M.com (a&F)-IfM-Foreign Exchange Markets

8/2/2019 M.com (a&F)-IfM-Foreign Exchange Markets

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FOREIGN EXCHANGE MARKETS


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-The foreign exchange market is a market . where foreign

currencies are bought and sold. It is an over- the counter

market.

-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.


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- 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

just be 4.30 a.m in London. In order to accommodate dealers

from different countries ,the foreign exchange market has to

function round- the- clock.


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Foreign Exchange Transactions:

- Settlement of a transactions takes place by transfer of depositsbetween

the two parties

-There are cases where delivery of foreign exchange takes place the

same day. Such transactions are known as ready transactions. Orsettlement date , value date.

- When the actual delivery takes place the next day, the

transactions are known as the value next day transactions.

- There is also spot transactions where the actual delivery takes

place with in two business days.


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- 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 zonespermits the delivery of the currency even earlier.

- If the currency is delivered the same day , it is known as the value-

same day, if it is done the next day , the contract is known as the

value next- day contract.


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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 ratein 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.


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- 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.


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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, investmentmanagers and corporate treasurers who trade currencies seeking

short term profits by belting on the direction of changes in their

relative price.)


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-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

nations 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 orbuyers 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.


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CustomerBuying us $

for IndianRupee.

Buyers

Local bank

Major banksrepresenting

inter bankmarket

Sellers

Local bank

Customerselling US $

To get IndianRupee.

Foreign

ExchangeBroker

PARTICIPANTS IN FOREIGN EXCHNAGE MARKETS


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-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.


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- 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.


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-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 thebanks need to make a profit in these transactions.

- The difference between these two quotes from the banks profit and

is known as the spread . In the above example the spread is Rs 0.30

per US dollar.


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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 one month three months

Rs 40.00 40.30 Rs 39.80 40.20 Rs 39.60 40.10


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-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 one-month three months

Rs 40.00 - 30 Rs (20) (10) Rs (40) (20)

Forward premium and discount

In the above quotes, it is found that the longer the maturity, thegrater is the change in the forward rates. Again, with longer maturity

the spread too gets wider.

-This is because of uncertainty in the future that increases with

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.


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-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 forcommon 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.


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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 foundthrough 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 $ 1* US $ 1/ C $ 0.78 = Rs 44.87/ C$.

Forward cross rate

The selling rate of one currency is divided by the buying rate of another

currency and vice-versa


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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.


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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 messagecommunications between banks . It dos not transfer money ,or any

other financial materials.


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- 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 SWIFT 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.


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-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 swift


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- 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.


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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.


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- 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

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M.com (a&F)-IfM-Foreign Exchange Markets