Risk Management in Foreign Exchange

Internship report on
“A PROJECT STUDY ON RISK MANAGEMENT IN FOREIGN EXCHANGE WITH
SPECIAL REFERENCE TO JAMMU AND KASHMIR BANK, SRINAGAR”
By
ISHFAQ GULL
4SH13MBA26
Submitted to
VISVESVARAYA TECHNOLOGICAL UNIVERSITY, BELGAUM
In partial fulfillment of the requirements for the award of the degree of
MASTER OF BUSINESS ADMINISTRATION
Under the guidance of
INTERNAL GUIDE EXTERNAL GUIDE
Prof. Lt.Cdr.P.K Suresh Kumar Mr. Irfan Ahmad Malik
Professor & H.O.D Relationship executive IT
SDIT Kenjar J & K Bank. Srinagar
Department of MBA
SHREE DEVI INSTITUTE OF TECHNOLOGY, MANGALORE
BATCH: 2013-2015

DECLARATION
I, Ishfaq Gull, hereby declare that the internship report entitled “A Project Study On Risk
Management In Foreign Exchange With Special Reference To Jammu And Kashmir Bank,
Srinagar” prepared by me under the guidance of Prof Lt Cdr Suresh Kumar, faculty of M.B.A
Department, Shree Devi Institute of Technology and external assistance by Mr.Irfan Ahmad
Malik, Relationship executive, Forex department, JK Bank Srinagar.
I also declare that this internship work is towards the partial fulfillment of the university
regulations for the award of degree of Master of Business Administration by Visvesvaraya
Technological University, Belgaum.
I have undergone a summer project for a period of Ten weeks. I further declare that this project
is based on the original study undertaken by me and has not been submitted for the award of any
degree/diploma from any other University /Institution.
Place : Mangalore Ishfaq Gull
Date : 4SH13MBA26

ACKNOWLEDMENT
I am elated to present my internship on “A Project Study On Risk Management In Foreign
Exchange With Special Reference To Jammu And Kashmir Bank, Srinagar”. I deem it a
privilege to acknowledgement to all those who have directly and indirectly helped me in the
preparation of this project report.
First and foremost, I express my grateful thanks and seeks blessing from almighty GOD, who is
and has been a constant support my life.
I would like to thank our principal Dr.Vijaya D.P Alva, for giving me an opportunity to carry
out this study.
I would like to thank our HOD of MBA department Prof. Lt. Cdr. Suresh Kumar, for giving
me an opportunity to carry out this study.
I would like to express my sincere gratitude to Prof. Lt. Cdr. Suresh Kumar, my esteemed
lecturer for her valuable guidance and encouragement during the preparation of this internship
report. I express my sincere thanks to her, as she has been continuously helping me in getting rid
of difficult situation.
My sincere thank to Mr. Irfan Ahmad Malik, Relationship executive JK Bank Srinagar who
has given their valuable guidance to carry on this internship. And also I thanks to staff members,
who have assisted me, provided information and supported throughout my internship.
I would like to thank my Parents who encouraged me throughout the making of this project
report and also my relatives, classmates, friends and well wishers for their moral support,
appreciation and sincere wishes.

TABLE OF CONTENTS
Executive summary
Chapter 1. Introduction…………………………………………………………………………………..1-5
Chapter 2. Industry and company profile…………………………………………………..........6-26
Chapter 3. Theoretical background of the study………………………………………………27-53
Chapter 4. Data analysis and interpretation……………………………………………….........54-63
Chapter 5. Summary of the findings, suggestions and conclusions ……………..….....64-67
Bibliography
Annexure

List of Tables
Table no. Particulars Page no
4.1 Table Showing Loans/Deposits ratio 56
4.2 Table Showing Quick Ratio 57
4.3 Table Showing Earning Per Share 59
4.4 Table Showing Return On Assets 60
4.5 Table Showing Return On Capital Employed 62
4.6 Table Showing Debt Equity Ratio 63

List of charts
Chart no. Particulars Page no
2.1 Chart showing structure of Indian banking industry 10
2.2 Chart showing brand identity of J&K Bank 13
2.3 Chart showing products/services of J&K Bank 15
2.4 Chart showing savings and deposits of J&K Bank 17
2.5 Chart showing businesses of J&K Bank 18
2.6 Chart showing Mc Kinsey’s 7S Frame Work 21
3.1 Chart showing Administration Of Foreign Exchange In India 34
3.2 Chart showing trade off between the value of firm and
financial distress
46
4.1 Chart showing Loans /deposits ratio 56
4.2 Chart showing quick ratio 58
4.3 Chart showing earning per share 59
4.4 Chart showing return on assets 61
4.5 Chart showing return on capital employed 62
4.6 Chart showing Debt Equity Ratio 64

Executive summary
Forex being a department in J&K Bank has a very vast impact over the economy of the country.
It has helped the country to boost up its economy and keep its exporters to earn more and more
profits. J&K Bank have always been a helping hand by providing financial help to the exporters
by the help of which exporters were able to lesser the risk in their business. The work reported in
this project is concerned with various concepts of forex in order to analyze and to know more
about Markets. This project gives a detailed description of forex trading mechanism of J&K
bank. Only due to foreign exchange one country is able to do trade with other countries. Foreign
exchange also gave us a vast vision of market, currencies and the various bank accounts that are
used in dealing with various currencies.
Risk Management is, “any activity which identifies risks, and takes action to remove or control
‘negative results’ (deviations from the requirements).” Effective risk management strategies have
become increasingly necessary due to the dynamic nature of the business environment.
Globalization is resulting in new markets, new competitors, and new products. Technological
advances are dramatically accelerating the pace of business and the volatility of financial
markets. Unpredictable changes in interest rates, yield curve structures, exchange rates, and
commodity prices, exacerbated by the explosion in international expansion, have made the
financial environment riskier today than it ever was in the past. For this reason, boards of
directors, shareholders, and executive and tactical management need to be seriously concerned
that corporate risk management activities be adequately assessed, prioritized, driven by strategy,
controlled, and reported.

The Jammu & Kashmir Bank
Shree Devi Institute Of Techonology Page 1
INTRODUCTION
Forex trading is one of the most well-known investment options out there. The term "Forex"
stands for "foreign exchange." Mainly, investors engage in Foreign exchange trading by buying
and selling currencies from around the world. Prior to 1970s, exchange rates were based on a
fixed system called the Breton Woods System. During the 1970s, however, countries started
switching to the modern Forex market, which was characterized floating exchange rates
determined by different economic factors viz Inflation levels and trends, as well as government
budget deficits or surpluses. The economic growth and health of a country also affect the Forex
market. This is determined through reports of GDP (gross domestic product), retail sales,
employment levels, and other factors. Today, the foreign exchange market is one of the world's
most expansive, liquid, and active financial markets. Before you make any investment, read on to
learn about the basics of Forex trading.
Every company that has exposure to foreign exchange risk has to prudently manage & control its
exposure simultaneously with management of other risks. Forex risk implies the exposure of a
company to the possible impact of fluctuations in foreign exchange rates. The risk caused by
unfavorable fluctuations in exchange rates may result in a loss to the company. Generally,
Foreign exchange risk arises due to currency differences in a company’s assets & liabilities and
cash flow differences. These risks continue till the foreign exchange position is settled. This risk
arises because of foreign exchange trading, foreign currency cash transactions, investments in
foreign companies and investments denominated in foreign currencies. The quantum of risk is
derived out by multiplying the degree of exchange rate changes with the size and duration of the
foreign currency exposure. Globalized financial markets and development in exchange markets
have resulted into complex transnational exposure management. It is complex essentially
because of (a) the growing size and multiplicity of exposures which companies incur as they
grow globally and (b) the increasing volatility & fluctuations in exchange rates of the Forex
markets. Due to this complication, a logical balanced approach is required in view of formulating
company’s Forex risk management programme. The introduction point in such a programme
relates to decide the exactly sum of the assets which are under risk. At micro economic level,
transnational companies face varying degrees of business structural risks. Their need for

information relevant to exposure identification differs. Therefore, no single exposure system may
be appropriate for all companies. The appropriate system must be firm-specific. It must consider
the size of the company and its constituent units, the exposure objectives and strategy of the
company, its operating and organizational characteristics and personnel strength. There are four
basic features which should be included in all exposure management method:
(1) The information should be anticipatory.
(2) The reporting frequency must be adequate.
(3) The information flow should be associated to the company.
(4) The rationale of the information systems.
Need and importance of the study
The world nations are progressively becoming more interrelated global trade and global
investment therefore results in cross country flow of world nations. Countries hold currencies of
the various other countries and that a market trade of Forex results. More appropriately, Forex
refers to claim to foreign money balances. Forex gives resident of one country a financial claim
on other country or countries. All deposits, credits and balances payable in foreign currency and
any drafts, travelers’ cheques, letters of credit and bills of exchange payable in foreign currency
constitute foreign exchange. Forex market is the market where money denominated in one
currency is purchased and sold against money denominated in another currency. Transactions in
currencies of countries, parties to these transactions, rates at which one currency is exchanged for
other or others, ramification in these rates, derivatives to the currencies and dealing in them and
related aspects constitute the Forex.
Foreign exchange transactions occur when a country imports goods and services, people of a
country take on visits to other counties, citizens of a country send money abroad for various
purpose, business units set up foreign subsidiaries and so on. In all these cases the nation
concerned purchases relevant and required foreign exchange, in exchange of its currency, or
draws from foreign exchange reserves built. In contrast, when resident of another country visits
the country, when the country exports goods and services to another country, when citizens of
the country settled in foreign nations remit money homewards, when firms, foreign citizens and

institutions invest in the country and when the country and its business community raises funds
from abroad, the country’s currency is purchased by others, giving foreign exchange, in
exchange. MNC’s operate in different countries and their operations involve multiple foreign
currencies. Their operations are affected by laws and the politics of the counties where they
operate. Thus, they face high degree of risk as compared to domestic firms. A matter of great
concern for the overseas firms is to analyze the implications of the variation in interest rates,
inflation rates and exchange rates on their decisions and minimize the Forex risk.
Objectives of the study
Primary Objective
 To study and understand the foreign exchange.
 To understand the risk management techniques
 To study the risk involved in foreign exchange.
Secondary Objective
 To identify the problems associated with pre shipment and post shipment advances
 To examine the relationship between the inflow and outflow of foreign currencies at the
branch level.
Scope of the study
The study aims to provide an outlook on managing the risk that firms face because of fluctuating
exchange rates. Foreign exchange is an integral part of doing international business. Their role is
often accepted as necessity, while the importance of risk associated with uncertain future
exchange rates is dismissed.
Research methodology
The research is done on the basis of primary and secondary data.
Primary data
The primary data is collected through discussions with J&K Bank Forex department officials and
personal interviews with customers of foreign exchange.

Secondary data
The secondary data is collected through research papers, annual reports, magazines, text books
and websites.
Review of literature
The Six Forces of Forex - Scott Owens, (2004)
The Forex Report is a periodic publication that investigates advanced strategies for superior
trading performance in the foreign exchange markets. These Reports utilize advanced statistical
and econometric modeling techniques to Create new insight into the trading strategy of the
average trader. This paper explains SIX forces to understand Forex trading
Who trades Forex?
Why trade Forex?
Where should you Forex?
What should you trade?
When should you trade?
How should you trade?
Trading as a Business - Charlie Wright.(1998)
The author explains the basics of trading, Do's and Don'ts of trading. He further explains the
strategies to be used and the investor or trader psychology & also gives a brief summary about
hoe the market works and how one can trade effectively and utilize the resources( Time and
Money) efficiently.
FOREX SCALPING “Tiny Trades For Terrific Profits”- Robert Borowski (2005)_
In this eBook He explains the wildly profitable technique of “scalping” in the Forex markets. He
discusses a few variations of how to accomplish “scalps”. He discusses the pros and cons of this
style of trading, and how to be well on the way to success with these techniques.
Limitations
 The study is confined just to the foreign exchange risk but not the total risk.
 The time constraint was a limiting factor, as more in depth analysis could not be carried.

 The analysis of this study is mainly done on the income statements.
 This study is limited for the year 2013-2014.
 It does not take into consideration all Indian companies foreign exchange risk.
 The hedging techniques are studied only which the company adopted to minimize foreign
exchange risk.
 Some of the information is confidential in nature that could not be divulged for the study.

Chapter 2-Industry and
company profile

Shree devi institute of technology Page 6
INDUSTRY PROFILE
A bank is a financial institution which deals with deposits and advances and other related
services. It receives money from those who want to save in form of deposits and it lends money
to those who need it. It is a financial institution which deals with other people’s money. A bank
may be a person, firm or a company. It gives safety to the deposits of its customers. It is a profit
seeking institution.
The Origin and Use of Banks
The Word ‘Bank’ is derived from the Italian word ‘Banko’ signifying a bench, which was
erected in the market place, where it was customary to exchange money. The Lombard Jews
were the first to practice this exchange business, the first bench having been started in Italy A.D.
808. Some authorities assert that the Lombard merchants started the business of money-dealing,
employing bills of exchange as remittances ,about the beginning of the thirteenth century.
About the middle of the 12th century it became evident, as the benefit of coined money was
progressively acknowledged, that there must be some controlling power, some corporation which
would undertake to keep the coins that were to bear the royal stamp up to a certain standard of
value, as independently of the ‘sweating’ which invention may place to the credit of the
ingenuity of the Lombard merchants all coins will, by wear or abrasion, become thinner, and
consequently less valuable; and it is of the last importance, not only for the credit of a country,
but for the easier regulation of commercial transactions, that the metallic currency be kept as
nearly as possible up to the legal standard. Much unnecessary trouble and annoyance has been
caused formerly by negligence in this respect. The gradual merging of the business of a
goldsmith into a bank appears to have been the way in which banking, as we now understand the
term, was introduced into England; and it was not until long after the establishment of banks in
other countries, for state purposes, the regulation of the coinage, etc. that any large or similar
institution was introduced into England. It is only within the last twenty years that printed
cheques have been in use in that establishment. First commercial bank was Bank of Venice
which was established in 1157 in Italy. One of the most famous Italian banks was the Medici
Bank, set up by Giovanni di Bicci de' Medici in 1397.

Fundamental Role and Evolution- Indian Banking
The reminisce of banking in India can be traced back to the 4th century BC in the 'Kautilya
Arthashastra', which contains references to creditors and lenders. It shows a reference to "Interest
on commodities loaned" (Prayog Pratyadanam) which was accounted as revenue of the state.
Lending activities were not entirely unknown in the medieval India and the concept such as
'priority of claims of creditors' and 'commodity lending' was established business practices.
However the real roots of commercial banking in India can be traced back to the early eighteenth
century.
The banking sector is meant to meet the financial needs of the economy. Too much of money can
cause inflation- too little can stifle economic growth and create problems of unemployment and
lost opportunity. Accordingly the apex banking institution, The Reserve Bank of India has a
basic function “- to regulate the issue of Bank Notes and keeping of reserves with a view to
securing monetary stability in India and generally to operate the currency and credit system of
the country to its advantage”.
Establishment of Reserve Bank of India (1935)
The Reserve Bank of India was established on April 1, 1935 in accordance with the provisions of
the RBI Act, 1934. It is at the centre of India’s financial system. Therefore, it is called the
Central Bank. It has a primary commitment to maintaining the nation’s monetary and financial
stability.
o RBI is banker to the Central Government, State Governments and Banks. Key functions
of RBI include:
o Monetary policy.
o Development of banking sector.
o Supervision of Banking companies, Non- banking Finance companies and Financial
Sector, Primary Dealers and Credit Information Bureaus.
o Regulations of money market, government securities market, foreign exchange market
and derivative linked to these markets.

o Management of foreign currency reserves of the country and its current and capital
account.
o Issue and management of currency
o Oversight of payment and settlement systems
o Research and statistics
RBI exercises its supervisory powers over banks under the Banking Companies Act, 1949, which
later became Banking Regulation Act, 1949.
The largest commercial bank in the country is State Bank of India (SBI). Its origins can be traced
back to 1806, when Bank of Calcutta was constituted. It was re-named Bank of Bengal in 1809.
Bank of Bombay (created in 1840), Bank of Madras (created in 1843) and Bank of Bengal were
amalgamated in 1921 to form Imperial Bank of India. Until 1935, the Imperial Bank of India
performed the functions of Central Bank as well as Commercial Bank.
In 1955, State Bank of India was constituted to take over the Imperial Bank of India. Later, 8
states associated banks (State Bank of Jaipur, State Bank of Bikaner, State Bank of Patiala, State
Bank of Hyderabad, State Bank of Indore, State Bank of Mysore, State Bank of Travancore and
State Bank of Saurashtra) were brought under SBI.
RBI earlier owned the entire share capital of SBI. Later, when SBI went public, other investors
too became shareholders. A few years ago, the shares of SBI that were owned by RBI were
transferred to the Government of India.
SBI, its subsidiaries, and the 20 nationalised banks are usually referred to as public sector banks.
Other private sector banks were allowed to continue as private entities under RBI supervision.
These are commonly known as old private banks. Foreign banks that were operating in the
country were similarly allowed to continue as private entities.
In order to enhance banking services for the rural sector, a framework of Regional Rural Banks
came up in 1975. Ownership of these banks is split between three stake-holders. Central
Government (50%), concerned State Government (15%) and the bank which sponsors the RRB
(35%).

Another vehicle for local reach is the Co-operative Banks, which have been in existence for over
a century. They are registered under the Co-operative Societies Act, 1960 and regulated under
the Banking Regulations Act, 1949 and Banking Laws Act, 1956.
In line with the liberalization in the 1990s, private sector was permitted to promote new banks,
subject to obtaining banking license from RBI. These are commonly referred to as new private
banks.
At a socio-economic level, the test of a country’s banking system is how well it meets the needs
of the weaker and disadvantaged sections of society.
Nationalisation of Indian Banks
By the 1960s, the Indian banking industry has become an important tool to aid the development
of the Indian economy. Meanwhile, it has emerged as a large employer, and a debate has ensured
about the possibility to nationalise the banking industry. Indira Gandhi, the-then Prime Minister
of India expressed the purpose of the Government of India (GOI) in the annual conference of the
All India Congress Meeting in a paper entitled "Stray thoughts on Bank Nationalisation". The
paper was received with positive enthusiasm. Thereafter, her move was fast and sudden, and the
Government of India issued an ordinance and nationalised the 14 major commercial banks with
effect from the midnight of July 19, 1969. Jayaprakash Narayan, a national leader of India,
described the step as a "Masterstroke of political sagacity" Within two weeks of the issue of the
ordinance, the Parliament passed the Banking Companies (Acquisition and Transfer of
Undertaking) Bill, and it received the presidential approval on 9th
August, 1969.
A second step of nationalisation of six more commercial banks followed in 1980. The stated
reason for the nationalisation was to give the government more control of credit delivery. With
the second step of nationalisation, the Government of India controlled around 91% of the
banking business in India. Thereafter, in the year 1993, the government merged New Bank of
India with Punjab National Bank(PNB). It was the only merger between nationalised banks and
resulted in the fall of the number of nationalised banks from 20 to 19. After this, until the 1990s,
the nationalised banks grew at a pace of around 4%, closer to the average growth rate of the
Indian economy.As of now till 2014, total 26 Nationalised banks are working in India.

Structure Of Indian Banking Industry
Fig: 2.1
RESERVE BANK OF INDIA
SCHEDULED UNSCHEDULE
DD
COMMERCIAL COOPERATIVE
PRIVATE
PUBLIC
FOREIG
N
RRB
RURAL
URBAN

COMPANY PROFILE
The Jammu and Kashmir Bank was founded on 1 October 1938 under letters patent issued by
the Maharaja of Jammu and Kashmir, Hari Singh. The Maharaja invited eminent Kashmiri
investors to become founding directors and shareholders of the bank, the most notable of which
were Abdul Aziz Mantoo, Pesten Gee and the Bhaghat Family, all of whom acquired major
shareholdings. The bank commenced business on 4 July 1939, and was considered the first of its
nature and composition as a State owned bank in the country. The bank was established as a
semi-State Bank with participation in capital by State and the public under the control of State
Government. In 1971, the bank acquired the status of a scheduled bank and was declared as an
"A" Class bank by the Reserve Bank of India in 1976. The bank had to face serious problems at
the time of independence when out of its total of ten branches two branches of
muzaffarabad, Rawalakot and Mirpur fell to the other side of the line of control (now Pakistan-
administered Kashmir) along with cash and other assets. Following the extension of Central laws
to the state of Jammu & Kashmir, the bank was defined as a government company as per the
provisions of Indian companies act 1956. Mushtaq Ahmed is the new Chairman & CEO of
Jammu & Kashmir Bank. J&K Bank's Annual Report 2008-09 has won three awards at the
prestigious LACP 2009 Vision Awards – the world's largest award programme for Annual
Reports, organized by California-based League of American Communications Professionals
(LACP), USA. The LACP is a forum within the public relations industry that facilitates
discussion of best-in-class practices in public relations and recognizes exemplary communication
capabilities at a global level. The awards received include – Rank 73 on the top hundred list of
annual reports from around the world, Platinum Award in the Commercial Banks – Up to $10
billion annual revenue from the Asia Pacific Region and Silver Award for Most Creative Report
across all sectors from the Asia Pacific Region. Dr Haseeb Drabu was chairman and chief
executive of the bank for the period 2005 to 2010.
Jammu and Kashmir Bank Limited was incorporated on 1st October, 1938 and commenced its
business from 4th July, 1939 in Kashmir (India). The Bank was first in the country as a State
owned bank. According to the extended Central laws of the state, Jammu & Kashmir Bank was
defined as a govt. Company as per the provision of Indian companies’ act 1956. In the year 1971,
the Bank received the status of scheduled bank. It was declared as "A" Class Bank by RBI in

1976. Today the bank has more than 750 branches across the country and has recently become a
billion Dollar Company.
Profile
1. Incorporated in 1938 as a limited company.
2. Governed by the Companies Act and Banking Regulation Act of India.
3. Regulated by the Reserve Bank of India and SEBI.
4. Listed on the National Stock Exchange (NSE) and Bombay Stock Exchange (BSE)
5. 53 per cent owned by the Government of J&K.
6. Rated "P1+" by Standard and Poor- CRISIL connoting highest degree of safety.
7. Four decades of uninterrupted profitability and dividends.
Unique Characteristics: One of a Kind
1. Private sector Bank despite government holding 53 per cent of equity.
2. Sole banker and lender of last resort to the Government of J&K.
3. Plan and non -plan funds, taxes and non-tax revenues routed through the bank.
4. Salaries of Government officials disbursed by the Bank.
5. Only private sector bank designated as agent of RBI for banking.
6. Carries out banking business of the Central Government.
7. Collects taxes pertaining to Central Board of Direct Taxes in J&K.

Brand Identity
The new identity for J&K Bank is a visual representation of the Bank’s philosophy and business
strategy. The three colored squares represent the regions of Jammu, Kashmir and Ladakh. The
counter-form created by the interaction of the squares is a falcon with outstretched wings – a
symbol of power and empowerment.
Fig: 2.2
The synergy between the three regions propels the bank towards new horizons. Green signifies
growth and renewal, blue conveys stability and unity, and red represents energy and power. All
these attributes are integrated and assimilated in the white counter-form.

Vision, Mission & Quality Policy
Vision
“To catalyze economic transformation and capitalize on growth”.
 Bank’s vision is to engender and catalyze economic transformation of Jammu and Kashmir
and capitalize from the growth induced financial prosperity thus engineered. The bank
aspires to make Jammu and Kashmir the most prosperous state in the country, by helping
create a new financial architecture for the J&K economy, at the center of which will be the
J&K Bank.
 The Bank's vision is to be financially sound, profitable, growth and technology oriented,
committed to building and maximizing sustainable value for all its stakeholders. The Bank is
committed to achieve healthy growth in profitability and simultaneously to remain consistent
with the Bank's risk appetite and at the same time ensuring the highest levels of ethical
standards, professional integrity and regulatory compliance.
Mission :
“Our mission is two-fold: To provide the people of J&K international quality financial service
and solutions and to be a super-specialist bank in the rest of the country. The two together will
make us the most profitable bank in the country.”
Quality Policy:
The bank begun its much-delayed expansion plan in 2011-12, improved its earnings and kept the
asset quality stable in the first half of this financial year. Recently, it sold a part of its stake in
MetLife for a profit of Rs 140-150 crore. This has made the bank’s share attractive to investors,
market analysts said.
“At the current market price, J&K Bank is trading reasonably at 1.15x FY14 ABV. We believe
they deserve to get a better multiple, on the back of consistent performance on asset quality as
well as strong return ratios (ROA/ROE) over the last couple of years. Its superior provision
coverage ratio is icing on the cake and stands as one of the best in the industry (greater than 93
per cent, including technical write-offs), providing cushion to its future earnings, with any

unforeseen deterioration in asset quality, going forward,” said Saday Sinha, vice-president,
equity research, Kotak Securities.
Products of J&K Bank
Fig: 2.3
Home finance:-
 Housing Loan Schemes
Educational Finance:-
 Education Loan Scheme
 Term Loan Scheme for B.ed / M.ed. courses
 Bud shah Primary Education Finance
Automobile Finance:-
 Car Loan Scheme
 Car Loan For Used Cars
 Commercial Vehicle Finance
LOANS
Home Finance Educational
Finance
Automobile
Finance
Commercial
loans
Specialized
Finance

 Commercial Vehicle Finance(Used Vehicles)
 Two Wheeler Finance
Other Finances:-
 Consumer Loan
 Consumption Loan
 Personal Loan to Pensioners
 Mortgage loan for Trade and Service Sector
 Loans against Mortgage of Immovable Property
 Fair Price Shop Scheme
 Travel and Tourist taxi operators
Specialized Finance:-
 Help Tourism (For Kashmir valley only)
 All purpose Agri term Loan
 Fruit Advances Scheme (Apple)
 Zaffron Finance
 Roshni Financing Scheme
 Craft Development Finance
 Dastkar Finance
 Giri Finance Scheme
 Khatamband Craftsmen Finance
 Commercial Premises Finance
 Laptop/PC Finance

Savings and deposits:-
Fig: 2.4
Saving Bank Deposits:-
 Saving Bank Deposit Scheme
 SB Ujala- No Frills Account
Term Bank Deposits:-
 Millennium Deposits Scheme
 Flexi Deposits Scheme
 Fixed Deposits Scheme
 Child Care Scheme
 Cash Certificates
 Super Earner Deposits Scheme
 Recurring Deposits Scheme
 Recurring Plus Account
 Smart Saver Scheme
 Depositors Pension Scheme
Saving and Deposits
Current
Accounts
Gift Cheque
Schemes
Value Added
Services
Term &
Deposits
Saving Bank
Deposits

Value Added Schemes:-
 Tax Saver Term Deposit Scheme
 Mehendi Deposit Certificate
Current Accounts:-
 Platinum Account
 Gold Account
 Premium Plus Account
 Premium Account
 Basic Account
Other Business of J&K Bank
Fig: 2.5
Non Life InsuranceMUTUAL FUNDLife Insurance
Bajaj Allianz
General Insurance
Co. Ltd
MetLife India
Insurance
CARDS
Empowerment
Credit Card
Merchant
Acquiring (Point of
Sale Equipment)
Global Access
Card

Area of Operation
 The Bank has its main market of operation in the state of Jammu and Kashmir. The
branch network of the bank is so dense that it has its branch every two kilometers.
 The bank has also registered its presence in the main cities of India.
 The bank is extensively supportive of small scale businesses and tourism in the state.
 The bank constituted the J&K Bank Rural Self Employment Training Institutes
(JKBRSETI) Society, registered with Registrar of Society, Directorate of Industries and
Commerce (Kashmir), Srinagar for setting up JKBRSETIs in all the 12 lead districts of
the bank.
 The bank constituted a trust under the title Jammu and Kashmir Bank Social Conscience
Trust to prevent heritage and to take eco-preservation initiative.
 The Bank operates a Regional Rural bank under the name J&K Grameen Bank.
The Bank is also active in the field of corporate social responsibility like providing financial
assistance for medical aid, supporting sports and educational institution.
Infrastructure Facilities
Head Office
 J&K bank has it’s headquarter in Srinagar. Due to extreme cold during the winters it
becomes necessary to provide heating facilities.
 The four storied building has several facilities for its employees and other customers. The
building houses the office of chairman and other important personnel’s of the bank.
 There is a cafeteria in the premises which serves the employees with quality food.
 The Basement consists of parking facility.
 There is a small park in the premises for employees.
 The bank currently has 11 zonal office
1. Kashmir central.
2. Kashmir south.
3. Kashmir north

4. Ladakh
5. Jammu central.
6. Jammu west
7. Jammu north
8. Upper north Mohali
9. North Delhi
10. Mumbai
11. South Bangalore.
Besides J&K bank have RCC’s in Kashmir (Srinagar), Jammu, Delhi and Mumbai.
Branches
 The bank has more than 750 branches all over the country, and 726 ATMs across the
country as on October 1, 2013.
 The branches are fully computerized with latest technology.
 All the CBS branches of the bank have been enabled for RTGS and NEFT facility.
Future Growth and Prospectus
 Over the last several years RBI has undertaken wide-ranging financial sector reforms to
improve financial intermediation and maintain financial stability.
 Over Rs. 30,800 Crore have been earmarked for the state under the prime minister’s
Reconstruction Program for the 11th
Five Year Plan.
 In order to compete with other nationalized and private sector banks J&K is planning to
register its presence across India by opening its branches.
 The Bank is adapting to new technologies effectively to provide faster and secure
banking services.
 The bank is reviving its Human Resource policies to acquire the best talent from the
market in order to compete with other international banks in India.
 Bank is emphasizing on its Small and Medium sector loans to promote growth in the
rural region of the state, including Tourism.

 The Bank has also implemented Disaster Recovery Setup of a zero data loss by TCS.
 The bank will continue its efforts to make every single process technology driven. All
business units will be migrated to CBS platform and more importantly, 0-Data Loss
system (3 ways DC/DR) will be setup by March 2012.
 Other future IT initiatives include introduction of mobile banking, back-up solution
upgrade tape library for DC/DR, setting up of call centre, enhanced IT security through
oracle audit vault & video surveillance for 50 business units.
Mc Kinsey’s 7S Frame Work
The McKinsey 7S Framework is a management model developed by well-known business
consultants Waterman and Peters in the 1980s. This was a tactical vision for groups, to consist
of businesses, business units, and teams. The 7S are structure, strategy, systems, skills, style,
staff and shared values.
Fig: 2.6

The model is based on the premise that, for an organization to perform well, these seven
elements has to to be aligned and mutually reinforcing. Therefore, the model can be used to help
identify what needs to be realigned to improve performance, or to maintain alignment (and
performance) during other types of change.
Whatever the type of change – restructuring, new processes, organizational merger, new systems,
change of leadership, and so on – the model can be used to understand how the organizational
elements are interrelated, and so ensure that the wider impact of changes made in one area is
taken into consideration.
Strategy
 To merge technology and business so as to deliver more products to more customers and
to control operating costs.
 To develop new products and services that meets the needs and wants of targeted
customers and address inefficiencies in the Indian financial sector.
 To boost the visibility in the market and improve the market share in the banking and
financial services.
 High quality of customer service.
 To continue to expand products and services that reduces our cost of funds.
 To focus on high earnings growth low volatility.
Systems
Under systems comes the procedures and processes to do the work, information systems,
performance appraisal system, financial systems etc.
 MIS: Entire computerized credit portfolio covered.
 Archival Database: For maintenance of historical records of branches rolled over to CBS.
 Disaster Recovery Setup: Implementation of a Zero Data Loss DR system by TCS.
Structure
The structure of the organization depicts the flow of work. It satisfies the interrelations among
departments. The organizational structure of J&K bank is quite good which allows smooth
functioning of work throughout the organization.

Skills
Skills specify the capabilities of personnel or of the organization as a whole. Banking industry
requires excellent analytical decision making skills. J&K Bank in this regard engages its staff
members in the training programs. The bank has tie up with two training institutions where
training for the organizational personnel takes place after every six months.
Staff
At J&K Bank, we recognize staff as an area of core competence, and seek to pursue, nurture and
retain the best talent. The ultimate aim of staff function is to build and manage a motivated pool
of professionals by growing internal resources.
 Introduction of IT based “RAAHAT” – an employee grievance redressal mechanism as a
part of Corporate Governance.
 More than 3650 officials have been trained/retrained in various fields.
 Various benefit schemes like DA/Pension, 30 % increase in yearly medical aid,
Reimbursement of newspaper and telephone bills enhancement of loan limits.
 The Staff strength is around 7267 employees with a plan of adding 1000 new employees
in the year 2011-12.
Style
 Being a government undertaking J&K bank follows democratic style of leadership.
 To guarantee smooth functioning of organization regular Board meetings are conducted
in which participation is encouraged right from the bottom level to the chairman.
 Employees are consulted frequently for their suggestions and feedbacks, and adequate
steps are taken to embrace the suggestions.
Shared Value
 Being a Financial Institution ethical and moral values are emphasized in the organization.
 Most of the employees are from the J&K region which results in a homogenous culture in
all its branches.
 Employees are expected to preserve secrecy and embrace fair work practices.

Achievements and Awards
 Annual Report 2008-09 of J&K Bank has won three awards at the prestigious LACP
2009 Vision Awards – the world’s largest award programme for Annual Reports,
organized by California-based League of American Communications Professionals
(LACP), USA.
 The LACP is a forum within the public relations industry that facilitates discussion of
best-in-class practices in public relations and recognizes exemplary communication
capabilities at a global level. The awards received include – Rank 73 on the top hundred
list of annual reports from around the world, Platinum Award in the Commercial Banks –
Up to $10billon annual revenue from the Asia Pacific Region and Silver Award for Most
Creative Report across all sectors from the Asia Pacific Region.
 J&K bank received the BANKING TECHNOLOGY 2009 Award presented by IBA &
TFCI on 28th
Jan 2010.
 The Bank was awarded with “ASIAN BANKING AWARD” 2005 for its development
project financing programme in recognition of contributing significantly to the
development of tourism industry of the J&K state. The Bank was awarded with the
ASIAN BANKING AWARD for the second consecutive year.
 The J&K Bank has bagged the prestigious Financial Express Best Banks Award in the
‘Old Private Sector Banks’ category “for scaling up its business and strengthening the
balance for the year ending March 2011.”
 J&K bank emerged as the ‘Best Bank’ in the ‘Old Private Sector Bank’ category at the
CNBC. TV18 India’s Best Bank and Financial Institution Awards 2012-13.
 The Sunday Standard FINWIZ Best Bankers Award 2012-13
J&K Bank’s sustained focus on all the areas of banking during the past two years enabled
it to win four national awards at ‘The Sunday Standard FINWIZ Best Bankers Award’.
 Conferred Best Banker in Financial Inclusion and Customer Friendliness award
 Runner-up for the ‘Best Banker in priority Sector Growth and Agricultural Credit’
 J&k Bank’s Chairman & CEO Mushtaq Ahmad were rated as the top ranked CEO
for being ‘accomplished in all aspects of banking’.

SWOT ANALYSIS
Strength:
 Main strength of J&K Bank is its monopoly in the state of J&K. The bank has almost
negligible competitors with respect to their market capture in the state.
 The bank has very strong market share in the state, with almost one branch at just 2kms
of distance.
 The bank has successfully created very strong brand image in the hearts and minds of
people of J&K, which is their main market. People have also great faith in the bank that
they can’t think of any other bank before it.
 J&K Bank is the highly growing bank which offers the widest range of financial
products.
 J&K Bank offers 3 in 1 account which shows its growing.
 It is one of the India’s largest Banks and has a national wide network 750 branches.
 It also provides every type of credit creation towards every field.
 J&K Bank pays a great attention towards rural development.
 J&K bank is also known as Billionaire Company nowadays celebrating its 75th
years of
service.
Weakness:
 Lack of promotional activity: The J&K Bank has targeted new customers and has
penetrated the market extensively. However, the customer relation has been a grey area
on account of growing customer disenchantment and required constant promotional
campaigns to ensure customer patronage. Hence, the level of brand awareness and
improvement has to be ameliorated to build customer patronage.
 Lack of training and facilities: The Company did not hitherto provide any training to the
customers for operation of accounts. Online Trading being a new service in the field of
banking requires pertinent training as to the mode of operation, customized facilities etc.
 Higher brokerage rates: The brokerage charged by the company, especially on the
delivery transactions is very high in comparison to the competitor.

Opportunities:
 Increasing users of Internet: As per research India is adding millions of internet users
every year. This provides a huge opportunity to J&K Bank to tap such users.
 Increase in the number of investors entering the stock market: Recently due to the
surge in IPO’S and increased income of people in India has led to more people taking
interest in stock market which is a huge opportunity for J&K Bank
 Tax saving online: ICICIdirect.com offers many products like tax saving Bond and
Mutual funds. People today are keen on tax saving and for the same they can invest in
these products online. Thus this brings in a huge potential market for J&K Bank.
 Providing true service: ICICIdirect.com reduces paper work, reduces hassles like the
brokers and following the investment along with this it assures safety and security.
Thus J&K Bank is potentially one of the most revolutionary products which will find
increased usage in this modern world.
Threats:
 Fear of safety: People in India are very averting to giving out their credit card numbers or
buying and selling shares. This mentality possesses a significant trend because J&K Bank
in its essence is a portal for online trading in securities.
 Emergence of other players: New players like Yes Bank and HDFC have entered the
market offering two in one (2 in 1) accounts and can in future grow into offering 3 in1
accounts.
 Fluctuations in the securities Market: Stock market scams, increase in oil prices, terrorist
attracts etc. because huge fluctuations in security market which dissuades investors who
opt for liquidity or gold.

CHAPTER 3-
THEORETICAL
BACKGROUND OF THE
STUDY

Shree Devi Institute of Technology Page 27
Definition of International Trade
International trade means trade between the residents of two different countries. Every country
functions as an autonomous state with its own set of laws and currency. The differentiation in the
nationality of the export and the import presents certain unusual problems in the conduct of
international trade and settlement of the transactions arising there from.
Importance among such problems are:
a) Every country has its own monetary system.
b) Limits set by countries on import and export of goods.
c) Restrictions imposed by nations on payments from and into their countries.
d) Difference in legal system..
The national monetary units pose difficulties in the resolution of international transactions.
The exporter would like to get the payment in the currency of its own country. For example,
if Malaysian exporters export machinery to India, Indian rupee will not serve their purpose
because Indian rupee cannot be used as currency in Malaysia. Thus the exporter needs to pay
in the currency of importer’s country. So the need arises for conversion of one country’s
currency with another.
Foreign exchange: Foreign exchange is the method by which the currency of one nation gets
converted into the currency of another nation. The exchange is done by banks who deal in
Forex. These banks keep stock of foreign currencies in the form of balances with banks
abroad. For example, Indian Bank may keep an account with Bank of America, New York, in
which dollars are held. In the earlier example, if Indian importers pay the equivalent rupee to
Indian bank, it will arrange to pay American exporter at New York in dollar from the dollar
balances held by it with Bank of America.
Exchange rate: Exchange rate is the rate at which one currency is converted into another
currency is the rate of exchange between the currencies .The rate of exchange for a currency
is known from the quotation in the foreign exchange market.

For example, if Indian bank exchanged us for Indian rupee at Rs.62 a dollar, the exchange
rate between the two currencies can be expressed as
1$ = Rs.62
The banks working at a financial center, and dealing in Forex, represents the foreign
exchange market. The rates in the foreign exchange market are determined by the dealings of
the forces of demand and supply of the commodity dealt, viz., Foreign exchange. The rates
keep on changing frequently as well as violently because of the fundamental and transitory
factors that affects the demand and supply.
Advantages of Forex.
1) Simple to understand –Forex is simple to understand as we deal with just a pair of
currencies.
2) Low Minimum Investment - The Forex market requires less investment to start trading
than most other markets. The initial outlay could go very low, depending on the leverage
offered by the broker. This is a great benefit since Forex traders are able to keep their risk
investment to the minimum level. Mini and Micro trading accounts are also offered by
the online Forex brokers with low minimum deposit.
3) 24 Hour Market – Different countries have different time horizons that make it possible
for the Forex market to operate 24*7. Since the Forex market is worldwide, trading is
uninterrupted as long as there is a market open somewhere in the world. Trading starts
when the markets open in Australia on Sunday evening, and ends after markets close in
New York on Friday.
4) High Liquidity - Liquidity is the capacity of an asset to be transformed into cash quickly
and without any price discount. In Forex high liquidity means that we can shift large
amounts of money into and out of foreign currency with negligible price movement.
5) Low Transaction Cost -The transaction cost in the Forex is low because it is built into
the price and is called the spread. Spread is the difference between the buying and the
selling price.

6) Leverage - Forex Brokers permit traders to trade the market with leverage. It is the
ability to trade more money on the market than what is truly in the trader's account. For
example, If you have to trade at 50:1 leverage, you can trade $50 on the market for every
$1 that was in your account. This means you can control a trade of $50,000 using only
$1000 of capital.
7) Profit Potential out of Rising and Falling Prices - The Forex market has no limitations
for directional trading. This means, if you think a currency pair is going to appreciate in
value; you can purchase it, or go long. Similarly, if you feel it could lessen in value you
can sell it, or go short.
8) Foreign exchange is the largest financial market in the world –on a daily basis Forex
market has a volume of over $4 trillion. Such a huge amount of a daily volume allows for
outstanding price stability in most market conditions. This means you possibly will never
have to worry about losses as you would when trading stocks or commodities. The price
you observe quoted on your trading screen is the price you get.
9) Price movements are highly expected in the Forex market - Due to its very
speculative character Forex price movements have a tendency to over shoot and then
correct back to the mean. This means there are a number of cyclical patterns that are
easily identifiable to the trader who is trained in price action analysis. Forex currency
pairs usually spend more time in very strong up or down trends than other markets; this is
also a huge benefit because it is by and large much easier to trade a strongly trending
market than a hectic and consolidating market.
10) No constraints on the type or number of transactions - The futures market at times
will have what is called a “limit up” or a “limit down” day, this refers to when the price
moves beyond a fixed daily level, traders are constrained from entering new positions and
are only permitted to exit existing positions if they want to do so. This is intended to
control volatility, but because the futures market for currencies follows the spot Forex
market the next day at the futures open their sometimes will be huge “gaps” or areas
where the price has adjusted over night to match the current spot Forex price.

Some of the essential factors which affect exchange rates are:
1. Inflation
2. Money supply
3. Balance of payments
4. Interest rates
5. National income
6. Resource discoveries
7. Political factors
8. Capital movements
Inflation: inflation in the country would enlarge the domestic prices of the commodities. With
increase in prizes exports may decrease because the price may not be competitive. With the
dwindle in export the demand for the currency would also decline; this in turn would outcome in
the decline of external value of the currency. It should be noted that it is the comparative rate of
inflation in the two counties that grounds changes in the exchange rates.
Money supply: An increase in money supply in the country will influence the exchange rates
though causing inflation in the country. It can also influence the exchange rate directly.
Balance of payment: It represents the demand for and supply of foreign exchange which
eventually determine the value of the currency. Exporters from the country require the currency
of the country in the Forex market. These exporters would offer the foreign currency in exchange
of the local currency. on the other hand, imports into the country will increase the flow of
currency of the country in the forex market. When the Balance of Payment of a country is
constantly at deficit, it implies that demand for the currency of the country is slighter than the
supply. Therefore, its value declines in the market. If the Balance of payment is surplus,
constantly, it shows the demand for the currency is more than its supply and hence the currency
gains in value.
Interest rates: The interest rate influences the short-term movement of capital to a great extent.
When the interest rate rises at a center, it attracts short term funds from other centers. This would

boost the demand for the currency at the center and hence its value. Rising of interest rate may
be adopted by a country due to money circumstances or as a deliberate attempt to attract foreign
investment.
National income: An increase in national income results in increase in the income of the
residents of the country. Increment in the income increases the demand for goods in the country.
If there is an excessive production capacity in the country, this would lead to increase in
production. There is also a change for growth in exports. Where the production does not increase
in consideration with income rises, it leads to increased imports and supply of the currency of
the country in the foreign exchange market. The outcome is similar to that of inflation viz., and
decline in the value of the currency. Thus an increase in national income will guide to an
increase in investment or in the consumption, and hence, its effect on the exchange rate will
change.
Resource discoveries: The country’s currency gains in value when the country is competent to
discover key resources.
Capital Movements: There are a lot of factors that influence movement of capital from one
country to another. The offer of higher interest in a country may lead to short-term movement of
capital; there will be a flow of short-term funds into the country. If interest rate in a country rises
due to increase in bank rate or otherwise the exchange rate of the country will also rise. Reserves
will happen in case of drop in interest rates.
Bright investment climate and political stability may push portfolio investment in the country.
This leads to upward trend in the rate and higher demand for the currency. Poor economic
position may mean repatriation of the investments leading to decreased demand and low
exchange value for the currency of the country.
External Borrowings and assistance also leads to Movement of capital. Extensive external
borrowings will increase the supply of foreign exchange in the market. This will have a positive
effect on the exchange rate of the currency of the country. When a repatriation of principal and
interest starts the rate may be badly affected.
Other factors include political factors and Speculation, Technical and Market factors,
Psychological factors.

ADMINISTRATION FRAME WORK FOR FOREIGN EXCHANGE IN INDIA
The Central Government has been empowered under Section (46 ) of the Foreign Exchange
Management Act to make rules to carry out the provisions of the Act. Likewise, Section 47
empowers the Reserve Bank to formulate regulations to carry out the provisions of the Act and
the rules made there under.
The Foreign Contribution (Regulation) Act, 1976 is to control the acceptance and utilization of
foreign contribution/ payment or foreign hospitality by certain persons or associations, with a
scrutiny to ensuring that political associations, Parliamentary institutions and academic and other
voluntary organizations as well as individuals working in the important areas of national life may
function in a manner consistent with the values of a sovereign democratic republic.
Basically it is an act to ensure that the integrity of Indian institutions and persons is maintained
and that they are not unduly influenced by foreign donations to the prejudice of India’s interests.
The Foreign Exchange Management Act (FEMA) is a law to replace the draconian Foreign
Exchange Regulation Act, 1973. Any offense under FERA was a criminal offense liable to
imprisonment; Whereas FEMA seeks to make offenses relating to foreign exchange civil
offenses. Unlike other laws where everything is permitted unless specifically prohibited, under
FERA nothing was permitted unless specifically permitted. Hence the tenor and tone of the Act
was very drastic. It provided for imprisonment of even a very minor offense. Under FERA, a
person is presumed innocent unless he is proven guilty. With liberalization, a need was felt to
remove the drastic measure of FERA and replace them by a set of liberal foreign exchange
management regulations. Therefore FEMA was enacted to replace FERA.
FEMA extends to the whole of India. It applies to all Branches, offences and agencies outside
India owned or controlled by a person resident in India and also to any contravention there under
committed outside India by any person to whom this Act applies.
Authorized persons:
The Reserve Bank has the power to manage foreign exchange in India, it is recognized that it
cannot do so by itself. Forex is received or required by a large number of exports and imports in
the country spread over a huge geographical area. It would be impossible for the reserve Bank to

deal with them individually. Therefore, provisions has been made in the Act, enabling the
Reserve Bank to authority any person to be known as authority person to deal in the foreign
exchange or foreign securities, as an authorized dealer, money changer or off- shore banking unit
or any other manner as it deems fit.
Authorized dealers:
Authorised dealers are the banks, financial institutions and other institutions authorised by the
RBI to deal in foreign exchange.An authorised dealer should follow with the directions and
instructions of RBI given from time to time.
Section 10 of FEMA requires the authorised dealers to obtain declarations and informations from
the customers as to ensure that the provisions of the Act are not violated. RBI has advised the
authoritied dealers to keep on record an information /documentation on the basis of which the
transaction was undertaken for verification by RBI. Authorised dealers are to devise their own
formats for these. RBI has classified authorised dealers into three categories:
 Category I:
A major portion of actual dealing in foreign exchange from the customers is dealt with
by such of the banks in India which have been authorised by the RBI to deal in foreign
exchange. These banks are know as Authorised Dealers- Category I. They are
authorised to carry out all types of transactions as permitted by RBI.
 Category II:
They comprise of upgraded full fledged money changers, cooperative banks, regional
rural banks and others. They can purchase foreign exchange and sell foreign exchange for
private and business visits abroad undertaken by residents, which is the function
performed by a full fledged money changers.
 Category III:
They comprise of selected financial and other institutions. They are pemitted to carry out
transactions incidential to the foreign exchange activities undertaken by them.

ADMINISTRATION OF FOREIGN EXCHANGE IN INDIA
Fig: 3.1
FOREIGN EXCHANGE MANAGEMENT ACT
CENTRAL GOVERNMENT
RESERVE BANK OF INDIA
AUTHORISED PERSONS
FEDAI
AUTHORISED
MONEY CHANGERS
AUTHORISED
DEALERS
CATEGORY
II
CATEGORY
I
CATEGORY
III
FULL RESTRICTED

FOREIGN EXCHANGE DEALER’S ASSOCIATION OF INDIA (FEDAI).
In 1958, FEDAI was establishing as an association of all authorized dealers in India. The main
functions of FEDAI are:
 To set up rules for the conduct of foreign exchange business in India. These rules envelop
various aspects like charges for foreign exchange transactions, hours of business,
quotation of rates to customer, interbank dealings, etc. All authorized dealers have given
undertaking to the Reserve Bank to abide these rules.
 To coordinate with RBI in Proper administration of exchange control.
 To direct information likely to be of interest to its members.
Thus, FEDAI provides a fundamental link in the administrative set-up of foreign exchange in
India.
Authorized Money Changers
To provide services for encashment of foreign currency for tourists, etc., Reserve Bank has
granted limited licenses to some established firms, hotels and other organizations permitting
them to deal in foreign currency notes, coins and travelers’ cheques subject to directions issued
to them from time to time. These organizations & firms are called ‘Authorized Money
Changers’. An authorized money changer may be a restricted money changer or a full-fledged
money changer. A full-fledged money changer is allowed to carry out both purchase and sale
transactions with the public. A restricted money changer is authorized only to purchase foreign
currency notes, traveler’s cheques & coins subject to the condition that all such collections are
surrendered by him in turn to authorized dealer in foreign exchange. The current view of the
Reserve Bank is to authorize more establishments as authorized money changers in order to
make possible easy conversion facilities.
The Foreign Exchange Market
The Forex market is the market where in which currencies are purchased and sold against each
other. It is the one of the biggest market in the world. It is to be notable from a financial market
where currencies are borrowed and lent.

Forex market facilitates the conversion of one currency to another for a number of purposes like
trade, payment for services, project developments, and speculation etc. Since the number of
participants in the market has improved over the years have become greatly competitive and
efficient. With development in trade between countries, there was a pressing need to have some
methods to facilitate easy conversion of currencies. This has been made possible by the Forex
markets.
Considering international trade, importing goods would be preferred by a country for which it
does not have a competitive advantage, while exporting goods for which it has a competitive
advantage over others. Thus trade between countries is important for common good but nations
are alienated by distance, which that there is a lot of time between placing an order and its actual
delivery. The supplier would not be willing to wait until actual delivery for receiving payments.
Therefore, credit is essential at every stage of the transaction. The much needed conversion of
the currency and credit servicing is facilitated by the foreign exchange market. The exchange
rates are also subject to wide fluctuations. Forex market is not accurately a place and that there is
no physical meeting but meeting is affected over phone or by mail.
Foreign Exchange Transactions
Foreign exchange transactions that take place in foreign exchange markets can be broadly
classified into Merchant transactions and interbank transactions. The Forex transactions that take
place among banks are known as interbank transactions and the rates quoted are called as
interbank rates. Similarly, The Forex transactions that take place between a bank and its
customers are called as’ Merchant transactions’ and the rates quoted are called as merchant rates.
Merchant transactions take place when an exporter approaches his bank to convert his sale
proceeds(foreign currency) to home currency or when an importer approaches his bank to
convert domestic currency into foreign currency to reimburse his dues on import or when a
resident approaches his bank to exchange foreign currency received by him into home currency
or vice-versa. The banks make profit from the foreign currency by purchasing the the same from
the customers and sells it in the interbank market at a higher rate. Similarly, the bank buys the
foreign currency from the interbank, loads its margin and sells it to the customers and therefore
makes profit.

Modes of Foreign Exchange Remittances
Foreign exchange transactions involve inflow and outflow of foreign currency depending upon
the nature of transactions. A purchase transaction means inflow of foreign exchange while a sale
transaction results in outflow of foreign exchange. The former is called as inward remittance and
the latter is called as outward remittance. Remittance can takes place through a number of
modes. Some of them are:
 Demand draft
 Mail transfer
 Telegraphic transfer
 Personal cheques
Types of buying rates:
 TT buying rate
 Bill buying rate
TT buying rate: It is the rate applied when the transaction does not involve any delay in the
conversion of the foreign exchange by the bank. In other words, the Nostro A/c of the bank
would already have been credited. The rate is calculated by deducting the exchange margin from
the interbank buying rate as determined by the bank.
Bill buying rate: It is the rate to be applied when foreign bill is bought. When a bill is bought,
the rupee equal of the bill values is paid to the exporter instantly. However, the bank will realize
the proceeds after the bill is presented at the overseas center.
Types of selling rates:
 TT selling rates
 Bill selling rates
TT Selling rate: The sale transactions which don’t handle documents are put through at TT
selling rates.
Bill Selling rates: It is the rate applied for all sale transactions with public which involve
handling of documents by the bank.

Inter Bank transactions: The exchange rates quoted by banks to the customer are based on the
rates prevalent in the Inter Bank market. The big banks in the market are called as market makers
because they are willing to sell or pay foreign currencies at the rates quoted by them up to any
extent. Depending upon its resources, a bank may be a market in one or few major currencies.
When a banker approaches the market maker, it would not reveal its intention to buy or sell the
currency. This is done in order to get a fair price from the market maker.
Two way quotations
Normally, the quotation in the Inter Bank market is a two- way quotation. It means the rate
quoted by the market maker will indicate two prices, one which it is willing to sell the foreign
currency and the other at which it is willing to buy the foreign currency. For instance. Karnataka
bank may quote its rate for US dollars as under.
USD 1= Rs.62.15255/1650
More often, the rate would be quoted as 1525/1650, since the players in the market are expected
to know the ‘big number’ i.e., Rs.62. in the above quotation, once rate is Rs.62.1525 per US
dollar and the other rate is Rs.62.1650 per US dollar.
Direct quotation
It is obvious that the quotation bank will buy dollars at Rs.62.1525 and sell dollars at
Rs.62.1650. if once dollar bought and sold, the bank makes a profit of 0.0125. In a Forex
quotation, the foreign currency is the commodity that is being bought and sold. The exchange
quotation that gives the price for the foreign currency in terms of the domestic currency is called
as direct quotation. In a Direct quotation, the quoting bank will follow the rule: “buy low” &
“sell high”.
Indirect quotation
There is one more way of quoting in the Forex market. The Karnataka bank quotes the rate for
US dollar as:
Rs.100=USD 1.6086/6095
This type of quotation which gives the quality of foreign currency per unit of domestic currency
is known as indirect quotation. In this case, the quoting bank will receive USD 1.6095 per

Rs.100 while buying dollars and give away USD 1.6086 per Rs.100 while selling dollars In other
words, “Buy high, sell low” is applied.
This buying rate is also known as the ‘bid’ rate and the selling rate as the ‘offer’ rate. The
difference between these rates is the gross profit for the bank and known as the ‘Spread’.
Spot and forward transactions
The transactions in the Inter Bank market May place for settlement-
1. On the same day
2. Two days later
3. Some days late; say after a month
When the agreement to buy and sell is agreed upon and executed on the same date, the
transaction is called as cash or ready transaction. It is also called as value today. The transaction
where the exchange of currencies takes place after the date of contract is called as the Spot
Transaction. For example, if the contract is made on Tuesday, the delivery should take place on
Thursday. If Thursday is a holiday, the delivery will take place on the next day, i.e., Friday.
Payment of rupee is also made on the same day the foreign exchange is received.
The transaction in which the exchange of currencies takes place at a particular future date,
following to the spot rate, is called as a forward transaction. It can be for delivery one month or
two months or three months, etc. A forward contract for delivery one month implies the currency
exchange will take place after 1 month from the date of contract. A forwards contract for
delivery 2 months implies the currency exchange will take place after 2 months and so on.
Spot and Forwards rates
Spot rate of exchange is the rate for instant delivery of foreign exchange. It is prevailing at a
specific point of time. In a forward rate, the quoted is for delivery at a future date, which is
generally 30 days, 60 days, 90 days or 180 days later. The forward rate may be at discount or
premium to the spot rate, Premium rate, i.e., forward rate is greater than the spot rate, implies
that foreign currency will appreciate its value in the future. It may be due to increasing demand
for goods and services of the country of that currency. The percentage of annualized discount or
premium in a forward quote, in relation to the spot rate, is computed by the following.

Forward Premium = Forward rate-spot rate * 12
If the spot rate is higher than the forward rate, there is forward discount and if the forward rate
higher than the spot rate there is forward premium rate.
Forward margin/Swap points
Forward rates are derived from spot rates, and are function of the spot rates and forward
premium or discount of the currency, being quoted.
Forward rate = spot rate + premium (or – discount).
Forward rate may be the same as the spot rate for the currency. Then it is said to be ‘at par’ with
the spot rate. But this happens rarely. To, simplify, if the forward value of the currency is higher
than the spot value, then the currency is said to be at a premium. The variation between the
forward rate and the spot rate is called as the ‘Forward margin’ or ‘Swap Points’. The forward
margin may be at a premium or at discount. If the forward margin is at premium, the foreign
currency will be costlier (higher) under forward rate than under the spot rate. If the forward
margin is at discount, the foreign currency will be cheaper for forward delivery than for spot
delivery. Under direct quotation, premium is added to the spot rate to arrive at the forward rate.
This is done for both purchase and sale transactions. Discount is deducted from spot rate to
arrive at the forward rates.
Other rates
Buying rate and selling rate are those rates at which a dealer in Foreign exchange is willing to
buy the Forex and sell the Forex. In theory, there should not be difference in these rates. But in
practices, the selling rate is higher than the buying rate. The Foreign exchange dealer, pays less
rupees while buying the Forex, but gets more when he sells the Foreign exchange. After
adjusting for operating expenses, the dealer books a profit through the ‘buy and sell’ rates
differences.
The transaction in exchange market consists of purchase and sale of currencies between dealers
and customers and between dealers and dealers. The dealers buy Forex in the form of bills, drafts
from foreign banks, enables the customers to receive payments from abroad. The resulting

accumulated currency balances with Forex dealers are disposed of by selling instruments to
customers who need Foreign exchange to make payment to foreigners. The selling price for a
currency quoted by a bank (dealer) is slightly higher than the purchase price to give the bank
small profit in the business. Each dealer gives a two-way quote in Forex.
Single Rate refers to the practices of adopting rate between the two currencies. A rate for
exports, other for imports, and other for transaction with preferred area, etc, if adopted by a
country, that situation is known as multiple rates.
Fixed rate refers to the rate which is fixed in terms of gold or is pegged to another currency
which has a fixed value in terms of gold. Flexible rate makes the exchange rate to remain fixed
over a short period, but allows the same to vary in the long term in scrutiny of the changes and
shifts in another as conditioned by the free of market forces. The rate is allowed to freely float at
all times.
Current rate: Current rate of exchange between two currencies fluctuates very frequently or
even minute to minute, because of changes in demand and supply. But these movements take
place around a rate which may be called the ‘normal rate’ or the par of exchange or the true rate.
International payments are made by different instruments, which differ in their time to maturity.
Slight rates applicable in the case of bill instrument with attending delay in maturity and
possible loss of instrument in transit, are lower than most other rates. Similarly, there are other
clusters of rates, such as, one month’s rate, 3month’s rate. Longer the duration, lower the price
(of the foreign currency in terms of domestic).The exchange rate between two given currencies
may be obtained from the rates of these two currencies in terms of a third currency. The resulting
rate is called the Cross rate.
Arbitrage in the Forex market refers to buying a foreign currency in a market where it is selling
cheaper and selling the same in a market where it is bought higher. It involves no risk as rates are
known in advance. Moreover, there is no investment required, as the purchase of one currency is
financed by the sale of other currency. Arbitrageurs gain in the process of arbitraging.

Introduction to the Foreign Exchange Risk Management
Risk:
Risk can b defined as the degree or probability of loss. The term Risk thus suggests about
uncertainty and unpredictability of the events which may affect the business or people at large.
Risk is the possibility that the actual result will deviate from the expected levels of result. The
greater the level of deviation and greater the probability of its occurrence, the greater is the risk.
A business has to take steps to reduce the risk by adopting suitable techniques or policies. Risk
management focuses on identifying and implementing these technique or policies, lest the
business should be left exposed to uncertain outcomes.
Risk management:
Risk management is a process to identify loss exposure faced by an organization and to select the
most appropriate technique to minimize such exposures. Risk management tools measure the
potential loss and potential gain. It enables us to stay with varying degree of certainty and
confidence levels, that our potential loss will not exceed a certain amount if we adopt a particular
strategy. Risk management enables us to tackle uncertainty head on, acknowledge its existence,
try to measure its extent and finally controls it.
Risk management makes sense for two reasons. First, a business entity generally wishes to
reduce risks to acceptable levels. Second, a business entity is by and large keen on avoiding
particular kind of risks, for it may be too great for the business to bear. For each situation where
one wishes to avoid a risk- a loss by fire, for example- three is, perhaps, a counter party who may
be willing such risk. For risk reduction, a business entity can adopt the following methods.
Hedging:
Hedging is a technique that enables one party to diminish the effect of adverse outcomes, in a
given situation. Parties come together to minimize the effect of which risk of one party gets
cancelled by the risk of another. It is not that risk minimization is the only strategy. An entity
may even choose to remain exposed, in anticipation of reaping profits from its risk taking
positions.

Foreign Exchange Exposure
Exposure:
Exposure is defined as the possibility of a change in the assets or liabilities or both of a company
as a result in the exchange rate. Forex exposure thus refers to the probability of loss or gain to a
company that arises because of exchange rate fluctuations. The value of a firm’s assets, liabilities
and operating income differ continually in response to changes in many economic and financial
variables such as interest rates, exchange rates, inflation rates, relative price and so forth. We can
call these uncertainties as macroeconomic environment risks. These risks influence all firms in
the economy. However, the degree and nature of impact of even macroeconomic risks
significantly depend upon the nature of firm’s business. For Example, fluctuations of exchange
rate will affect net importers and exporters quite differently. The impact of interest rate
fluctuations will be very different from that on a manufacturing firm. The nature of
macroeconomic uncertainty can be illustrated by a number of commonly encountered situations.
An appreciation of value of a foreign currency(or equivalently, a depreciation of the domestic
currency), increase the domestic currency value of a firm’s assets and liabilities denominated in
the foreign currency-foreign currency receivables and payables, banks deposits and loans, etc. It
will also change domestic currency cash flows from exports and imports. An increase in interest
rates reduces the market value of a portfolio of fixed-rate in the rate of inflation may increase
value of unsold stocks, the revenue from future sales as well as the future costs of production.
Thus the firms exposed to uncertain changes in a numbers of variable in its environment. These
variables are sometimes called Risk Factors.
The nature of Exposure and Risk
Exposures are a measure of the sensitivity of the value of financial items to changes in the
relevant risk factor while risk is a measurable of the variability of the item attributable to the risk
factor. Corporate treasurers have become more and more concerned about exchange rate and
interest rate exposure and risk during the last ten to twenty years or so. In the case of exchange
rate risk, The increased awareness is firstly due to tremendous increase in the volume of cross
border financial transactions (which create exposure) and secondly due to the significant increase
in the degree of volatility in exchange rates(which, given the exposure, creates risk)

Classification of Foreign Exchange Exposure and Risk
Since the advent of floating exchange rates in 1973, firms around the globe have become acutely
aware of the fact that fluctuations in exchange rates expose their revenues, costs, operating cash
flows and thence their market value to substantial fluctuations. Firms which have overseas
transactions-exports and imports of goods and services, and lending, foreign portfolio, foreign
borrowings and direst investment etc, are directly exposed: but even purely domestic firms which
have absolutely no cross-border transactions are also exposed because their suppliers, customers,
and competition are exposed. Considerably effort has since been devoted to identifying and
categorizing currency exposure and developing more and more sophisticated methods to quantify
it.
Foreign exchange exposure can be classified into three broad categories:
 Transaction exposure
 Translation exposure
 Operating exposure
The first and third together are sometimes called “Cash Flow Exposure” while the second is
referred to as “Accounting Exposure” or Balance sheet Exposure”.
Transaction exposure
When a firm has a payable or receivable in a foreign currency, a change in the exchange rate will
change the amount of local currency receivable or paid. Such a risk or exposure is called as
transaction exposure.
For instance, if an Indian exporter has a receivable of $1000, due three months hence and if in
the in the interim the dollar depreciates relative to rupee a cash loss occurs. on the other hand, if
the rate of dollar appreciates relative to the rupee, a cash gain occurs. In the case of payable, the
outcome will be different: a decrease in the rate of the dollar relative to the rupee results in a
gain, where as an appreciation of the dollar relative to the rupee result in a loss.
Translation exposure
Many MNC’s require that their accounts of branches and foreign subsidiaries get consolidated
with those of it. For such consolidation, assets and liabilities expressed in foreign currencies have

to be translated into domestic currencies at the exchange rate existing on the consolidation dates.
If the values of foreign currency changes between a two or consecutive consolidation dates,
translation exposure will arise.
Operating exposure
Operating exposure, like translation exposure involves an actual or potential gain or loss. While
the former is specific to the transaction, the latter relates to entire investment. The essence of this
operating exposure is that exchange rate changes significantly and alter the cost of firm’s inputs
along with price of it output and thereby influence its competitive position substantially.
For instance, Volkswagen had a successful export market for its ‘BEETLE’ model in the US
prior to 1970. With the breakdown of Bretten-woods of fixes exchanged rates, the deutschemark
appreciated significantly against the dollar. This created difficulty for Volkswagen as its
expenses were mainly in deutschemark but its revenue in dollars. However, in a highly price-
sensitive US market, such an action caused a sharp decreased in sales volume-from 600,000
vehicles in 1968 to 200,000 in 1976.
Techniques for managing forecasts
The aim of Forex risk management is to stabilize the cash flows and decrease the uncertainty
from financial forecasts. To hedge any transaction is to buy certainty to make sure that
unexpected exchange rate movements will have no impact on our operations. What determines
the price of this certainty?
 Flexibility -- Do we want to have perfect coverage?
 Opportunity – Do we want the chance to gain on the upside?
 Efficiency – How (liquid/transparent /regulated) is the market?

Fig: 3.2
The above graph shows that the value of the firm increases after the risks are hedged. There are a
variety of hedging instruments that can be used to reduce risk. Hedging Alternatives include:
Forwards, futures, options, swaps, etc.
Example: Swedish company has got a sales order to an American customer. Delivery time is
In three months and price is in US dollar.
 Open position
No hedging. If the Swedish Kroner (SEK) increases in value the Swedish company loses.
 Forward contract
An exchange rate quoted today for settlement at a future date.
 Futures contract
A standardized agreement for settlement at a future date.
 Money market hedge
Borrow US dollar today and exchange the proceeds to local currency.
 Options contract
A contract giving the Swedish company the right, but not the obligation to sell US dollar at an
agreed rate. Provides a hedge and a chance to win.

Derivatives: A derivatives transaction is a mutual contract or payment exchange agreement
whose value depends on - derives from - the value of an underlying asset, reference rate or index.
Nowadays, derivatives transactions cover a broad range of underlyings -, exchange rates, interest
rates, commodities, equities and other indices. Adding to privately negotiated, global
transactions, derivatives include standardized futures and options on futures that are vigorously
traded on organized exchanges and securities such as call warrants.
The term “derivative” is also used to refer to a large mixture of other instruments. These have
payoff characteristics, which reflect the fact that they comprise derivatives products as part of
their make-up. While the variety of products is diverse it is not complicated. Each derivatives
transaction is constructed from two straightforward building blocks that are basic to all
derivatives: forwards and options. They include:
 Forwards: forwards and swaps, as well as exchange-traded futures (ETF’s).
 Options: privately negotiated over the counter options (including caps, collars, floors and
options on forward and swap contracts), exchange-traded options.
Diverse forms of derivatives are shaped by using these building blocks in diverse ways
and by applying them to a wide variety of underlying assets, rates or indices.
(a) Forwards-Based Derivatives
There are three divisions of forwards-based derivatives:
• Forward contract;
• Swaps;
• Future contract.
(i) The Forward Contract: The simplest form of derivatives is the forward contract. It obliges
one party to purchase, and the other to sell, a particular quantity of a nominated underlying
financial instrument at a particular price, on a particular date in the future. There are markets for
a multitude of underlyings. Among these are the traditional agricultural or physical commodities,
currencies (foreign exchange forwards) and interest rates (forward rate agreements - FRAs). The
volume of trade in forward contracts is huge.

The change in value in a forward contract is generally equal to the change in value in the
underlying. Forwards vary from options in that options carry a different payoff profile. Forward
contracts are distinctive to every trade. They are tailored to meet the definite requirements of
each end-user. The characteristics of every transaction include the specific business, financial or
risk-management targets of the counterparties. Forwards are not standardized. The terms in
relation to contract size, delivery date, delivery grade, location, and credit period are always
negotiated.
In a forward contract, the buyer of the contract draws its value at maturity from its delivery terms
or a cash settlement. The buyer makes a profit if on maturity the price of the underlying is higher
than the contract price. On the other hand, If the price is lower, the buyer incurs a loss. The gain
to the buyer is a loss to the seller.
 Forwards Rates: The forward rate is quite different from the spot rate. Depending upon
whether the forward rate is more than the spot rate, given the currency in consideration,
the forward may either be at a ‘premium’ or at a 'discount'. Forward premiums and
discounts are generally expressed as an annual percentage of the distinction between the
spot and the forward rates.
 Premium: When a currency is costlier (higher) in forward or say, for a future value date,
it is said to be at a premium. In case of direct method of quotation, the premium is added
to both the selling and buying rates.
 Discount: If the currency is cheaper (lower) in forward or for a future value date, it is
said to be at a discount. In case of direct quotation method, the discount is deducted from
both the selling and buying rate. The following example explains how to calculate
Premium / Discount both under Direct/indirect quotes.
To calculate the Premium or Discount of a currency vis-à-vis another, we have to to find out how
much each unit of the first currency can buy units of the 2nd
currency. For example, if the Spot
rate between INR and USD is ` 56 to a dollar and the six months forward rate is ` 62 to a dollar,
it is obvious the USD is strengthening against the Rupee and therefore is at a premium. Which
also means that Rupee is at discount?

Forward Rates in India: in India, Forward rates are not determined by interest rate differentials
i.e. forward quotations do not have a obvious rule but are determined by actual demand/supply
conditions for individual currencies, mostly the US dollars. These rates reveal to an extent the
actual and expected currency changes, while re-booking and cancellation of forward contracts
are introduced in India. The cost of forward cover will be the agreed forward rate minus the
ruling spot rate on the transaction day (opportunity cost).
According to the Reserve Bank Of India guidelines, Authorized Dealers can enter into contracts
for forward sale and purchase of foreign currency with residents (corporate) who have a
crystallized exposure to exchange risk in respect of actual transactions permitted under Exchange
Control Regulations. The choice of the currency and tenor are left to the customer. Where the
exact amount is not ascertainable owing to the rates/costs being linked to variable factors,
contracts may be booked on the basis of a reasonable estimate. However, the maturity of the
cover should not surpass the maturity of the underlying transaction.
The greater flexibility provided by the Reserve Bank Of India now requires the corporate
treasurer to be well familiar with the mechanism of cancellation and early delivery under a
forward contract.
Extension of forward contracts: Extension of a forward contract becomes essential when the
contract is booked for a short period as compared to the due date or when the payment to be
made is delayed beyond the period covered by the forward contract. Extension of a forward
contract involves a swap (concurrently selling in the spot market and buying in the forward
market or vice versa), the cost of which is recovered or paid to the corporation, as the case may
be. According to the FEDAI rules, if the swap period is for a period of 30 days or less than 30
days, gain from the swap will not be conceded on the corporation. The extension cost, simply
put, is the distinction between the spot rate existing on the date of the extension and the forward
rate for the period upto which the contract is sought to be extended.
Cancellation of forward contract: In case of cancellation of a contract on the demand of the
customer, the bank shall recover or pay as the case may be, the variation between the contracted
rate and the rate at which the cancellation is effected. In case there is no instruction from the
customer, contracts which have matured, shall on the 15th day from the date of maturity be

automatically cancelled. The customer will not be permitted to the exchange difference, if any, in
his favour as the contract has been cancelled on account of his default.
(ii) Swaps: Swaps are considerably flexible. In scientific terms they are a method of exchanging
the underlying economic basis of an asset or debt without affecting the underlying principal
obligation on the debt or asset.
A swap transaction enables the participants to exchange cash flows at particular intervals, which
are called settlement or payment dates. Cash flows are either fixed or calculated for particular
dates by multiplying the quantity of the underlying by particular reference rates or prices. The
vast majority of swaps are classified into the following groups:
 Equity
 Currency
 Interest rate
 Commodity
The notional principal (i.e. the face value of a security) on all these, excluding currency swaps, is
used to ascertain the payment stream but not exchanged. Interim payments are generally netted -
the difference is paid by one party to the other. Like forwards, the key users of swaps are huge
multinational banks or corporations. Swaps create credit exposures and are individually tailored
to meet the risk-management objectives of the participants.
Interest Rate Swaps: In an interest rate swap, the exchange of principal do not takes place but
interest payments are made on the notional principal amount. Interest payments can be
exchanged between two parties to attain changes in the calculation of interest on the principal,
for instance:
 Floating to fixed
 Fixed to floating
 LIBOR to prime - based
 Prime to LIBOR
 Currency A to currency B.

In an interest rate swap, both parties raise finance as they generally would in the markets where
they have relative benefit. They then engage in the swap. The arrangement benefits both parties
as it exploits one's comparative advantage. Here LIBOR refers to the ‘London Interbank Offered
Rate’, which is a daily reference rate based on the interest rates at which banks borrow unsecured
funds from other banks in the interbank market. This rate is formally fixed once a day by the
British Bankers Association but the rate changes throughout the day.
Currency Swaps: These involve an exchange of liabilities between currencies. A currency swap
can consist of three stages:
 A spot exchange of principal - this forms part of the swap agreement as a similar effect
can be obtained by using the spot foreign exchange market.
 Continuing exchange of interest payments during the term of the swap - this represents a
series of forward foreign exchange contracts during the term of the swap contract. The
contract is typically fixed at the same exchange rate as the spot rate used at the outset of
the swap.
 Re-exchange of principal on maturity.
A currency swap has the following benefits:
 Treasurers can hedge currency risk.
 It can provide considerable cost savings. A strong borrower in the Japanese Yen market
may be interested in borrowing in the American USD markets where his credit rating
may not be as good as it is in Tokyo. Such a borrower could get a better US dollar rate by
raising funds first in the Tokyo market and then swapping Yen for US dollars.
 The swap market permits funds to be accessed in currencies, which may otherwise
command a high premium.
 It offers diversification of borrowings
 A more complex version of a currency swap is a currency coupon swap, which swaps a
fixed-or-floating rate interest payment in one currency for a floating rate payment in
another. These are also known as Circus Swaps.
 In a currency swap the principal sum is usually exchanged:
 At the start;

Risk Management in Foreign Exchange

Risk Management in Foreign Exchange

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