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FOREIGN EXCHANGE MARKETS

-The foreign exchange market is a currencies are market.

market . where foreign

bought and sold. It is an over- the counter

-This means that there is no single physical or electronic market place or an organised exchange (like stock exchange) with a central trade clearing mechanism where traders meet and exchange currencies. - The market itself is actually a world wide network of inter-bank traders, consisting primarily of banks, connected by telephone lines and computers. -The market features in each country are influenced by the local regulatory frame work.

- In

the

UK

or

the

USA

the

market

relies

more

on

the

communication network, - While in Frankfurt, Paris and some other European countries physical meeting of participants at browsers is also customary. -Since Foreign Exchange dealers are spread all over the globe. - The time of transactions differs from one place to another depending up on the longitude of the place. -Example:If a dealer in India transactions at 10.A.m . It will in London. In order to accommodate dealers

just be 4.30 a.m

from different countries ,the foreign exchange market has to function round- the- clock.

Foreign Exchange Transactions: Settlement of a transactions takes place by transfer of deposits between the two parties -There are cases where delivery of foreign exchange takes place the same day. Such transactions are known as ready transactions. Or

settlement date , value date. - When the actual delivery takes place transactions are the next day, the

known as the value next day transactions.

- There is also spot transactions where the actual delivery takes place with in two business days.

- Depending upon the time elapsed between the transaction date and settlement date , foreign exchange transactions can be categorized into - Spot - Forward - Swaps. Spot in the spot market, currencies are traded for immediate delivery at a rate existing on the day of transaction. - Some times there are short date contracts where the time zones permits the delivery of the currency even earlier. - If the currency is delivered the same day , it is known as the valuesame day, if it is done the next day , the contract is known as the value ±next- day contract.

Currency Arbitrage in spot market: With fast development in the telecommunication system , rates are expected to be uniform in different foreign exchange markets, nevertheless inconsistency exists at times . -The arbitrageurs take advantage of the inconsistency and garner profits by buying and selling of currencies. They buy a particular currency at cheaper rate in one market and sell it at a higher rate in the other . This process is known as currency arbitrage. FORWARD In the forward market, contracts are made to buy and sell currencies for future delivery, say after one month, two months and so on. The rate of exchange for the transaction is agreed up on the very day the deal is finalized.

- Both parties have to abide by the contract at the exchange rate mentioned there in irrespective of whether the spot rate on the

maturity date resembles the forward rate or not. -In other words , no party can back out of the deal of changes in the future spot rate are not in his or her favour. -The value date in case of a forward contract lies definitely beyond the value date applicable to a spot contract . If it is a one month

forward contract, the value date will be the date in the next month corresponding to the spot value date. -Example; currency is purchased on 1 August if it is a spot

transaction the currency will be delivered on 3 August . But if it is a one-month forward contract, the value date will fall on 3

September. If the value date falls on a holiday, the subsequent date will be the value date.

SWAP; The purpose of swap in the forward market is to reap profits. There are two kinds of swap 1. option forward 2. Forward- forward swap PARTICIPANTS IN FOREIGN EXCHNAGE MARKETS In foreign exchange markets the participants can be identified at the base, are traditional users( such as tourists, importers, exporters and investors who exchange domestic currency for foreign currencies and vice versa). As well as traders and speculators ( Individuals, investment managers and corporate treasurers who trade currencies seeking ± short ±term profits by belting on the direction of changes in their relative price.)

-At the next level

are the commercial banks, which ac as clearing

house between users and earners of foreign exchange. -At the next level foreign exchange brokers. Through whom the

nation¶s commercial banks even out their foreign exchange inflow and out flows among themselves -Finally , at the top is the nations central bank which acts as a seller or buyers of last resort when the nations total foreign exchange earnings and expenditures are required . When the market rate of the currency reaches the upper lines (upper intervention point) of the bond. The central bank of the country must increase sales of its currency in exchange for other currencies. -Similarly the central bank must sell foreign exchange and buy its own currency when the market rate reach the lower intervention point.´

PARTICIPANTS IN FOREIGN EXCHNAGE MARKETS

Customer Buying us $ for Indian Rupee.

Buyer¶s Local bank

Major banks representing inter bank market

Sellers Local bank

Customer selling US $ To get Indian Rupee.

Foreign Exchange Broker

-Since the purpose of Inter-bank transactions not only to meet the foreign exchange demand of the ultimate customers but also to reap gains out of movement in foreign exchange rates. Exchange rate types: In a foreign exchange market where different currencies are bought and sold, it is essential to know the ratio between different currencies. Or how many units of one currency will equal one unit of another currency. The ratio between two currencies is known as an exchange rate. Direct and Indirect Quote The methods quoting exchange rates are both direct and indirect. - Direct quote gives the home-currency price of a certain amount of foreign currency , usually one or 100 units.

- In India quote gives the exchange rate between the rupee and the US dollar in a direct way, the quotation will be written as Rs. 35/us $. -In case of indirect quoting the value of one unit of home currency is presented in terms of foreign currency. if india adopts indirect quotation , the banks in india will quote the exchange rate Rs US $ 0.02857/ Re -If the quotation is published in a third country to which neither of the two currencies belongs, the usual practices is to put the stronger currency on the numerator. - if the US dollar- Indian rupee rate is published in London it will be quoted as US$ 0.02857/ Re.

-In practice the method of quotation varies from one market to another. Buying and Selling Rates buying quote of a currency denotes the rate at which banks buy it, selling quote at which banks sell it. -The buying rate is also known as the bid rate. The selling rate is known as the ask rate or offer rate. - The bid rate is always given first .followed by the ask rate quote. - if the rupee-US dollar rate is Rs.40.30/ US $ -EXAMPLE: A bank in india selling one US dollar to customer will change the selling rate. That is Rs 40.30 per US dollar . Since the banks need to make a profit in these transactions. - The difference between these two quotes from the bank¶s profit and is known as the spread . In the above example the spread is Rs 0.30 per US dollar.

Spread = (ask price ± Bid price) / Ask price* 100 Spread = ( 40.30-40.00) / 40.30*100 =0.746% Forward market quotation;The quotes for the forward market are also published in the new papers and periodicals -The quoting rates may be expressed as outright quotes or as swap quotes. - The outright quote for US dollar in terms of the rupee can be written for different periods of forward contracts as follows Spot Rs 40.00 ± 40.30 one ±month Rs 39.80 ± 40.20 three months Rs 39.60 40.10

-The swap quote . On the other hand , expresses only the difference between the spot quote and the forward quote ,it can be written follows Spot Rs 40.00 - 30 one-month Rs (20) ± (10) three months Rs (40) ± (20)

Forward premium and discount In the above quotes, it is found that the longer the maturity, the grater is the change in the forward rates. Again, with longer maturity the spread too gets wider. -This is because of uncertainty in the future lengthening of maturity. - The change in forward rates may be upward or downward, With such movements , disparity arises between spot and forward rates. This is known as the swap or forward rate differential. that increases with

-If the forward rate is lower than the spot rate, it will be a case of forward Discount -If the forward rate is higher than the spot rate is would be known as forward premium. For premium (Discount) = (n ± day forward rate ± spot rate) / spot rate *360/ n Cross rates: The value of a currency in terms of another one is not known directly. In such cases, one currency is sold for common currency. And again the common currency is exchanged for the desired currency . This is known as cross rate trading and the rate established between the two currencies is known as the cross rate.

Spot cross rates The selling rate of the Canadian dollar in india can be worked out by selling the rupee for the US dollar at Rs .35.20 /US $ and then buying Canadian dollars with the US dollar at C$ 0.76 /US $ this means Rs. 35.20 /US $ 1* US $ 1/ C$ 0.76 = Rs= 46.32/ C$. The buying rate of the Canadian dollar in India can be found through buying the Indian rupee for the US dollar at Rs 35.00/ US $ and selling the Canadian dollar for US dollar at C$ 0.78/ US $ this means Rs 35.00/ US $ Forward cross rate The selling rate of one currency is divided by the buying rate of another currency and vice-versa 1* US $ 1/ C $ 0.78 = Rs 44.87/ C$.

Example: One Month forward rate in case of the two currencies is Rs 34.50 -34.80 /US $ and C $0.79 ± 0.83 / US $ the forward rate of the Canadian dollar in terms of the rupee can be found as Rs 34.80/ C$ 0.79 = Rs 44.05 / C$ Rs 34.50/ C$ 0.83 = Rs 41.57 combining the two we get Rs = 41.57- 44.05 /C$. Nominal and Real exchange rates: The exchange rates mentioned in the preceding section are the nominal exchange rates/ bilateral exchange rates. They represent the ratio between the value of two currencies at a particular point of time.

The Real exchange rate on the other hand is the price ±adjusted nominal exchange rate . The relationship between nominal exchange rate ,e and the real exchange rate er can be written in the form er = e P / p
*

Where P and p are domestic and foreign price indices.

SWIFT (society for worldwide inter bank financial telecommunication) A corporative society that provides highly secure message

communications between banks . It dos not transfer money ,or any other financial materials.

- But simply provides

information. It also standardized forms

between members so as to reduce costs. And operational risk. -Founded in 1973 and head quarters in Belgium. SWIFT has thousands of members in more than 200 countries world wide. - SWIFT offers as its principals service to its members and other financial institutions, a highly secure automated and standardized financial messaging service , known as ³SWIFT Net FIN´. - Which is used by financial institutions to perform international payment and other transactions. On behalf of their clients. SWIFT only has contractual relation with financial institutions. And not with the clients of those institutions.

-India was 74th country

to join the society for worldwide inter-bank

financial Tele-communication (SWIFT) network on December 2, 1991. - The initial membership of banks in india was 34. using advanced data processing and telecommunication technology the swift system is based on the following. - It is available worldwide , 24 hours a day ,7 days a week. - Standard message formats for transaction enable members to avoid language and inter petition problem and permit the automated handling of message. -Delivery of a message is very ³swift´

- Ensure a high level of security while transmitting all messages. -Assumes financial liability for the accuracy , completeness and timely delivery of all validated messages. - Each country has a SWIFT gateway called the Swift Access Point (SAP) to which the individual users terminals are connected. -The users are connected to the SAP through leased lines with PSTN as Backup. -The SAPs are connected to the regional processors , which in turn are connected on-line to mother operating centers in the USA, and Netherlands from where the messages are distributed to the

ultimate destination address indicated in each message.

Indian Foreign Markets and their Characteristics:
Foreign exchange markets in India works under the central Govt in india and executives wide powers to control transactions in foreign exchange. -The foreign exchange market act,1999 are FEMA regulates the whole foreign exchange market in india. - Before this act was introduced the foreign exchange market in india was regulated by the Reserve bank of India, through the exchange control department by the FERA are foreign exchange regulation act, 1947. - After independence FERA was introduced as a temporary measure to regulate the inflow of the foreign capital. But with the economic and industrial development the need for conversation on foreign currency was urgently felt and on the recommendation of the public accounts committee - The Indian Govt passed the foreign exchange regulation act. 1973, and gradually this act became famous as FEMA.

- Until 1992 all foreign investment in india and the repatriation of foreign capital required previous approval of the Government. - The foreign exchange regulation act rarely allowed foreign majority holding for foreign investment policy announced in 1991, declared automatic approval foreign exchange in india for 34 industries. - These industries were designated with high priority upto an equalent limit of 51% of the foreign exchange market in india is regulated by the Reserve Bank of India through the exchange control department