FOREIGN EXCHANGE Adani Wilmar Limited

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INDEX

INTRODUCTION....................................................................................................................3 FUNCTIONS OF FOREIGN EXCHANGE MARKET.........................................................5 EXCHANGE RATE SYSTEM IN INDIA..............................................................................6 TYPES OF TRANSACTIONS AND SETTLEMENT DATES.............................................8 FOREIGN EXCHANGE RATES..........................................................................................11 PURCHASING POWER PARITY........................................................................................13 FOREIGN EXCHANGE PRODUCTS.................................................................................15 EXPORT IMPORT FINANCE..........................................................................................15 LETTER OF CREDIT...................................................................................................18 FINANCING EXPORTS...............................................................................................22 INTERNATIONAL FACTORING...............................................................................24 FORFEITING AN EXPORT FINANCE OPTION...................................................29 SWAPS...............................................................................................................................40 CURRENCY SWAPS....................................................................................................41 INTEREST RATE AND CURRENCY SWAPS..........................................................45 ROLE OF INTERMEDIARY.......................................................................................47 OPTIONS...........................................................................................................................48 Short.........................................................................................................................49 TYPES OF OPTIONS...................................................................................................62 OPTIONS PUT AND CALL......................................................................................63 OPTION STYLES.........................................................................................................64 THE OPTIONS CLEARING CORPORATION...........................................................65 PRICING OF OPTIONS................................................................................................66 OPTIONS TRADING IN OPTIONS.........................................................................71 FINANCING FOREIGN OPERATIONS.............................................................................76 RAISING FOREIGN CURRENCY FINANCE....................................................................78 FOREIGN EXCHANGE EXPOSURE..................................................................................81 TYPES OF EXPOSURE....................................................................................................81 MANAGEMENT OF FOREIGN EXCHANGE EXPOSURE.............................................84 CORPORATE PRACTICES IN MANAGING EXCHANGE RISK...................................86 FOREIGN EXCHANGE MANAGEMENT ACT (FEMA).................................................87 SOME SUGGESTIONS FOR MANAGING RISK..............................................................90 DERIVATIVES......................................................................................................................91 BIBLIOGRAPHY..................................................................................................................94

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SUMMER PROJECT FOREIGN EXCHANGE

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SUMMER PROJECT FOREIGN EXCHANGE

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INTRODUCTION

FOREIGN EXCHANGE Foreign Exchange can be defined as the system or process of converting one national currency into another and of transferring the ownership of money from one country to another. Foreign Exchange can also be said as that section of Economic Science that deals with the means and methods by which rights to wealth in one countrys currency are converted into rights to wealth in terms of another countrys currency. In this definition the term currency includes not only such notes and coins as are legal tender, but also all instruments credit instruments which are capable of being used as currency, such as bills of exchange, promissory notes, cheques, drafts, airmail transfers, telegraphic transfers and all other instruments which convey to the holder a right to wealth. FOREIGN EXCHANGE MARKET The Foreign Exchange market plays the part of a clearing house through which purchases and sales of foreign currencies are offset against each other. The foreign exchange market, however, is not a market in the concrete sense of the term or a geographical entity. This term is used in an abstract sense only, meaning a number of buyers and sellers systematically in contact with each other for the purpose of transacting foreign exchange business. This is the sense in which the term market is used in Economics.

Structure of Foreign Exchange Market Retail market Wholesale market

The Retail Market is a market in which travelers and tourists exchange currencies through currency notes or travelers cheque. The Wholesale Market is a market wherein exchange of currencies takes place thorough commercial banks, investment banks, corporations, central banks and various institutions. So, this market is also termed as interbank market

NRIBM

SUMMER PROJECT FOREIGN EXCHANGE

2003-2004

3

Price Makers

Primary Price Makers

Secondary Price Makers

The Primary Price Makers or professional dealers make a two way market to each other and to their clients i.e. they will quote a two way price and be prepares to take either the buy or the sell side. This group includes mainly commercial banks and some large investment dealers. A few large corporations have also assumed the role of primary dealers. Primary price makers perform an important role in taking positions off the hands of a dealer or corporate customer and then offsetting these by doing an opposite deal with another entity, which has a matching requirement. Eg. a primary dealer will sell USD against the euro to one corporate customer, carry the position for a while and offset it by buying USD against the euro from another customer or professional dealer. The primary price makers consist of three types of tiers or segments. In the First Tier there are a few giant multinational banks that deal in a large number of currencies, in large amounts and often deal directly with each other without using brokers. In the Second Tier are large banks that deal in a smaller number of currencies and use the services of brokers more often. Lastly, there are small local institutions, which make the market in a very small number of major currencies against their home currency. In retail market, there are entities, which make foreign exchange prices but do not make a two-way market. They are Secondary Price Makers. These types of entities are often driven by prices decided by Primary Price Makers.

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FUNCTIONS OF FOREIGN EXCHANGE MARKETThe Foreign Exchange department is a high-specialized department in a bank. A wide variety of services are rendered by a foreign exchange department. The principal function is the transfer of funds & currency from one nation to another. Broadly, the functions of a foreign exchange department may be classified as follows FINANCING EXPORTS The financial needs of the exporter right from the moment he conceives of the project and till he realizes export proceeds are provided by banks. The exporter may be eligible to receive cash incentives from the Government on exports. FINANCING IMPORTS Letters of credit are issued by banks on behalf of their importer - customers. The opening of the Letter of credit by the bank, whereby id undertakes to make payment to the exporter on shipment, enables the importer to conclude the deal with ease. REMITTANCE FACILITIES An importer in India has to pay the overseas exporter. Similarly, an Indian exporter has to receive payment from abroad. An Indian who is now employed abroad may like to remit funds for maintenance of his family in India. The payment into or from India can be arranged through any of the credit instruments. DEALING IN FOREIGN EXCHANGE Banks buy and sell foreign exchange form and to the public. To carry out this function banks have to keep sufficient stock of foreign exchange. FURNISHING CREIDT INFORMATION With a network of correspondent relationship with banks, abroad, a bank in India is in a position to furnish business information to exporter and importer in India.

NRIBM

SUMMER PROJECT FOREIGN EXCHANGE

2003-2004

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EXCHANGE RATE SYSTEM IN INDIA

Initially the Indian Re was under the fixed exchange rate system linked to the british pound . As sterling become more volatile, it came to pegged to basket of currency. Then with a view to making US$ directly available to authorized dealer for meeting their customer requirement, RBI commenced the sale of US$ for spot delivery with effect from 2nd Feb1987

ABOLITION OF STERLING RATE SCHEDULE The abolition of system of regulating exchange rates through the sterling rate schedule enabled the banks to quote exchange rates to customer on the basis of on going market rates. Its abolition put an end to era of fixed exchange margins. RBI brought in a system where by Authorized Dealers could have an opportunity to change rates eve in the course of day if such changes were w