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Foreign Exchange Market
A market for the purchase and sales of foreign currencies is called “foreign exchange market”.
Foreign Exchange Market
Need of foreign exchange market
Need for foreign exchange market arises because of the multifarious international currencies and need for trading in such currencies
Foreign Exchange Market
Electronic market Geographical dispersal Transfer of purchasing power Intermediary Volume Provision of credit Minimizing risks
Foreign Exchange Market
Inter bank market
It’s a wholesale market through which most currency transactions are channeled. It is used for trading among bankers It’s a market through which around 95% of the foreign exchange transactions are carried out
Foreign Exchange Market Three constituents of inter bank market Spot market Forward market Swap market .
.Foreign Exchange Market The SWIFT It is an international bank communications network that links electronically all brokers and traders in foreign exchange.
Their role comprises in actual market making.Foreign Exchange Market Participants (1)Foreign exchange dealers Bank and non-bank agencies take part in activities of these dealers. Their profit comes from buying exchange at bid price and selling it at a higher offer/ask price. . They actively deal in foreign currency for their own account. They help in maintaining the foreign currency within the trading limit.
importers. . tourists and others who use foreign exchange market to facilitate the execution of commercial or investment transaction.Foreign Exchange Market (2)Individuals and firms Exporters. international portfolio investors. MNC’s.
Biggest speculator includes leading bank and investment bank. without engaging in the other sorts of business dealing for which foreign exchange is essential. .Foreign Exchange Market (3) Speculators and Arbitragers Speculators buy and sell currencies solely to profit from anticipated changes in exchange rates.
Government make deliberate attempt for altering the exchange rate between two countries by buying one and selling another is called interventions. .Foreign Exchange Market (4) Central Bank and Treasuries They use FEM for the purpose buying and selling country’s foreign exchange reserves.
.Foreign Exchange Market (5) Foreign exchange brokers These are commission agents who bring together suppliers and buyers of foreign currency Some of the service give by them are:Provision of information on prevailing and future rates of exchange Maintaining confidentiality of participants in foreign exchange market Helping banks to keep at minimum the contacts with other traders.
delivery and payment for the same take place between banks usually on the second following business day.Foreign Exchange Market Transactions Spot transactions Foreign exchange transaction where by the purchase of exchange. .
Foreign Exchange Market Forward transactions Foreign exchange transaction where by a specified amount of one currency is exchanged for a specified amount of another currency at a future value date .
Foreign Exchange Market Swap transactions Foreign exchange transaction where by simultaneously and sale of given amount of foreign exchange for different value dates takes place. .
Foreign Exchange Market Rate and Quotations Inter-bank Quotations Direct Quotation Indirect Quotation Bid Quotation Ask (offer) Quotation Cross rates .
income or expenditures owing to a unanticipated changes in exchange rates are known as foreign exchange risk is present in uncovered foreign exchange claim or liability.Foreign Exchange Market Foreign exchange risk Fluctuation and consequent appreciation or deprecation in the value of assets. . Uncovered claim in foreign currency is “long” and an uncovered liability in foreign currency is “short”. liabilities.
Foreign Exchange Market Payment methods Payment in domestic currency Payment in any currency Travails of trading currencies Spot exchange rate Forward exchange rate .
Foreign Exchange Market Foreign exchange risk. loss arises when domestic currency is exchanged for a foreign currency in relation to business proposed to be under taken. The occurrence of exchange risk can be explained as follows: .illustration Where some of the assets of an enterprise are not denominated in the currency of its home country. foreign exchange risk or exposures arises. Owing to the exchange rate fluctuations.
Foreign Exchange Market Indian entrepreneur enters into a contract for the purchase of machinery with the American supplies.00/$1 after 3 months . » » Exchange rate at the time of contract 47. payment to be made after 3 months.50/$1 Value of machinery $50000 » » The value of Indian rupee declines to 49.
dollar) = $50000 Amount to be paid to US exporter at spot rate (Indian rupees): $50000*Rs.75000 .S.24.47.50 = Rs.49.000 Loss suffered: Rs.50.00 = Rs.23.000 Amount to be paid to US exporter at future rate (Indian rupees)/amount required for purchasing US $ 50000 on that date: $50000*Rs.75.Foreign Exchange Market Results: Amount to be paid to US exporter at the time of contract (U.
Or In short the method securing oneself against loss from various risks is called hedging .Foreign Exchange Market Risk management tools Hedging techniques Mechanism through loss on a transaction can be minimized by a bull operator buying a put option (right to sell) where he agrees to purchase the security from some body.
Foreign Exchange Market Types of exchange risks Transaction exposure Translation exposure Economic exposure .
at a future date. of a specified amount of one currency against dollar payments at the rate which is determined at the time of contract Future contract Firm legal commitment to buy or sell a stipulated quantity of a specified asset at a predetermined price on a predefined future.Foreign Exchange Market Techniques of hedging foreign exchange risk Forward contract Contract between banks which calls for delivery. . which is traded on a wellorganized exchange.
Foreign Exchange Market Currency Arbitrage Buying currency in one market and selling the same in another market simultaneously .
Foreign Exchange Market Interest rate parity theory According to this theory the currency of the country with a lower interest rate should be at a forward premium in terms of the currency of the country with the higher rate .
Foreign Exchange Market Covered Arbitrage Movement of short-term funds between two currencies to take advantage of interest differentials with exchange risk eliminated by means of forward contracts. .
.Foreign Exchange Market SWAPS Private arrangements where by cash flows in future are exchange according to prearranged formula are called swaps.
equivalent loan in another currency. Types of currency SWAP Fixed currency SWAP Floating currency SWAP .Foreign Exchange Market Currency swap Exchange of principle and fixed rate interest payments on a loan in one currency for principle and fixed rate interest payments on approx.
Foreign Exchange Market Benefits of currency SWAP Choice Hedge Benefit firms Equilibrium Low cost Tax savings Risk-free rate Subsidized loans Off-balance sheet items .
Foreign Exchange Market Management of exchange rate (A) Fixed rate system Bretton woods Pegged rate Currency board Gold standard (B) Semi-fixed rate system Bands Target zones Pegs and baskets The crawling pegs .
Foreign Exchange Market (C) Floating rate system .
Indian Foreign Exchange Markets Currency options. This concept started gaining relevance in 1991 when liberalization was initiated by Govt. the main purpose was to enable cooperates importers and exporters with foreign investors.until the beginning of 90’s the currency option is largely unnoticed in India. . Indian context . since 1982 option market witness a tremendous growth this was on the account of desire to manage foreign currency and interest rate risk more effectively.was introduced in 1982 in Philadelphia.
Thus to satisfy the cooperate and financial institutions. . Provision of benefits of favorable movement in rates.Indian Foreign Exchange Markets Incentives and uses Provision of insurance cover against adverse rate movement while keeping the chance to gain if the rate move favorably.
Indian Foreign Exchange Markets User of currency options Financial firms Firms Banks .
Maintain accounts abroad to meet public requirements.Indian Foreign Exchange Markets Role of commercial banks Take active part in financing of foreign trade. They help in regulating the Foreign Exchange Regulations Act (FEMA) They maintain correspondent or agency relationship with the banks abroad. .
Indian Foreign Exchange Markets All sales and purchases of foreign currency are routed through the accounts they maintain with the banks in important financial centers abroad. They quote rates at which they buy and sell foreign exchange in accordance with rules and regulations of RBI and FEDAI (Foreign Exchange Dealer Association of India) The rates quoted depends upon the rates prevailing in inter-bank or international market and the banks margin profit. .
Currency Payments Borrowings VOSTRO a/c – these constitutes the rupee a/c of foreign banks opened with Indian banks.Foreign Exchange Market Foreign currency accounts NOSTRO a/c –foreign currency a/c maintained by banks in India with banks in abroad (our a/c with you). (Your a/c with us) Payments .
.Foreign Exchange Market EXCHANGE RATE MANAGEMENT Every country that is the member of the agreement with IMF has an obligation to keep the fund and the members of the fund informed of the exchange arrangements they wish apply and of any subsequent changes in them with fund to ensure orderly exchange arrangements Main purpose is to promote a stable system of exchange rate.
Foreign Exchange Market EXCHANGE ARRANGEMENT Fluctuating or Fixed exchange rate in term of other currencies or the special drawing rights or some other basket of currencies. . Cooperative arrangements by which members maintain the value of their currencies in relation to the value of the currency or currencies of other members.
A striking feature of the LERMS has been that it followed a dual exchange rate system. . Some of the important features are as follows. dollar replaced pound sterling as the intervention currency. 1992.Foreign Exchange Market Liberalized Exchange Rate Management System It came to introduce with effort from March 1. The U.S. All Foreign exchange receipts on the current account transaction (exports and remittance) were required to be surrendered to the Authorized Dealers (Ads) in full as hitherto.
The balance 60 percent of foreign exchange can be sold in the free market for permissible transactions at the free market rate quoted by the ads. taxes to be levied on these exports proceeds. 40 percent was to be surrender to the RBI at the official rate of exchange announced by the RBI. .Foreign Exchange Market Of the total Foreign Exchange receipts.
All payments involving foreign exchange are also effected at market-determined exchange rate through ads . both current and capital are put through by Authorized Dealers (ads) at market-determine-rates of exchange.Foreign Exchange Market Unified Market Determined System. 1993 The unified Market Determined Exchange Rate System from March 1993 replaced the dual exchange rate system. The important features of the system are as follows: All the Foreign exchange transactions. The exporters instead of surrendering their export earnings to the RBI shall hereafter do so to the ads.
RBI enters into swap transactions under which it buys U.S. dollars from Ads for spot deliveries and sells the same for purposes approved by the government of India.Foreign Exchange Market The market rate of exchange is determined by the RBI on the basis of the prevailing market rates within a 5 percent margin on either side of the market rate. RBI buys U.S. Duetsche mark or Japanese yean. dollars spot and sells forward for period ranging for 2 to 6 months.S. Using U. dollar as the intervening currency. instead of buying spot bound sterling. Accordingly. .
Forward contracts are allowed for remittance of dividend in respect to FDI.Foreign Exchange Market Beside the selling and buying rates of Ads RBI makes announcement of its own reference rate based on the rates quoted by a few selected banks in Bombay at noon. the EBI reference rate being use for effecting transactions in SDRs and with countries in Asian clearing union. . Splitting of currency exposure and long-term forward cover is allowed in order to provide depth to the exchange market and flexibility to market operators.
. Convertibility may be of two types Current account convertibility: .Convertibility for current international transaction is known as current account convertibility.Foreign Exchange Market Currency Convertibility The freedom to convert one currency into other internationally accepted currencies may be defined as currency convertibility.Convertibility capital movements are known as capital account convertibility. Capital account convertibility : .
. Payment of moderate amounts of amortization of loans for depreciation of direct investments. other current business including services and normal short.term banking and credit facilities.Foreign Exchange Market Currency Convertibility has defined as the freedom to buy or sell foreign exchange for the following purposes: The international transaction consisting of payment due in connection with foreign trade. Payment due as interest on loans and as net income from other investments. Moderate remittances for family living expenses.
Foreign Exchange Market Benefits of Currency Convertibility Enhanced confidence: Providing a signal to the international community that the country intends to manage its affairs without exchange restrictions. . which would eventually help enhance international confidence in the country’s policies. Capital flows: Chances of increased capital inflows.
Foreign Exchange Market BoP management: Freeing exchange restrictions would uplift the quality management of balance of payments of the country. Flexible and realistic approach in exchange rate determination combined with favorable macro economic policies would help provide a viable of balance of payments. Efficient allocation: elimination of exchange restrictions would tend to increase capital inflows in the short run thus and promoting efficiency in the allocation of these inflows to the best advantage of the nation’s economy. .
Foreign Exchange Market Consequences of Capital Account Convertibility Danger of India becoming fully vulnerable to free movement of foreign capital. which might worsen our macro economic imbalances The high interest rates prevalent in the Indian economy would serve as an open invitation to the inflow of capital. which will result in an appreciation of the rupee and consequent fall in exports Banks and financial institutions with their capital base are not financially strong to grapple with the intricacies of full convertibility .
.Foreign Exchange Market Exchange rates The different types of exchange rates are used in the Indian foreign exchange market is explained below briefly: Merchant rate: The rate at which the foreign exchange dealing takes place between a bank and the merchant business is called the “merchant rate”. which is agreed and executed the same day. Cash transaction or ready transaction or spot transaction refers to the contract for buying or selling foreign.
Foreign Exchange Market Inter-bank rate: “The inter-bank rate” also known as the “base rate” Refers to exchange rate quoted between banks. Depending upon the time taken for the realization of foreign exchange by the bank. two types of buying rates namely TT Buying Rate and Bill Buying Rate are quoted in India. .
Foreign Exchange Market Merchant rate: The rate at which the foreign exchange dealing takes place between a bank and the merchant business is called the “merchant rate”. Cash transaction or ready transaction or spot transaction refers to the contract for buying or selling foreign. . which is agreed and executed the same day. In foreign countries the charges are negotiable with their clients. Transaction costs are fixed and charged to the member banks by the FEDAI.
.Foreign Exchange Market Nominal Real & Effective exchange rates Nominal exchange rate it is the price of one currency in terms of others. Real exchange rate it measures purchasing power of the currency. RE = [NE * DP]/ FP Effective exchange rate a measure of appreciation and depreciation of currency weighted against the basket of currency with whom the country trades.
Booking of forward contracts based on past performance Cancellation and rebooking of forward contracts Forward cover for foreign direct investments in India Investments in overseas money/ debts markets Hedging of Tier I capital of foreign banks.Foreign Exchange Market RBI’s substantial relaxation for Forex Markets Foreign currency-rupee swaps – earlier the banks were permitted to access the market upto USD 50 million while offering the product to the customers. .
Foreign Exchange Market (A) Fixed rate system Gold standard Bretton woods Pegged rate Currency board .
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