Foreign Exchange Market


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Foreign Exchange Market

  1. 1. Welcome
  3. 3. Foreign Exchange Market <ul><li>The market where one currency is traded for another is called foreign exchange market </li></ul><ul><li>Every international sale or purchase of commodities, services or assets, there corresponds an international sale or purchase of currencies </li></ul>
  4. 4. Features of Foreign Exchange Market <ul><li>Location: OTC Market – banks and brokers at a financial centre </li></ul><ul><li>Wholesale and Retail segments </li></ul><ul><li>Size : Daily turnover of over $3.98 trillion </li></ul><ul><li>24 hours market </li></ul><ul><li>Efficiency </li></ul><ul><li>Currencies traded </li></ul>
  5. 5. Most traded currencies by value 200.0% Total 12.2% Other 0.9% INR ( ) Indian rupee 15 1.3% MXN ($) Mexican Peso 14 1.3% NOK (kr) Norwegian Krone 13 1.4% SGD ($) Singapore dollar 12 1.5% KRW (₩) South Korean Won 11 1.6% NZD ($) New Zealand dollar 10 2.2% SEK (kr) Swedish Krona 9 2.4% HKD ($) Hong Kong dollar 8 CAD ($) CHF (Fr) AUD ($) GBP (£) JPY (¥) EUR (€) USD ($) Symbol 5.3% Canadian dollar 7 6.4% Swiss franc 6 7.6% Australian dollar 5 12.9% Pound sterling 4 19.0% Japanese yen 3 39.1% Euro 2 84.9% United States dollar 1 % daily share( April 2010) Currency Rank
  6. 6. Top 10 currency traders % of overall volume, May 2011 3.64% Morgan Stanley 10 4.13% Goldman Sachs 9 4.80% Credit Suisse 8 6.20% Royal Bank of Scotland 7 6.26% HSBC 6 6.43% JP Morgan 5 8.88% Citi 4 10.59% UBS AG 3 10.75% Barclays Capital 2 15.64% Deutsche Bank 1 Market Share Name Rank
  7. 7. Foreign Exchange Market <ul><li>Participants: </li></ul><ul><ul><li>Corporates </li></ul></ul><ul><ul><li>Commercial banks </li></ul></ul><ul><ul><li>Exchange brokers </li></ul></ul><ul><ul><li>Central banks </li></ul></ul>
  8. 8. SWIFT : Society for Worldwide Interbank Financial Telecommunications - a co-operative society owned by about 250 banks in Europe and North America - registered in Brussels, Belgium Settlement of Transactions
  9. 9. CHIPS : Clearing House Interbank Payment System- an electronic payment system owned by 12 private commercial banks constituting New York Clearing House Association CHAPS : Clearing House Automated Payment System - London Settlement of Transactions
  10. 10. <ul><li>The foreign exchange market has two segments </li></ul><ul><ul><li>Spot Market </li></ul></ul><ul><ul><li>Forward Market </li></ul></ul><ul><li>The rate at which one currency is traded for </li></ul><ul><li>another is called exchange rate </li></ul>Foreign Exchange Market
  11. 11. Spot Market <ul><li>The exchange rate for immediate delivery is called Spot Exchange Rate and is denoted by S (.) e.g. S (Rs. /$) = Rs.46.85/$ </li></ul><ul><li>Here immediate delivery means delivery after two business days </li></ul><ul><li>The market where the purchase and sale of currencies is contracted for spot delivery is called the Spot Market </li></ul>
  12. 12. Quotations at the FX Market <ul><li>The quotes are usually made in the form of ‘buy’ and ‘sell’ or ‘bid’ and ‘ask’ rates </li></ul><ul><li>Sometimes ‘ask’ is also referred as ‘offer’ price </li></ul>Buy/ Bid Sell/ Ask Exchange dealer is ready to buy Exchange dealer is ready to sell
  13. 13. In case of ‘direct’ quotes, a unit of foreign currency is quoted in terms of domestic currency For example: At Mumbai foreign exchange market , the US dollar is quoted as: USD 1 = Rs. 45.1525/1650 Spot (bid) = Rs. 45.1525/$ Spot (ask) = Rs. 45.1650/$ Direct & Indirect Quotes Rule : “ Buy low: Sell high”
  14. 14. In case of ‘indirect’ quotes, a unit of domestic currency is quoted in terms of foreign currency For example: At Mumbai foreign exchange market , the quotation are made as: Rs. 100 = USD 2.0762/0767 Spot (bid) = $ 2.0767/Rs.100 Spot (ask) = $ 2.0762/ Rs.100 Direct & Indirect Quotes Rule : “ Buy high: Sell low”
  15. 15. <ul><li>Sometimes the quotes are made against 100 </li></ul><ul><li>units of a currency instead of a unit of the </li></ul><ul><li>currency </li></ul><ul><li>European quotes are indirect quotes </li></ul><ul><li>Indian quotes are direct quotes </li></ul>Direct & Indirect Quotes
  16. 16. <ul><li>When a bank quotes for a currency, it simultaneously offers another currency in lieu i.e. if it buys dollars for rupees, it is simultaneously offering rupees for dollars </li></ul><ul><li>Thus, there are two sides of all quotes </li></ul><ul><ul><li>S ( x /bid y ) = 1/ S ( y /ask x ) and S ( x /ask y ) = 1/ ( y /bid x ) </li></ul></ul><ul><ul><li>Where: </li></ul></ul><ul><ul><li>x and y are currencies of two countries </li></ul></ul>Relationship between Bid/ Ask prices
  17. 17. <ul><li>Ask and bid differential is called the spread </li></ul><ul><li>When quotes are direct : </li></ul><ul><li> Spread = Ask – Bid </li></ul><ul><li>When quotes are indirect : </li></ul><ul><li> Spread = Bid – Ask </li></ul><ul><li>Spread represents cost of transaction </li></ul><ul><li>It is represented by the percentage of spread and is </li></ul><ul><li>given by: </li></ul><ul><li>[( Ask- Bid)/ Ask] x 100 when quotes are direct </li></ul><ul><li>2. [(Bid – Ask)/ Bid] x 100 when quotes are indirect </li></ul>Spread
  18. 18. Let ‘c’ be one side average cost of transaction and ‘ M’ be the mid rate, then the bid and ask rates are given as: S (bid) = M x ( 1-c) and S (ask) = M x (1+c) The mid rate is issued by the central banks of the countries if convertibility conditions exist Spread equals twice the one side average cost of transaction How ‘ BID’ and ‘ASK’ rates are formed
  19. 19. Determinants of Spread <ul><ul><li>The currency being traded </li></ul></ul><ul><ul><li>The volume of currency being traded </li></ul></ul><ul><ul><li>The nature of organisation making quotes </li></ul></ul><ul><ul><li>Overall perception of the Dealer about the </li></ul></ul><ul><ul><li>conditions of the economy and forex market </li></ul></ul><ul><li>Usually these spreads are regulated by foreign exchange dealers associations such as FEDAI </li></ul>
  20. 20. Factors Determining Spot Exchange Rates <ul><ul><li>Balance of Payments </li></ul></ul><ul><ul><li>Inflation </li></ul></ul><ul><ul><li>Interest Rates </li></ul></ul><ul><ul><li>Money Supply </li></ul></ul><ul><ul><li>National Income </li></ul></ul><ul><ul><li>Resource Discoveries </li></ul></ul><ul><ul><li>Capital Movements </li></ul></ul><ul><ul><li>Political Factors </li></ul></ul><ul><ul><li>Psychological Factors and Speculation </li></ul></ul><ul><ul><li>Technical and Market Factors </li></ul></ul>
  21. 21. Forward Market <ul><li>Forward contracts are bought and sold at forward exchange rates </li></ul><ul><li>Hedging and speculation are the main activities which pertain to forward markets </li></ul>
  22. 22. <ul><li>The exchange rates for delivery and payment </li></ul><ul><li>at specified future dates are called Forward </li></ul><ul><li>Exchange Rates and is denoted by F(.) </li></ul><ul><li>For example, 60 days F (Rs. /$) : forward rate </li></ul><ul><li>between rupees and dollar is the rate at which </li></ul><ul><li>the foreign exchange dealer can arrange a </li></ul><ul><li>transaction between rupees and dollar 60 days </li></ul><ul><li>hence </li></ul>Forward Exchange Rate
  23. 23. Forward Exchange Rate <ul><li>Forward exchange rates are determined by </li></ul><ul><li>forward demand and forward supply of </li></ul><ul><li>various currencies </li></ul><ul><li>A foreign currency is said to be at a forward </li></ul><ul><li>premium if its future value exceeds its </li></ul><ul><li>present value in terms of domestic currency </li></ul><ul><li>and it is said to be at discount if the converse </li></ul><ul><li>is true </li></ul><ul><li>For example : S (Rs. /$) = Rs. 45.70 </li></ul><ul><li> F 3 (Rs./$) = Rs. 46.60 </li></ul>
  24. 24. <ul><li>These rates are also quoted in the form of </li></ul><ul><li>‘ bid’ and ‘ask’ rates and the spread also </li></ul><ul><li>depend on approximately the same factors as </li></ul><ul><li>spot rates plus: </li></ul><ul><ul><ul><li>Rate of Interest </li></ul></ul></ul><ul><ul><ul><li>Demand and Supply </li></ul></ul></ul><ul><ul><ul><li>Speculation about Spot Rates and </li></ul></ul></ul><ul><ul><ul><li>Exchange Regulations </li></ul></ul></ul>Quotations of Forward Rates
  25. 25. Payoffs in the case of a forward contract Quotations of Forward Rates 20,000.00 0.200 46.3500 46.1500 10,000.00 0.100 46.3500 46.2500 0.00 0.000 46.3500 46.3500 - 10,000.00 -0.100 46.3500 46.4500 - 20,000.00 -0.200 46.3500 46.5500 Profit/Loss (Rs.) Unanticipated Change Contracted Rate (Rs.) Realised Rate (Rs.)
  26. 26. <ul><ul><ul><ul><li>Traders </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Arbitrageurs </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Hedgers </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Speculators </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Banks </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Governments </li></ul></ul></ul></ul>Participants in the Forward Market
  27. 27. The exchange rate which is obtained by cross product of two exchange rates is called Cross Rate Spot rate at Mumbai :S(Rs./$) = 31.2022/$ Spot rate at Frankfurt : S(Rs./DM) = 15.87 / DM Then Cross Rate = S(DM/$) = DM 2.0983/$ This is the rate a Mumbai broker may expect the Frankfurt price of dollar in terms of DM Cross Rates
  28. 29. <ul><li>In Indian forex market, not all currencies are </li></ul><ul><li>bought or sold </li></ul><ul><li>For non-traded currencies, the banks use </li></ul><ul><li>London, New York or Singapore markets </li></ul><ul><li>Exchange Market Segments: </li></ul><ul><li>1. RBI and ADs( Commercial Banks) </li></ul><ul><li>2. Interbank market </li></ul><ul><li>3. Retail segment – ADs with corporate clients and other retail customers </li></ul>Indian Forex Market
  29. 30. <ul><li>The rates quoted by authorised dealers (ADs) are merchant rates at which trading can take place in the Retail segment </li></ul><ul><li>Merchant rates are different than inter-bank rates and contain administrative cost, cover for exchange fluctuation and some profit on the transaction for the Bank </li></ul>Indian Forex Market
  30. 31. <ul><li>Four types of rates are quoted: </li></ul><ul><ul><li>1. TT( Telegraphic Transfer) rate </li></ul></ul><ul><ul><li>2. Bill rate </li></ul></ul><ul><ul><li>3. Currency notes </li></ul></ul><ul><ul><li>4. Travellers cheque rate </li></ul></ul>Types of Exchange Rates
  31. 32. <ul><li>Transactions where TT rate is applied: </li></ul><ul><ul><li>Issue/ Payment of demand drafts, mail transfers, telegraphic transfers etc. </li></ul></ul><ul><ul><li>Foreign bill collected and amount received in nostro account </li></ul></ul><ul><ul><li>Cancellation of foreign exchange sold/ purchased earlier </li></ul></ul>TT ( Telegraphic Transfer) rate
  32. 33. Rate applied for a foreign bill purchased or payment against import bill Bill Buying rate: Basic rate (+ or -) Forward Premium ( Discount) for transit period plus usance period – Exchange margin Bill selling rate = TT selling rate + service margin Bill Rate
  33. 35. <ul><li>In India, the official rate is determined by the </li></ul><ul><li>RBI on the basis of the multi-currency basket </li></ul><ul><li>The official buying and selling rates are </li></ul><ul><li>announced </li></ul><ul><li>FEDAI announces indicative free market rate on </li></ul><ul><li>every business day </li></ul><ul><li>The RBI has the discretion to enter the market </li></ul><ul><li>so as to stabilise the exchange rate </li></ul>Indian Forex Market
  34. 36. FEDAI Indicative Rates 11.30 am 22nd August 2011 65.9900/66.0225 59.8500/9025 EUR JPY 75.7150/7450 45.9350/9450 GBP USD