy rate
• Bank sells currency to Customers at sell rate
• As the currency rates fluctuate, holding currencies can be risky,
• All currencies bought have to be sold
• All currencies sold are bought back
• This matching of sale and purchase is called cover operation.
• Customers not always available for sale/ purchase
• Banks deal among themselves – Interbank market
• This is a wholesale market for currencies
6
Exchange Rate Mechanism - What it is ?
Exchange rate is the conversion rate of one

currency in terms of another currency
Exchange rate conversion is made on account of :
•Export Receivables
•Import Payables
•Disbursal of Forex Loan
•Repayment of Forex Loan
•Foreign Investment
7
Exchange Rate Mechanism
Factors Affecting Exchange Rate Movements
DOMESTIC
Political/ Economic/ Speculative
Political
•Type of Government
•Stability
•Track Record of the Country
•Current Political Developments
•Vision Of Political Leadership
•Exchange Control Regulations
8
DOMESTIC
Economic
•Inflation Rate Differential
•Price Elasticity Of Imports / Exports
•Interest Rate Differential
•Relative GDP Growth Rates
•Relative Fiscal and Monetary Policies
•Relative BoP Position
•Relative Share Market Movements
•Relative Capital Flows
•Central Bank Interventions
•Regulations
9
DOMESTIC
Speculative
•Buying / Selling by Banks
•Speculative Activities by
Corporates/ Investment Houses mainly
in International Markets
10
GEOPOLITICAL
Global/ People/Event/ Monetary & Financial
Global
•Oil / Commodity Prices
•Capital Market Flows
•Trade Flows
•War / Threat of War / Terror Attack
•Speculative Flows
11
GEOPOLITICAL
People Market Movers

•President of U.S.
•Chairman of Federal Reserve
•Prime Minister of U.K. / Japan / China
•Chancellor of Exchequer, Germany
•Indian P.M / F.M / RBI Governor
•ECB (European Central Bank) President
•Summit/Trade Talks
12
GEOPOLITICAL
Event Market Drivers

•Unexpected Events
•Internal Trouble / Coup
•Nuclear Tests
•Scandals
•Epidemic / Bird Flu/Tsunami/Heavy Rains
•War / Threat of War
•Terrorist Attacks
13
GEOPOLITICAL
Monetary & Financial Market Movers

•Interest Rates -Short Term/Long Term
•Yield Curve
•Discount Rate
•RBI monitored Rate
•Inflation and Money Supply (Too Much Money Chasing
Too Few Goods ?)
•Open Market Operations
•Taxation - Hikes and Cuts
14
Evolution of Currency (Exchange Rate) System
 The Bretton Woods system was in place between 1945 and

1971. Under this variant of the gold standard,
standard most countries
settled their international balances in U.S. dollars, but the U.S.
government promised to redeem other central banks’ holdings
of dollars for gold at a fixed rate of USD 35 per ounce.
 The Bretton Woods System collapsed on 15th August 1971.
 Euro Single Currency Free Float – 1st Jan 1999
 For most of the 20th century, at least one national currency

has played a role in the international financial system as a
major international currency,
currency first sterling and then dollar.
15
ERM and RBI
 To reduce excess volatility in exchange rates - ensuring

that the market correction of overvalued or undervalued
exchange rate is orderly and calibrated. (No fixed target or
pre-announced target or a band – flexibility in the
exchange rate with ability to intervene, if and when
necessary.)
 To build and help maintain an adequate level of foreign

exchange reserves (a policy that takes into account not
only anticipated current account deficits but also ‘liquidity
at risk’ arising from unanticipated capital movements)
 A judicious policy for management of the Capital Account.
 To help eliminate market constraints to the development of

a healthy foreign exchange market dollar. 16
Exchange Rates- Currency Coding
Each currency bears its three- letter ISO code , developed

by the International Organization for Standardization.
e.g.. USD; CHF; GBP; EUR; AUD; INR; etc.
Exchange rate codes are expressed in 6 letter currency

codes.
e.g.. USD / CHF ; GBP/USD ; EUR / USD ;

USD / INR ;
In the first place is base currency code ; quotations are

expressed in units of the second currency against one
unit of the first currency.
17
How the currency rates are quoted in the Market?
In Interbank Market currency quotes are made in two way prices-

BID -
Bid rate is the rate at which market is willing to buy a currency being sold
by the other.
The left hand side (LHS) of currency quote is called ‘Bid’ rate. This is the
rate at which the Quoting Entity Buys the First currency against the
second.
OFFER/ASK -
This is the rate at which market is willing to sell a currency . The right
hand side (RHS) quote is called ‘Offer’ or ‘Ask’ rate. This is the rate at
which the Quoting Entity Sells the first currency against the second.
e.g. BID ASK

1 USD= INR 60.50 INR 60.75
i.e. market is willing to buy 1 USD at INR 60.50 and sell 1 USD at INR 60.75
( BUY LOW, SELL HIGH) 18
Are all the currencies are quoted in the same way?
No, Currencies are quoted in two different ways in forex market:
Direct quote- System of expressing exchange rate for 1 unit of foreign

currency in units of home currency. If no. of units of home currency are
expressed in terms of one unit of foreign currency.
For example- 1 USD = INR 60.50/54 ( USD/INR 60.50/54)
Indirect quote- System of expressing exchange rate of a unit of local

currency in units of foreign currency. If no. of units of foreign currency
are expressed in terms of one unit of home currency.
For example- 1 EUR= USD 1.2450/2455 ( EUR/USD 1.2450/2455)
If direct quote USD/INR is 1 USD = INR 60.50, corresponding

indirect quote for USD in India would be USD 1.7762 = INR 100;
or, INR 100 = USD 1.7762 / 1.7749
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Sale/ Purchase of currencies – The mechanism
How one should ask IBD/Treasury for a quote?........
To avoid errors while taking a quote from the IBD/Treasury, one
should speak in terms of the first currency in the standard pair.
Suppose, you want to sell USD 1 mio against INR. Since the
standard pair is quoted as USD/INR, ask for a quote for ‘Buy
USD/INR 60.00 mio’
Likewise, if you want to buy USD 1 mio against INR, seek a

quote for ‘Sell USD/INR 60.00 mio’
!!! ONE need to be careful while asking for indirectly quoted

currencies as customers tend to place orders in terms of USD.
Although most of the trades are in standard pairs such as EUR/USD or
USD/INR, one can ask for rates in any two permitted currencies. Rates
for currency pairs are calculated by “crossing” standard pairs.
E.g. EUR/INR rates will be derived by crossing EUR/USD and USD/INR.If

EUR/USD= 1.50 and USD/INR= 60.00 EUR/INR= 90.00 (1.50*60) 20
SALE / OUTWARD PURCHASE/ INWARD

When you talk to IBD/ Treasury for some sale Likewise, if a customer likes to
or purchase of currency for your customer, sell the first currency in a
it is determined from THEIR point-of-view, conventional pair, it is a
as to whether the transaction is a sale or purchase of that currency for
purchase of currency. the Bank, and we call it a
Suppose, a customer likes to buy a currency purchase or inward transaction.
(being the first currency in a conventional
pair), the branch taking the quote from
IBD/ Treasury will substitute itself for the
customer and will ask for a buy quote),
whereas it is a sale of that currency for the RISK FACTOR
Bank (IBD/ Treasury), and it is called a sale If a customer wants to buy JPY
or outward transaction. 10 mio against USD, the quote
RISK FACTOR asked should not be ‘buy JPY 10
mio against USD’ but the same
Risk arises when if a customer wants to
should be asked in the form
SELL 1 mio USD against EURO, the branch ‘USD/JPY, 0.1 mio (approx),
asks ‘sell USD 1 mio against Eur’ whereas, inward’
the same should be asked in the form ‘Buy
EUR/USD 0.66 mio (approx) or EUR/USD,
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0.66 mio (approx) , outward’.
SALE / OUTWARD PURCHASE/ INWARD
• Clean outward remittances • Clean inward remittances

• Import Bill/LC payment • Export Bill/LC payment
• Foreign currency loan • Foreign currency loan
repayment conversion to INR
• Forward Sale booking • Forward purchase booking
• DD/TC /FCN issue • DD/TC /FCN paid
• INR deposit closure for • Export bill
remittance in Foreign discounting/negotiation
Currency • INR deposit issuance by
converting Foreign Currency
into INR
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Market conventions- Determination of Value Dates
• Every forex transaction involves exchange of two currencies by the
counter parties to the transaction. The date on which the two
currencies involved in an exchange transaction change hands i.e.
when the nostro account is credited in case of a purchase and
debited in case of a sale, is the value date.
• Exchange normally takes place two working days after deal date and
is called spot date.
• When settlement is done on next working day; it is a Tom

transaction
• When settlement is done on the same day; it is a Cash transaction
• When the settlement date is beyond the spot date, it is called a

forward transaction.
• Spot, Tom and Cash transactions are called ready transactions. 23

How is the Spot Date determined?.....
Calculation of Spot Date for USD/INR trade
1. Where there is NO intervening holiday in either of the currency markets

The settlement will be done on the second business day after the trade date.
e.g. for a USD/INR trade done on 16 June 2014 value spot, the subsequent
business days in both markets are 17 June 2014 and 18 June 2014. Therefore,
settlement date is 18 June 2014.
2. Where there is/are intervening holiday/(s) in BOTH markets

The settlement will be done on the second business day after the trade date.
e.g. for a USD/INR trade done on 18 June 2014 value spot, the subsequent
business days in both markets are 21 June 2014 and 22 June 2014. Therefore,
settlement date is 22 June 2014.
24
How the Spot Date determined?.....
Calculation of Spot Date for USD/INR trade
3. Where there is/are intervening holiday/(s) in INR market but not in USD Market
The settlement will be done on the second business day in INR MARKET after the
trade date.
e.g. for a USD/INR trade done on 15 May 2014 value spot, the subsequent business
days in INR market are 16 May 2014 and 20 May 2014 , (only INR market being
closed on 19 May and both markets closed on 17 and 18 May 2014). Therefore,
settlement date is 20 May 2014.
4. Where there is/are intervening holiday/(s) in USD MARKET but not in INR market
The settlement will be done on the first business day in USD Market, after the trade
date.
e.g. for a USD/INR trade done on 03 July 2014 value spot, the subsequent business
day in USD market is 07 July 2014 (only USD market closed on 04 July 2014, both
markets closed on 05 and 06 July 2014) . Therefore, settlement date is 07 July
2014.
In this case, TOM and SPOT both trades will be settled on 07 July 2014.
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How is the Cash/ Tom Date determined?.....
Calculation of Cash date for USD/INR trade

Cash Transaction - A forex transaction with value date same as the trade date.
In other words the customer INR a/c is credited or debited and currency delivered
on the date of the deal.
For example- Spot USD/INR = 53.16/17
and Cash/spot = 1.60/1.70
USD/INR will be 53.1600 53.1700

53.1430/53.1540 value CASH 0.0170 0.0160
53.1430 53.1540
TOM Transaction - A forex transaction with value date being business day
immediately after the deal date.
53.1600 53.1700
Similarly if Tom/Spot = 0.80/0.85 0.0085 0.0080
USD/INR will be
53.1515 / 53.1620 value TOM 53.1515 53.1620
(For USD/INR pair the cash rate is at a discount to spot rate)

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Sale/ Purchase of currencies – Market conventions
Recapitulating……….
Market Prices are usually quoted in terms of Spot, Cash, Tom etc.
Spot
Settlement of funds in foreign market normally takes place after
two working days. Rates quoted are on spot basis.
A spot deal in foreign exchange is sale / purchase of one currency

against another with settlement usually on the second business day
after the trade date (T+2), i.e.
If the settlement date is two working days after the txn date i.e.
if the Txn date is 18-07-14
Settlement date will be 20-07-14
Forward - When the settlement is done beyond the spot date27

Recapitulating……….Market
Recapitulating………. Prices are usually quoted in terms of
Spot, Cash, Tom etc.
Cash txn-
When settlement is done on the same day; it is a cash transaction.
If the settlement date is same as txn date (e.g. TT buying/selling
value cash) i.e.
Settlement date will be 20-07-14
Tom txn-
When settlement is done on next working day; it is a Tom
transaction. If the settlement date is one working day after the txn
date i.e.
Settlement date will be 19-07-14 28
Value Date – Time Scale.
Cash Tom Spot Forward Maturities
Cash Deal is done today for delivery Today
Tom Deal is done today for delivery Tomorrow
Spot Deal is done today for delivery on 2nd Business Day
Forward Deal is done today for delivery beyond Spot Date

To be an eligible value date, a value date must be a business day in the home countries
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of the currencies involved in the transaction.
Forward Exchange Contract
• An outright forward FX deal is a firm and binding contract to buy or sell a given
amount of currency for settlement at some future date, at a market-determined
rate of exchange (plus or minus Bank’s spread). At the time of booking the deal,
no money changes hands. Debits/credits are carried in to the Customer’s
account only on the settlement date.
• !!! Although no money changes hands/ no accounting entries are passed,

forward contracts create a ‘position’ at a future date (future cash flow), and
therefore must be reported.
• The Customer and the Bank are under an obligation to buy/sell on settlement
date at the contracted rate if the contract is run to maturity. The customer can
however cancel the contract, take partial, early or late deliveries.
• The forward rates are quoted in the market and are available on Reuters/
Bloomberg/ Newswire 18 or any other information screen
• Forwards are used to “hedge”i.e. cover the risk of future currency fluctuations
as also to “Trade/ Speculate” i.e. profit from currency movements
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Forward Exchange Contract
Calculation of Forward Rate

Suppose a Customer wants to book one year forward say USD 1 million
for export-
Given that-
Interest rate scenario : USD 4%, INR 7%; Spot-INR/USD : Rs 55
Bank borrows USD 1 mio @4% and in return sells USD 1 mio value spot
@ Rs 55/= to market
Bank places Rs 55,000,000 @ 7% p.a.
Bank borrows USD 1 mio @4% while it places Rs 55 mio @ 7%

After 1 year
USD 1,000,000 INR 55,000,000
Int paid 40,000 Int recd 3,850,000
Total 1,040,000 51,150,000
Effective rate after one year 51,150,000/1,040,000=49.18

Disadvantage of Forward Contract-
No chance of participating in market volatility 31
Forward Exchange Contract-Some
Contract- Finer Points
In USD/INR the forwards market is active for up to 1 year tenor
USD/INR forwards are also quoted for month end maturities.
Typically the spot and forward margins/points (premium or discount) are quoted instead of
outright forward rates.
e.g.. at USD/INR spot of 52.37/38 on 23 May 2015, forward margins
bid / offer bid / offer
1 month 25 / 27 May 13 end 5 / 6
6 month 104 / 106 Nov 13 end 106.50 / 108.50
12 month 178 / 180 April 14 end 168 / 170
Therefore, the USD/INR 6 month forward sale for 23 May 2015 is calculated as 52.38 + 1.06
= 53.44.
Similarly, the USD/INR forward purchase for end of Nov 2015 is calculated as 52.37 + 1.065
= 53.4350
Forward premium or discount in a currency pair normally denotes the carrying cost
of the first currency.
For most currencies the standard contract maturities are one, two, three, six, nine
and twelve months
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Forward Exchange Contract-
Forward rate for Currency Pairs
Forward rate for a currency pair is usually determined by the interest rate
differential in the two markets
e.g.. EUR / USD = 1.5930/35
6 mth EUR intt rate = 5.1% p.a.
6 mth USD intt rate = 3.1% p.a.
The differential is 2% annualised or 1% semi-annualised
THEORY : Market does not normally countenance arbitrage, hence to

equate the two sides USD (with lower interest rate) needs to be at a premium of
1% for six months, which in terms of “forward points’ is
EUR / USD 6mth fwd= 1% of 1.5930 = -0.0159 (quoted as 159.00 / 158.30)
final rate EUR/USD 6 mth= 1.5771/1.5777
Aide memoire – The spread in forward rate should not be narrower than that in
spot rate.
PRACTICE : In practice, the demand and supply and future expectations also have
some impact so the theoretically calculated price will not be equal to the actually
traded prices.
33
Forward Rate - Forward Margin
Forward margin or swap points is difference between the spot rate and forward
rate
If forward margin in ascending order- premium – add to spot rate

If forward margin in descending order- discount – deduct from spot rate
Factors affecting Forward margin

• Rate of interest (example)
• Demand and supply
• Speculation about spot rates
• Exchange regulations
• Forward margin is normally available for periods of a calendar months and

not for fraction of days say ,20, 22 days.
• For calculating bill buying rate, if forward margin is at premium round off
the transit period and usance period to lower month and
• if forward margin is at discount round off the transit period and usance
period to higher month.
FM= spot rate*forward period*interest difference/100*time

34
Forward Rate -Exchange Margin
TT Purchasing Rate- 0.025% to 0.080%

Bill Purchasing Rate- 0.125% to 0.150%
TT Selling Rate- 0.125% to 0.150%
Bill Selling Rate- 0.175% to 0.200%
Fineness of Quotation
•Exchange rate is quoted upto 4 decimals in
multiples of 0.0025.
•Rounding off –upto 49 paise to be ignored

•50 to 99 paise – to higher rupee.
35
Delivery Scenario
Forward rate is today’s expected market rate for a future date. The actual rate
(spot) on the maturity date usually differs from the forward rate of the contract.
Eg. - A customer has booked a 1 month outward USD 1 mio at 52.00
Scenario 1: On maturity, USD/INR spot is 52.50

The customer has bought USD/INR at 52.00, while it is available at 52.50 in the
spot market. Notional Gain to customer INR 0.50 per USD or total INR 500,000.

The customer has bought USD/INR at 52.00, while it is available at 51.00 in the
spot market. Notional Loss to customer INR 1.00 per USD or total INR 1,000,000.

The customer has bought USD/INR at 42.00, and it at same level in the spot
market. No Loss/Gain to customer.
36
Settlement of Contract
A customer can settle the contract-
Types of tenor in a forward contract -
At the time of booking a forward contract the customer can choose for
1. A fixed delivery date
2. A period called option period (upto 1 calender month) within which the customer can
deliver his part of the contract on any date
In both the cases, the forward rate is fixed. However, in the latter case, as the customer is
buying the option to deliver anytime during the contracted month, the forward rate may
be worse than that of a fixed date delivery.
Delivery types :-
a.a customer can deliver his part of the contract on delivery date as per the contract, at the
contracted rate
b.a customer can deliver his part of the contract during an option period as per the contract,
at the contracted rate.
c.a customer can deliver a part or whole of the contracted amount, anytime prior to the fixed
delivery date or prior to the start of option period, at an adjusted rate given by Global
Markets
d.a customer can cancel the contract anytime before the final delivery date by settling the
difference between the contracted rate and prevailing spot
37
Cancellation of Contract
A customer can opt for cancelation of Forward Contract- entered into earlier,
subject to limits specified by the Regulator.
For the IBD/Treasury, Cancellation of Forward Contract earlier done by a customer

is like booking an opposite contract for the same maturity at prevailing market
rates. This may result into a loss/gain for the customer and the customer may
choose to take the net gain/loss on delivery date or on the cancellation date.
Eg. A customer books 1 year inward USD 1 mio at 51.25. The customer cancels
the contract after 6 months at a prevailing rate of 53.28. As is clear, the customer
has sold USD 1 mio at 51.25 but buys it after 6 months at 53.28. The customer
incurs a loss of INR 2.03 million (approx) value delivery date.
If the customer in the above example wishes to bear the loss immediately, INR
2.03 million is discounted for the period and the amount is recovered from the
customer.
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Advantages:
• Simple
• Easy to use
• Liquid
• Transparent
Disadvantages:
• No chance of participating in market volatility.

• Theoretically the upside and downside
(opportunity profit / loss) is unlimited.
• INR based forwards are demand and supply
dependent.
39
Types of Merchant Rates- Sales
T.T. Selling Rate:-

Rate All sale transactions other
than issue of Travellers Cheques and also
remittances arising out of Import Bills.
Bill Selling Rate:-

Rate Outward remittances arising out of
handling Import Bills by way of retirement of
documents under LC, Collection etc.
Travellers Cheques selling rate:-

rate Issue of Travellers
Cheques.
Currency Notes Selling Rate:-

Rate Selling currency
notes.
40
Types of Merchant Rates- Purchases
T.T. Buying Rate:- Transactions where our Bank’s Nostro accounts
have already been credited on or before the transaction date e.g.,
proceeds of bills/instruments sent on collection basis and realised,
Encashment Drafts/TTs for which cover is provided by the Foreign Banks in
advance as per agency arrangement.
Bill Buying Rate:- Discounting/ Purchase/ Negotiation of export bills.
DD Buying Rate:- Purchase of DDs drawn on us for which reimbursement is

to be obtained by drawing a reimbursement draft on Foreign
Branches/Correspondents.
TC Buying Rate:- Purchase of Travellers Cheques.
Currency Notes Buying Rates:- Purchase of Currency notes
Others:- Purchase of clean instruments. e.g., Customer’s personal cheques,

demand drafts, international money orders, Cashiers checks/ Banker’s
pay-orders payable abroad where cover is not provided. Selling currency
notes.
41
Merchant Rates- Mechanism
TT Buying Rate-
• Transaction does not involve any delay in realization of foreign exchange
by the bank
• Bank’s nostro account has already been credited
• Calculated by deducting exchange margin from the interbank buying rate.
When is applied
• Payment of DD, TT etc.- nosrto account already credited
• Foreign bills collected- after payment by the importer and crediting of
nostro account
• Cancellation of foreign exchange sold earlier
Calculation methodology
USD/INR spot buying rate-

Less exchange margin
TT Buying Rate-
Rounded off to nearest multiple of 0.0025
42
Bill Buying Rate-
• Proceeds are realized after presentation of bill and crediting of nostro
account
• Transaction involve delay in realization of foreign exchange by the bank
• Calculated by deducting exchange margin from the interbank buying rate
and
• adding or deducting forward premium or discount
When is applied
• When foreign bill is purchased.
Calculation methodology
USD/INR spot buying rate-
Add- Forward Premium (for transit and usance period rounded off to lower month)
OR
Less-Forward Discount (for transit and usance period rounded off to higher month)
Less -exchange margin
Bill Buying Rate-
Rounded off to nearest multiple of 0.0025
Recovery of Interest on Bills purchased

Exchange Earner’ s Foreign Currency Account (EEFC) 43
TT Buying Rate
•Bank has received a TT for USD 250,000;
•Nostro a/c has been funded for value date 17-06-14;
•customer requests on 18-06-13 to convert it into rupee and credit his account
immediately
Spot INR/USD Rate BID ASK
1USD = 56.1700 56.1800
Cash Spot (i.e interest rate differential for two days) 0.0050 0.0075
•bank notionally borrows cash for two days from mkt to pay customer;
•sells $ bought against INR in interbank mkt at spot rates –
•settlement: two days – T+2 )
Spot Rate (Bid) = 56.1700

Cash Spot (Ask) = 0.0075
Base Rate = 56.1625
Margin = 0.0300
Final Rate = 56.1325
Every customer buy rate should be < rate of cover sale in inter-bank market
44
Forward Purchase Rate (for export transactions)
A customer wants to take a fwd contract for USD 250,000 for its export
proceeds to be received on 30-10-14-
customer requests on 18-06-14 to book a forward cover for the amount for
value 30-10-14

1USD = 56.1700 56.1800
Forward Prem 0.2500 0.2600
(i.e interest rate differential upto 30-10-14 ; relative Forward Difference Points)
Forward Purchase Rate will be

Spot Rate (Bid) = 56.1700
Forward Premium = 0.2500
Base Rate = 56.4200
Margin = 0.0400
In case of forward contract no accounting entry is passed on date of txn.

Accounting entry is passed only on the date of settlement or cancellation 45
Forward Sale Rate (for import transactions)
A customer wants to take a fwd contract for USD 250,000 for its import
remittance to be made on 30-10-14;
customer requests on 18-06-14 to book a forward cover for the amount for
value 30-10-14

1USD = 56.1700 56.1800
Forward Prem 0.2500 0.2600
(i.e interest rate differential upto 30-10-14 ; relative Forward Difference Points)
Forward Sale Rate will be

Spot Rate (Ask) = 56.1800
Forward Premium = 0.2600
Base Rate = 56.4400
Margin = 0.0700
In case of forward contract no accounting entry is passed on date of txn.

Accounting entry is passed only on the date of settlement or cancellation 46
Indicative Margins
TT Buying Rates: 3 p per USD

TT Selling Rates: 4 p per USD
Bill Buying Rates: 4 p per USD
Bill Selling Rates: 7 p per USD
Say, Spot (inter-bank) USD / INR bid / offer: 55.80 / 82
Merchant e Rates (USD / INR):
TT Buying: 55.80 – 0.03 = 55.77

TT Selling: 55.82 + 0.04 = 55.86
Bill Buying: 55.80 – 0.04 = 55.76
Bill Selling: 55.82 + 0.07 = 55.89
Exchange Rates for Currencies other than USD/INR: i.e.

GBP / INR, EUR / INR, Sing.$ / INR not quoted in Inter-bank Mkt –
need to be derived from respective currency’s quote vis-à-vis USD 47
Exchange Rates for Currencies other than USD/INR:
For Example
To quote GBP / INR rate (GBP is indirect quote currency):
Say GBP / USD spot bid / offer rates are: 1.4850 / 1.4853
Say customer wants to convert GBP 10,000 into INR
How to Calculate
Sell GBP 10000 and buy USD @ 1.4850
Sell USD amt & buy INR @ 55.80
Net effect: bank sells GBP & buys INR @ 1.4850 x 55.80= 82.86
(notional market bid rate for GBP against INR)
Quote to customer will be less margin, say : 82.81
GBP / INR Merchant rates will be as follows:
TT Buy: 1.4850 x 55.77 = 82.82
Bill Buy: 1.4850 x 55.76 = 82.80
TT Sell: 1.4853 x 55.86 = 82.97
Bill Sell: 1.4853 x 55.89 = 83.01
(in practice, profit margins loaded on USD-INR rates; no margin loaded
on GBP/USD leg of transaction 48
Exchange Rates for Currencies other than USD/INR:
For Example
Customer wants to convert Sing $ into INR
Quote Sing $ / INR rate (Sing $ is direct quote currency)
Say USD/ Sing $ spot bid / offer rates are: 1.7145 / 1.7150
How to Calculate
Sell Sing $ and buy USD @ 1.7150
Sell USD amt & buy INR @ 55.80
Quote to customer will be less margin.

Sing $ / INR Merchant rates will be as follows:
TT Buy: 55.77 / 1.7150 = 32.52
Bill Buy: 55.76 / 1.7150 = 32.51312
TT Sell: 55.86 / 1.7145 = 32.01
Bill Sell: 55.89/ 1.7145 = 32.03
49
Why Exchange Rates –Recapitulation
•Booking of Forward Contracts

•Cancellation of Forward Contracts
•Early Delivery of Forward Contracts
•Extension of Forward Contracts
50
Setting Up of Forward Contract / Derivative Limits
Past Performance Method : Eligibility Notional:
•Importers / exporters are permitted to book forward contracts on the basis of past
performance (without production of any underlying documents) upto the average of the
past three years’ or the previous year’s turnover, whichever is higher.
•Outstanding contracts under this facility at any point of time can now be upto 100%
(increased from 50%) of the eligible limit. The enhanced limits may be permitted by
branches on being satisfied about the genuine requirements of their constituents after
examination of the respective documents .
•Average of last three years turnover or last year’s turnover, whichever is higher. A
certificate of import / export turnover of the customer during the past three years duly
certified by their Chartered Accountant in the prescribed format
•Limits is assessed separately and not in conjunction with normal credit facilities
•The forward contracts booked in the aggregate during the year and outstanding at any
point of time should not exceed the eligible limits
51
Setting Up of Forward Contract / Derivative Limits
Past Performance Method : Eligibility Notional:
•Contracts booked in excess of 75% of eligible limit will be on deliverable basis and cannot
be cancelled. Contract once cancelled can not be re-booked
•CA certificate is required that all guidelines are adhered to, if outstanding Forward
Contracts are higher than 50% of the limit.
•Importers and exporters should furnish declaration regarding amounts booked with other
ADs.
•An undertaking from the customer to provide documentary evidence before the maturity.
•In case of exporters, overdue export bills should not exceed 10% of the total export.
•The sanctioned limit works like a demand loan and not a cash credit limit.
•Exposure calculated on basis of credit conversion factor methodology by some banks.
52
Forward Contract- Cancellation
• A customer can opt to cancel a forward contract entered into earlier, subject to
limits specified by the Regulator.
• Cancellation of forward contract earlier done by a customer is like booking an

opposite contract for the same maturity at prevailing rates resulting into a loss /
gain.
• 7 days prior to the maturity date, constituents should be requested to advise
• For pipeline transactions, a grace period of 6 working days after maturity of the
contract to reconcile the pipeline transactions. To cancel the contract on 7th
working day.
• For other transactions, to cancel the outstanding contracts latest by 2nd day
after expiry of the contract.
• Overdue Forward Conctracts. After due date, customer not entitled to any
exchange gains while liable for recovery of exchange losses.
• Cancellation after maturity to be done at card rates.

53
Forward Contract- Limitation
• No chance of participating in market volatility.
• Profit / loss crystallized on the date of booking.
• The upside and downside (opportunity profit /

loss) theoretically unlimited.
• INR based forwards demand and supply

dependent.
54
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International Finance & Banking

Foreign Exchange Rate Mechanism

• International transaction in cash requires two

• Bank buys currency from Customers at buy rate

• Bank sells currency to Customers at sell rate

• As the currency rates fluctuate, holding currencies can be risky,

• All currencies bought have to be sold

• All currencies sold are bought back

• This matching of sale and purchase is called cover operation.

• Customers not always available for sale/ purchase

• Banks deal among themselves – Interbank market

• This is a wholesale market for currencies

Exchange rate is the conversion rate of one

Exchange rate conversion is made on account of :

•Buying / Selling by Banks

People Market Movers

Event Market Drivers

Monetary & Financial Market Movers

 The Bretton Woods system was in place between 1945 and

 Euro Single Currency Free Float – 1st Jan 1999

 For most of the 20th century, at least one national currency

 To reduce excess volatility in exchange rates - ensuring

 To build and help maintain an adequate level of foreign

 A judicious policy for management of the Capital Account.

 To help eliminate market constraints to the development of

Each currency bears its three- letter ISO code , developed

Exchange rate codes are expressed in 6 letter currency

e.g.. USD / CHF ; GBP/USD ; EUR / USD ;

In the first place is base currency code ; quotations are

In Interbank Market currency quotes are made in two way prices-

e.g. BID ASK

No, Currencies are quoted in two different ways in forex market:

Direct quote- System of expressing exchange rate for 1 unit of foreign

For example- 1 USD = INR 60.50/54 ( USD/INR 60.50/54)

Indirect quote- System of expressing exchange rate of a unit of local

If direct quote USD/INR is 1 USD = INR 60.50, corresponding

Likewise, if you want to buy USD 1 mio against INR, seek a

!!! ONE need to be careful while asking for indirectly quoted

E.g. EUR/INR rates will be derived by crossing EUR/USD and USD/INR.If

SALE / OUTWARD PURCHASE/ INWARD

SALE / OUTWARD PURCHASE/ INWARD

• Clean outward remittances • Clean inward remittances

• When settlement is done on next working day; it is a Tom

• When settlement is done on the same day; it is a Cash transaction

• When the settlement date is beyond the spot date, it is called a

• Spot, Tom and Cash transactions are called ready transactions. 23

Calculation of Spot Date for USD/INR trade

1. Where there is NO intervening holiday in either of the currency markets

2. Where there is/are intervening holiday/(s) in BOTH markets

Calculation of Spot Date for USD/INR trade

Calculation of Cash date for USD/INR trade

USD/INR will be 53.1600 53.1700

(For USD/INR pair the cash rate is at a discount to spot rate)

A spot deal in foreign exchange is sale / purchase of one currency

Forward - When the settlement is done beyond the spot date27

Value Date – Time Scale.

Cash Tom Spot Forward Maturities

Cash Deal is done today for delivery Today

Tom Deal is done today for delivery Tomorrow

Spot Deal is done today for delivery on 2nd Business Day

Forward Deal is done today for delivery beyond Spot Date

• !!! Although no money changes hands/ no accounting entries are passed,

Calculation of Forward Rate

FM= spot rateforward periodinterest difference/100*time