Foreign Exchange

Markets & its

Operating
Mechanism

Financial Institutions and

Markets
Prepared By: Rubab Fiaz (152-FMS/BBA-2Y/F22)
Nazish (144-FMS/BBA-2Y/F22)
Fiza Rafique (141-FMS/BBA-2Y/F22)
Aqsa Shehzaadi (153-FMS/BBA-2Y/F22)
Farwa Zainab (146-FMS/BBA-2Y/F22)

Presented To: DR. Aijaz Mustafa Hashmi

2
Contents:
 Participant
 Definition  Pakistan Interbank Foreign Exchange
 History Market
 Types  Methods of Quoting Exchange Rates
 Functions  Forex Transactions (Supply And
 Mechanism Demand Dynamics In Pakistan's Forex
 Features Market)
 Foreign Exchange Risk

 Future

3
 DEFINITION:
• Foreign exchange (Forex) is the market for trading currencies.

• It allows businesses and individuals to:

 Conduct international trade (importing/exporting goods and

services).

 Invest in foreign assets (stocks, bonds, real estate).

 Hedge against currency fluctuations (protect wealth from

exchange rate movements).

• The Forex market is the largest financial market globally, with

trillions of dollars traded daily.
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The Nature of the Forex Market: A Decentralized
Powerhouse

24/5 Operation & Decentralized Network:

 The Forex market operates electronically, 24 hours a day, 5

days a week, across different time zones.

 Unlike a traditional stock exchange, it has no physical

location; it's a decentralized network of:

• Commercial Banks
• Investment Banks
• Central Banks
• Forex Brokers
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• Individual Traders
HISTORY:
• The foreign exchange market has undergone
significant transformations throughout history,
shaping the global economy and financial systems.
Here are the key milestones:

 Bretton Woods System (1944-1971)

 The Plaza Accord (1985)
 Formation of the European Union and the Euro
 Emergence of Internet Trading
 Evolution of Forex Markets
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TYPES:

1. Spot Market (Immediate Delivery): Buy/sell

currencies now for settlement in 2 business
days (think exchanging cash for travel).

2. Forward Market (Locking Rates): Contracts

to buy/sell currencies at a set rate on a future
date (businesses use this to hedge against rate
changes).

3. Futures Market (Standardized Contracts):

Similar to forwards, but standardized
contracts traded on exchanges for speculation
on future rates.
7
CONTD.

4. Swap Market (Complex Transactions):

Simultaneous exchange of 2 currencies with repurchase
agreements, often used for managing debt or hedging
interest rates.

5. Options Market (Flexibility & Risk Management):

Grants the right, not obligation, to buy/sell a currency at
a specific price by a certain date (used for hedging or
speculation).
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PARTICIPANTS OF FX MARKET:
 The Players in Forex

 Central Banks: Regulate monetary policy and influence

exchange rates.

 Commercial Banks: Facilitate currency exchange for

businesses and individuals.

 Investment Banks: Trade currencies on behalf of clients and

for their own profit.

 Forex Brokers: Provide platforms and services for individual

traders to access the Forex market.

 Speculators: Take calculated risks in the hope of profiting

from currency fluctuations. 9
FUNCTIONS:

 Facilitates Currency Conversion: The primary function of the Forex market is to

facilitate the conversion of one currency into another.

 Provides Liquidity: The Forex market is the most liquid financial market in the
world, with trillions of dollars traded daily.

 Determines Exchange Rates: Exchange rates, or the relative value of one currency
compared to another, are determined by supply and demand in the Forex market.

 Facilitates Hedging and Risk Management: Forex markets provide a platform for
businesses and investors to hedge against currency risk.

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CONTD.

 Supports International Trade and Investment: The Forex market plays a crucial role

in facilitating international trade and investment by providing a mechanism for buying

and selling currencies.

 Enables Speculation and Investment: In addition to facilitating transactions, the

Forex market provides opportunities for speculation and investment.

 Promotes Price Discovery: The Forex market is a decentralized over-the-counter

(OTC) market where prices are determined by supply and demand.

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MECHANISM:
 Over-the-counter (OTC) Market: Trades happen electronically between
participants through a network of forex brokers and banks. There's no physical
exchange location.
 Currency Pairs: Currencies are always traded in pairs (e.g., USD/EUR, JPY/USD).
The price of one currency is quoted in terms of another.
 Bid and Ask Prices: The bid price is the maximum a buyer is willing to pay for a
currency, while the ask price is the minimum a seller is willing to accept. The
difference (spread) is the broker's profit.
 Market Participants: Major players include banks, corporations, investment firms,
central banks, and retail investors.
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FEATURES:

o Largest & Most Liquid Market: The Forex market boasts the highest daily trading volume of any
financial market globally, exceeding $7 trillion. This ensures easy entry and exit for participants.

o 24/7 Operation: Unlike stock exchanges with limited trading hours, the Forex market operates
continuously across the globe, following the sun as financial centers open and close.

o Decentralized Market: There's no central location or exchange controlling the Forex market.
Transactions happen electronically over vast networks of banks and other institutions.

o Wide Range of Participants: A diverse cast of characters participates in Forex, including central
banks, commercial banks, investment banks, forex brokers, retail investors, and corporations. 13
CONTD.
o Leveraged Trading: Forex allows for leveraged trading, where a
smaller investment controls a larger position. However, leverage
is a double-edged sword, amplifying both profits and potential
losses.

o High Volatility: Exchange rates constantly fluctuate based on

various factors, creating a dynamic and potentially volatile
market environment.

o Accessibility: Technological advancements have made Forex

trading more accessible to retail investors through online
platforms and forex brokers. 14
PAKISTAN INTERBANK FOREIGN EXCHANGE
MARKET
 The Pakistani Rupee (PKR) in Forex
 The Pakistani Rupee (PKR) is a floating exchange rate
currency.
 Its value fluctuates based on market forces like supply
and demand.
 The SBP intervenes in the Forex market to maintain
exchange rate stability.
 Factors affecting PKR's value include:
 Pakistan's economic performance
 Global oil prices (Pakistan is a major oil importer)
 Foreign investment inflows
 Political stability 15
CONTD.

 Exchange Rate Regime:

• Market-Based Flexible System (since May 1999): Supply and demand determine
the exchange rate between the Pakistani Rupee (PKR) and other currencies.

• Interbank Market: Authorized dealers (banks and money changers) trade currencies
to meet client needs (businesses, individuals, government).

• Floating Rates: No fixed peg to another currency; PKR value fluctuates based on
market forces.

16
CONTD.

 Foreign Exchange Reserves:

• The State Bank of Pakistan manages the country's

foreign exchange reserves, authorized by the Foreign
Exchange Act of 1947 and the State Bank of Pakistan
Act of 1956. An Investment Committee oversees
reserve management, aiming for safety, liquidity, and
optimal returns. Reserves are diversified across assets
to manage risk and facilitate external debt repayment
while maintaining macroeconomic stability.
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SUPPLY AND DEMAND DYNAMICS IN PAKISTAN'S
FOREX MARKET

 Factors Affecting Demand for PKR:

1. Imports: Higher import demand requires converting foreign currency (USD) to PKR,
increasing PKR demand.

2. Foreign Investment Inflows: Investments from abroad involve converting foreign

currency to PKR, boosting PKR demand.

3. Remittances: When overseas Pakistanis send money back home, they convert foreign
currency to PKR, increasing PKR demand.

4. Speculation: If traders believe the PKR will appreciate, they may buy PKR now, driving
up demand. 18
CONTD.

 Factors Affecting Supply of PKR:

1. Exports: When Pakistani businesses export goods and services, they receive foreign
currency which is converted to PKR, increasing PKR supply.

2. Foreign Investment Outflows: When foreign investors withdraw their investments from
Pakistan, they convert PKR to foreign currency, increasing PKR supply.

3. Government Intervention: The State Bank of Pakistan (SBP) can occasionally sell foreign
currency reserves (mostly USD) to increase the supply of USD in the market, which
weakens PKR (considered a form of market intervention). 19
IMPACT ON PAKISTAN'S ECONOMY:

 Export Competitiveness: A weaker PKR can make

Pakistani exports cheaper on the global market, potentially
boosting export volumes.

 Import Costs: A stronger PKR can make imports cheaper

for Pakistani businesses and consumers.

 Inflation: Exchange rate fluctuations can impact the cost of

imported goods, potentially affecting inflation.

 Remittances: Millions of overseas Pakistanis send money

back home, contributing significantly to Pakistan's economy.
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GRAPHICAL REPRESENTATION:

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METHODS OF QUOTING EXCHANGE RATES IN
PAKISTAN:

In Pakistan, foreign exchange rates are typically quoted as PKR/USD (Pakistani

Rupees per US Dollar). This means the price is given in terms of how many
Pakistani Rupees it takes to buy one US Dollar.

1. Direct Quote:

This is the most common method, where the price is directly quoted as PKR/USD.

2. Indirect Quote (Less Common):

In some rare cases, an indirect quote might be used, expressed as USD/PKR (US
Dollars per Pakistani Rupee). 22
CONTD.

3. Bid and Ask Prices:

o Bid Price: The price at which authorized dealers (banks and money changers) are willing
to buy foreign currency (USD) from you. It's typically lower than the ask price.

o Ask Price: The price at which authorized dealers are willing to sell foreign currency (USD)
to you. It's usually slightly higher than the bid price.

4. Interbank vs. Customer Rates:

o Interbank Rate: The exchange rate at which authorized dealers trade foreign currency
amongst themselves. This rate is generally not available to the public.

o Customer Rate: The rate applied to retail customers exchanging foreign currency. 23
FACTORS AFFECTING EXCHANGE RATES IN
PAKISTAN

 Domestic Factors:  International Factors:

 Trade Balance  Global Economic Conditions

 Monetary Policy
 Interest Rates in Major Economies
 Inflation
 Exchange Rates of Major Currencies
 Economic Growth
 Foreign Direct Investment (FDI)
 Political Stability
 Remittances from Overseas Pakistanis

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FOREIGN EXCHANGE RISK

 Currency Volatility: Fluctuations in exchange rates

can lead to significant losses if not managed
properly.
 Leverage Risk: Leveraging can magnify both gains
and losses, leading to substantial financial losses if
the market moves against you.
 Counterparty Risk: There's always a risk that the
other party in a forex transaction may default on
their obligations.
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SBP’S ROLE IN THE FOREX MARKET

 To manage the exchange rate mechanism.

 Regulate inter-bank forex transactions and

monitor the foreign exchange risk of the

banks.

 Keep the exchange rate stable.

 Manage and maintain country's foreign

exchange reserves.

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UNIQUE FEATURES OF THE PAKISTANI FOREX
MARKET:
 Managed Float: The SBP manages the exchange rate within a band, intervening when
necessary to maintain stability and prevent excessive volatility.

 Interbank Market: This is the primary platform where ADs trade currencies electronically,
determining the interbank exchange rate.

 Kerb Market: An informal market exists alongside the formal system, where currency can
be exchanged at slightly different rates. The SBP discourages reliance on the kerb market.

 Hawala System: This informal money transfer system is used by some overseas Pakistanis
to send remittances back home. While convenient, it can bypass official channels and raise
concerns about money laundering. 27
CHALLENGES IN THE PAKISTANI FOREX
MARKET:

Balance of Payments: Pakistan's trade deficit, where imports exceed exports, creates a
demand for foreign currency, putting pressure on the Rupee's value.
Speculative Trading: Excessive short-term currency speculation can increase volatility
and make it difficult for the SBP to manage the exchange rate effectively.
Foreign Exchange Reserves: Maintaining adequate foreign exchange reserves is crucial
for the SBP to intervene in the market and stabilize the Rupee.
Exchange Rate Management: Balancing the need for a stable exchange rate to facilitate
trade and investment with allowing some flexibility to reflect economic realities is a
constant challenge for the SBP.
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FUTURE OUTLOOK:
 Potential Trends: Increased regulations to curb speculation
and promote stability are likely. Further integration with global
markets could enhance efficiency and attract investment.

 Influencing Factors: Global economic conditions, Pakistan's

domestic economic performance, SBP policies, and
technological advancements will all shape the future.

 Challenges and Opportunities: Mitigating volatility,

enhancing transparency in interventions, and developing a
skilled workforce are key challenges.
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