Exchange rates


Published on

Published in: Business, Economy & Finance
  • Be the first to comment

No Downloads
Total views
On SlideShare
From Embeds
Number of Embeds
Embeds 0
No embeds

No notes for slide

Exchange rates

  1. 1. Foreign Exchange Markets By Akshay Samant
  2. 3. History Of Money <ul><li>Barter & Ancient Trade </li></ul><ul><ul><li>Historians trace the origins of barter to the early stone age period between 8000 BC and 6000 BC in middle east, Greece, Turkey, Asia & Africa. </li></ul></ul><ul><ul><li>Barter – To trade by exchanging goods and services for other goods & services not money. </li></ul></ul><ul><ul><li>Successful Barter – Mr. A must want what Mr. B has & Mr. B must simultaneously want what Mr. A has. </li></ul></ul>
  3. 4. <ul><ul><li>Coins first struck in the region of Lydia now modern Turkey </li></ul></ul><ul><ul><li>The paper money first emerged in China under Tang Dynasty (618 AD - 907 AD) </li></ul></ul><ul><ul><li>The functions of currency </li></ul></ul><ul><ul><ul><li>Medium of exchange </li></ul></ul></ul><ul><ul><ul><li>Value of exchange </li></ul></ul></ul><ul><ul><ul><li>Store of value </li></ul></ul></ul><ul><ul><li>Characteristics of money - convertibility, portability, divisibility, durability, stability of value </li></ul></ul>
  4. 5. The History of Foreign Exchange Markets <ul><li>The origins of modern – day financial centers were the late 17 th century </li></ul><ul><li>Coffee houses of London close to the Royal Exchange, mercantile hub set up by English merchant and financier Sir Thomas Gresham in the 16 th century. </li></ul><ul><li>Information list, Lloyd’s list – Exchange rate </li></ul><ul><li>East India Company – Longest surviving company of all time, global trade. </li></ul>
  5. 6. <ul><li>The advent of Fx markets in 1970s led to the development of inter bank markets, Fx trading. </li></ul><ul><li>Sole domain of commercial banks & investment banks. </li></ul><ul><li>New players – Insurance companies, pension funds, mutual funds & hedge funds. </li></ul>
  6. 7. <ul><li>Before the invention of fax machines and internet Fx business was conducted via telex and dedicated telephone lines </li></ul><ul><li>These channels were replaced by electronic communications networks ECN’s set up by information service providers such as Reuters & EBS (electronic broking service) </li></ul><ul><li>The advent of ECN’s fueled explosive growth in foreign exchange trading. </li></ul>
  7. 8. <ul><li>The growth was further driven by the emergence of the internet in the 1990’s </li></ul><ul><li>It lowered the cost of handling and processing information, and brought foreign exchange trading services online. </li></ul><ul><li>Services such as prime brokerage, white – labeling & algorithmic trading are growing in these markets. Amid intense competition between the different liquidity providers to capture market share in foreign exchange trading </li></ul>
  8. 9. <ul><li>Prime brokerage – The term ‘prime broker’ describes an investment banks package of services for clients, mostly hedge funds clients. </li></ul><ul><li>White labelling – this allows smaller banks & financial institution to outsource their currency pricing to providers with large liquidity base, such as HSBC, Citigroup, Deutsch bank, while promoting these services under their own name. </li></ul>
  9. 10. <ul><li>Algorithmic trading – Also known as ‘automatic’, blackbox, or robo trading where the investor places an order to buy or sell and the computer automatically generates the timing of orders and the size of orders based on goals specified by algorithmic parameters and constraints. </li></ul><ul><li>The online foreign Exchange trading platform – Fx connect, Fxall & Currenex. These are multibank foreign exchange trading network that provides secure, real time trade execution with multiple counterparties 24 hours a day </li></ul>
  10. 11. <ul><li>The most important component of daily trading volume is speculation activity </li></ul><ul><li>This usually relates to global capital seeking the most profitable return in the shortest period of time. </li></ul><ul><li>Currency market players worldwide followed two key strategies </li></ul><ul><ul><li>One is based on interest rate differentials by investing in high yielding currencies. Popular among high leveraged players “carry trade” </li></ul></ul>
  11. 12. <ul><ul><li>Momentum trading – where investors took large positions in currencies aimed at exploiting long swings or runs in exchange rates </li></ul></ul><ul><li>Characteristics of Fx market </li></ul><ul><ul><li>24 hour market – time zone enter / exit </li></ul></ul><ul><ul><li>Liquidity – better depth & breadth </li></ul></ul><ul><ul><li>Easy entry – (online trading) </li></ul></ul><ul><ul><li>Simple trading decisions – (a few of the worlds currencies </li></ul></ul>
  12. 13. <ul><ul><li>High leverage possible – (leverage their position as much as 100 times) </li></ul></ul><ul><ul><li>Low transaction cost – (commission free & no exchange or Clearing free) </li></ul></ul><ul><ul><li>Real time quotes, instant execution (execute their trades directly off real time bid-ask quotes, trade executed with much more certainty) </li></ul></ul>
  13. 14. <ul><li>Leading currencies </li></ul><ul><ul><li>The four most imp currencies in foreign exchange markets in term of trading volume are: </li></ul></ul><ul><ul><ul><li>US Dollar – USD </li></ul></ul></ul><ul><ul><ul><li>Euro – EUR </li></ul></ul></ul><ul><ul><ul><li>Japanese yen – JPY </li></ul></ul></ul><ul><ul><ul><li>UK pound sterling – GBP </li></ul></ul></ul>
  14. 15. <ul><ul><li>International organization for standardization (ISO) has assigned the above codes. Generally currency code is composed of the country’s two character code plus extra character to denote the currency unit </li></ul></ul><ul><ul><ul><li>Swiss Franc – CHF (Confoederatio Helvetica) </li></ul></ul></ul><ul><ul><ul><li>Canadian dollar – CAD </li></ul></ul></ul><ul><ul><ul><li>Australian dollar – AUD </li></ul></ul></ul><ul><ul><ul><li>New Zealand dollar – NZD </li></ul></ul></ul><ul><ul><ul><li>Indian rupee – INR </li></ul></ul></ul>
  15. 16. <ul><ul><li>Currencies trade in pairs in foreign exchange market. This involves simultaneously buying one currency and selling another currency. </li></ul></ul><ul><ul><li>Important currency pairs are </li></ul></ul><ul><ul><ul><li>EUR/USD </li></ul></ul></ul><ul><ul><ul><li>USD/JPY </li></ul></ul></ul><ul><ul><ul><li>GBP/USD </li></ul></ul></ul><ul><ul><ul><li>USD/CHF </li></ul></ul></ul><ul><ul><ul><li>USD/CAD </li></ul></ul></ul><ul><ul><ul><li>AUD/USD </li></ul></ul></ul><ul><ul><ul><li>NZD/USD </li></ul></ul></ul>
  16. 17. <ul><ul><li>The first currency in the pair is considered the base currency and the second currency is the quote currency </li></ul></ul><ul><ul><li>Most of the time, the US dollar acts as the base currency. Quotes are expressed in units of US $1 per quote currency. </li></ul></ul>
  17. 18. Exchange Rates <ul><li>Need of exchange of currency of one country or another country. </li></ul><ul><li>Inflow or outflow of goods, capital or services, cross border movement of man power travel and tourism. </li></ul><ul><li>Foreign exchange has become an integral part of the world financial system. </li></ul>
  18. 19. Definition <ul><li>(FEMA) defines </li></ul><ul><li>1. Foreign Exchange means foreign currency, and includes </li></ul><ul><li>(a) All deposits, credits and balances payable in foreign currency, and any drafts, travellers chques, letter of credit and bills of exchange expressed or drawn in Indian currency and payable in any foreign currency. </li></ul><ul><li>(b) Any instrument payable at the option of the drawee or holder, then of or any other party then to, either in Indian currency or its foreign currency or partly in one and partly in the other. </li></ul><ul><li>2. Exchange rate is the price or the ratio or the value at which one currency is exchanged for another currency. </li></ul><ul><li>3. Exchange rate is the dynamic rate. </li></ul>
  19. 20. Who Uses Foreign Exchange? <ul><li>Comprise individuals, business entities, banks investors, users and arbitrageurs, across the globe. </li></ul><ul><li>OTC (over the counter) communication system based, with no boundries and round the clock. </li></ul><ul><li>Tokyo and Sydney (east) through Hong Kong, Singapore, Middle East, India, London, Europe, New York – Different time zones. </li></ul><ul><li>Participants: </li></ul><ul><li>Central Banks </li></ul><ul><li>Commercial Banks </li></ul><ul><li>Investment funds / Banks </li></ul><ul><li>Forex Brokers </li></ul><ul><li>Corporations </li></ul><ul><li>Individual </li></ul><ul><li>Global forex turnover US $ 1.90 trillion trade turnover 750 Billion (other investment / speculation) India turn over 1.20 billion </li></ul>
  20. 21. Factors Affecting Exchange Rates <ul><li>Exchange control </li></ul><ul><li>Balance of payment </li></ul><ul><li>Relative price – inflation, asset market, economic growth rate, monetary policy </li></ul><ul><li>Interest rate </li></ul><ul><li>Political issues </li></ul><ul><li>Demand and supply – visible / invisible trade export and import, services, shipping, insurance banking, tourists, student studying, gifts </li></ul>
  21. 22. Currency Trading Trends <ul><li>Foreign exchange trading volume is $1.9 trillion a day </li></ul><ul><li>It is estimated 95% of foreign exchange transactions are speculation </li></ul><ul><li>This usually relates to global capital sucking the most profitable return tn the shortest period of time. </li></ul>
  22. 23. <ul><li>UK & US accounted for the 50% of the daily turnover while Japan 8% and Singapore 5% of the average daily turnover </li></ul><ul><li>The major attraction of foreign exchange markets include </li></ul><ul><ul><li>High liquidity level </li></ul></ul><ul><ul><li>High accessibility for many different types of participants. </li></ul></ul><ul><ul><li>Efficiency </li></ul></ul>
  23. 24. <ul><li>The USD, Euro, UK pound and Japanese continue to be the four most important currencies in the world and account for the dominant share of foreign exchange trading. </li></ul><ul><li>There is also a notion that currencies have become an asset class in themselves as investors search for yield around the globe. </li></ul>
  24. 25. Exchange Rates & Their Movements <ul><li>There is no exchange rate model that can predict future currency prices with 100% accuracy. </li></ul><ul><li>In rapidly growing global foreign exchange markets, currency movements become harder to predict as more participants enter the market on daily basis. </li></ul><ul><li>Research, opinions, emotions, expectations about where currencies headed. </li></ul>
  25. 26. <ul><li>Currency movements in the short term can be influenced by publicly available information's – </li></ul><ul><ul><ul><li>Country’s GDP data </li></ul></ul></ul><ul><ul><ul><li>Consumer price index </li></ul></ul></ul><ul><ul><ul><li>Employment data </li></ul></ul></ul><ul><ul><li>Central banks, such as the US Federal reserve or the European Central bank raising or covering interest rates </li></ul></ul>
  26. 27. <ul><ul><li>Central banks making public their thoughts on monetary policy </li></ul></ul><ul><ul><li>Political developments, both globally and in individual countries. </li></ul></ul><ul><ul><li>Natural disasters and perceptions about how they will impact economies. </li></ul></ul><ul><ul><li>Changes in commodity prices, particularly oil and gold. </li></ul></ul>
  27. 28. <ul><ul><li>Individual traders – in – house strategic analyze an currencies or buy & sell orders that come from customers, which can affect the decisions process of market participants. </li></ul></ul><ul><ul><li>FOMC – Federal Open Market committee </li></ul></ul><ul><li>If a country’s stock market rallies, its currency could strengthen – the correlation between stocks and currencies is strong enough to make currency traders watch stock markets for cues on the performance of currencies. </li></ul>
  28. 29. <ul><li>If oil prices surge to record high, it can have a negative impact on some currencies. </li></ul><ul><li>An increase in a country’s unemployment numbers can have a negative impact on its currency </li></ul><ul><li>If a country’s Central bank makes a surprise decision to raise rates by more than expected, its currency could rally. </li></ul>
  29. 30. Exchange Rate Mechanism <ul><li>Spot - settlement / delivery of funds takes place on the second after / following the date of contract deal 21.7.09 - 23.7.09 </li></ul><ul><li>Forward - Delivery takes place after day </li></ul><ul><li>Ready Cash - settlement on the same day 21.7.09 - 21.7.09 </li></ul><ul><li>TOM - settlement takes place next day of date of deal 21.7.09 - 22.7.09 </li></ul><ul><li>Value date - The date of delivery of funds on the date on which the exchange of currencies actually takes place is also referred as value date </li></ul>
  30. 31. Forward Margins <ul><li>Forward rate are derived from spot rates and are either at premium or discount. (forward margin) </li></ul><ul><li>Forward rate= spot rate +/- premium or discount </li></ul><ul><li>Forward value of the currency is higher than the spot (present) value, the currency is said to be in premium. </li></ul><ul><li>₤ = $ 1.8350 21.7.09 </li></ul><ul><li>₤ = $ 1.8450 21.8.09 (100 pips) </li></ul><ul><li>GBP- is dearer and at Premium </li></ul><ul><li>USD – is at Discount against GBP </li></ul>
  31. 32. <ul><li>1$ = 47.50/52 Spot (21.7.09) </li></ul><ul><ul><li>1 USD being bought at 47.50 & sold at 47.52 </li></ul></ul><ul><ul><li>40/42 Six month premium </li></ul></ul><ul><ul><li>It means that USD being quoted dearer in forward & is quoted 47.90/94 </li></ul></ul><ul><ul><li>Rupee is quoted at discount </li></ul></ul><ul><li>The correlations clearly established as the quotes are for a pair of currencies, where one is exchanged for another. </li></ul><ul><li>The forward premiums & discount are based on the interest rate differentials of two currencies involved as also the demand and supply of forward in the markets </li></ul>
  32. 33. <ul><li>Direct – one unit of FC to so many units of home currency (variable). </li></ul><ul><li>Indirect – one unit of home currency to so many units of FC (GBP, Euro, AUd, NZd, indirect rates) </li></ul><ul><li>Purchase and Sale </li></ul><ul><li>Export – purchase – FC to Rs (domestic </li></ul><ul><li>currencies) </li></ul><ul><li>Import sale – sale – Rs to FC </li></ul><ul><li>Outward – sale </li></ul><ul><li>Inward – purchase </li></ul><ul><li>US $ 1 = 40.50 Buy Low (give less) </li></ul><ul><li>= 40.52 Sell High (take more) </li></ul>
  33. 34. <ul><li>When we deal in a market where rate for a particular currency pair are not directly available , the price for the said currency pair is then obtained indirectly with help of a cross rate mechanism. </li></ul><ul><li>Quote for Euro / Rupee </li></ul><ul><ul><li>No one will quote Euro / Rupee Directly </li></ul></ul><ul><ul><li>The rate can be worked out by the Euro/USD & USD/Rupee quotes. </li></ul></ul><ul><ul><li>Euro/USD is available in the international market. </li></ul></ul><ul><ul><li>USD/Rs is available in the domestic market. </li></ul></ul>Cross Rate
  34. 35. <ul><ul><li>By crossing out USD in both the quotes, we can arrive at Euro/Rs </li></ul></ul><ul><ul><ul><li>For example we need to quote </li></ul></ul></ul><ul><ul><ul><li>GBP against INR </li></ul></ul></ul><ul><ul><ul><li> USD/INR & GBP/USD </li></ul></ul></ul><ul><ul><ul><li>to compute GBP / INR rate </li></ul></ul></ul><ul><ul><ul><li>1 USD = Rs 45.50/60 </li></ul></ul></ul><ul><li>$1.8340/50= £ 1 </li></ul><ul><li> £ 1= 83.447 Rs (buying) </li></ul><ul><li> 83.676 Rs (selling) </li></ul>
  35. 36. Fixed vs. Floating Rates <ul><li>Fixed Exchange rate is official rate set by the monetary authorities for one or more currencies. It is usually pegged to one or more currencies. </li></ul><ul><li>Floating Exchange rate – The value of the currency is decided by supply and demand factors </li></ul>
  36. 37. Bid and Offer Rate <ul><li>Buying rates and selling rates are also referred to as bid and offered rates (bid & ask) </li></ul><ul><ul><li>In USD/INR = 47.00/02 </li></ul></ul><ul><ul><ul><li>The quoting bank is bidding for USD at 47 and is offering to sell the USD at 47.02 </li></ul></ul></ul><ul><ul><li>On the other hand in GBP/USD = 1.8810/15 </li></ul></ul><ul><ul><ul><li>The quoting bank is willing to buy GBP at 1.8810 and willing to sell at 1.8815. </li></ul></ul></ul>