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Foreign exchange market and it's structure in india

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  • 1. F i E h M k tForeign Exchange Market & It’s Structure Saturday, October 31, 2009 Nitin Kulkarni @ IF 2009 1
  • 2. What is Foreign Exchange ? • In narrow terms, Forex simply means foreign currency or money other than the domestic currency or money • In Broader Terms, Forex Means Study of all the currencies of the different countriesy How they are exchanged or traded with each other Exchange rates and how they are set Th E h k tThe Exchange markets The Participants Saturday, October 31, 2009 Nitin Kulkarni @ IF 2009 2
  • 3. Function of a Forex Department Exports Pre/post Imports Opening of LC shipment Advance Export Advance bills Bills for collection Exchange Dealings Rate Computation Nostro / Vostro accounts Forward Contracts Guarantees,LC’ S & bills for collection Import loan and guarantees Forward Contracts Derivatives Exchange position and cover position Remittances Issue of DD,MT,TT Statistics Submission of returns , , Cheques,sale of Foreign currency notes,NR deposits returns, collection of credit information Saturday, October 31, 2009 Nitin Kulkarni @ IF 2009 3
  • 4. Foreign Exchange Market-World View • Globally, operations in the foreign exchange market startedy, p g g in a major way after the breakdown of the Bretton Woods system in 1971, which also marked the beginning of floating exchange rate regimes in several countriesfloating exchange rate regimes in several countries. • Over the years, the foreign exchange market has emerged as the largest market in the worldas the largest market in the world. • The decade of the 1990s witnessed a perceptible policy shift in many emerging markets towards reorientation of theirin many emerging markets towards reorientation of their financial markets in terms of new products and instruments, development of institutional and market infrastructure and realignment of regulatory structure consistent with the liberalised operational framework. Saturday, October 31, 2009 Nitin Kulkarni @ IF 2009 4
  • 5. Foreign Exchange Market in India • The changing contours were mirrored in a rapid expansiong g of foreign exchange market in terms of participants, transaction volumes, decline in transaction costs and more efficient mechanisms of risk transfer. • The origin of the foreign exchange market in India could be traced to the year 1978 when banks in India were permittedtraced to the year 1978 when banks in India were permitted to undertake intra-day trade in foreign exchange. • However, it was in the 1990s that the Indian foreign exchange market witnessed far reaching changes along with the shifts in the currency regime in India. Saturday, October 31, 2009 Nitin Kulkarni @ IF 2009 5
  • 6. Foreign Exchange Management Act Structure of Forex Market in India Foreign Exchange Management Act Central Govt. R.B.I. Authorized Persons F.E.D.A.I. Authorized Money Changes Authorized Dealers Saturday, October 31, 2009 Nitin Kulkarni @ IF 2009 6 Full Fledged Restricted
  • 7. Authorised Persons Authorised Dealers Commercial Banks -84 State Co-op Banks – 1 Financial institutions FI -4 Factoring Agencies -5 Full Fledged Money Changers Department of Post Others Th C kState Co-op Banks – 1 Urban Co-op Banks -2 Factoring Agencies -5 UCB,FFMC Thomos Cook India Ltd. Activities All Permissible current and capital account Activities Activities related to financing of Activities Sale/Purchase of foreign exchange for Activities Specified nonand capital account transactions financing of international trade undertaken by these institutions exchange for private and business visits abroad p trade related current account transactions Saturday, October 31, 2009 Nitin Kulkarni @ IF 2009 7 transactions
  • 8. Authorised Persons R t i t d A th i dAuthorised Dealers Commercial Banks -84 State Co-op Banks – 1 Restricted Authorised Dealers Category – I - FI Full Fledged Money Changers Department of Post State Co-op Banks – 1 Urban Co-op Banks -2 Activities Activities incidental to financing of international trade related activities undertaken by these UCB,FFMC Activities All Permissible current and capital account activities undertaken by these institutions. Category – II Activities Sale/Purchase of foreign exchange forand capital account transactions Upgraded FFMC, Selected UCB & RRB Thomos Cook Activities Private Visits Business Travel exchange for private and business visits abroad Saturday, October 31, 2009 Nitin Kulkarni @ IF 2009 8 Private Visits, Business Travel
  • 9. F.E.D.A.I Foreign Exchange Dealer's Association of India (FEDAI) was set up in 1958 as an Association of banks dealing in foreign exchange in India (typically called Authorizedforeign exchange in India (typically called Authorized Dealers - ADs) as a self regulatory body and is incorporated under Section 25 of The Companies Act, 1956. It's major activities include framing of rules governing the conduct of inter-bank foreign exchange business amongconduct of inter bank foreign exchange business among banks vis-à-vis public and liaison with RBI for reforms and development of Forex market. Saturday, October 31, 2009 Nitin Kulkarni @ IF 2009 9
  • 10. Functions of F.E.D.A.I • Guidelines and rules for the forex business • Training of bank personnel in the areas of Forex business Accreditation of brokers• Accreditation of brokers • Advising / Assisting member banks in settling issuesAdvising / Assisting member banks in settling issues, matters in their dealings • Represent member banks on Govt, R.B.I. and other bodies Saturday, October 31, 2009 Nitin Kulkarni @ IF 2009 10
  • 11. Functions of F.E.D.A.I • Announcement of daily and periodical rates to member banks • Prescribing margin for calculating exchange rates for various merchant transactionsvarious merchant transactions • Formulating code of conduct for dealers working in banks exchange brokers for dealing between each other Saturday, October 31, 2009 Nitin Kulkarni @ IF 2009 11
  • 12. Members of F.E.D.A.I. • Public and private sector banksPublic and private sector banks • Foreign banksg • Co-operative banks • Financial institutions such as EXIM bank, I.D.B.I.,I.F.C.I. and S I D B I and others such as Thomas Cook (I) Ltdand S.I.D.B.I. and others such as Thomas Cook (I) Ltd. • As on May 2008 F.E.D.A.I. has 89 membersAs on May 2008 F.E.D.A.I. has 89 members Saturday, October 31, 2009 Nitin Kulkarni @ IF 2009 12
  • 13. Authorized Dealers Commercial Banks, Co-Op Banks & Financial Institutions Category A Category –B Category CCategory –A It can undertake all types of Forex These are branches of the bank ,handling all Category –C These branches can undertake onlytypes of Forex Transactions Can set up dealing room to types of Forex transactions and reporting to dealing room of their bank. undertake only limited type of transactions like sale and dealing room to handle such transactions room of their bank. These branches cannot undertake dealing room purchase of foreign currency TC’s and Currency Saturday, October 31, 2009 Nitin Kulkarni @ IF 2009 13 dealing room operations and Currency
  • 14. Forex Market - Features • The Market Has No Physical Presence.y • It Is The Largest Market On The Planet “ Earth ”. • It Is Mostly Speculative In Nature. • It Is A 24 – Hour Market. • Some New York banks maintain 2 shifts (one arriving at office at 3 am when London and Frankfurt are open)office at 3 am when London and Frankfurt are open). Large New York banks also have branches in Tokyo, Frankfurt, and London. Thus, they are in contact with all financial centers 24 hours. • Daily Turn Over – 2.75 To 3.00 Trillion Dollar Per Day Saturday, October 31, 2009 Nitin Kulkarni @ IF 2009 14
  • 15. 24 Hour MarketMarket Saturday, October 31, 2009 Nitin Kulkarni @ IF 2009 15
  • 16. Saturday, October 31, 2009 Nitin Kulkarni @ IF 2009 16
  • 17. Forex Market - Features • It Is A Market Connected By Advanced Communication• It Is A Market Connected By Advanced Communication Channels Like S.W.I.F.T. • It Is An Extremely Active And Also An Unpredictabley p Market. • The Market Is Truly Global As Trades Take Place Across ContinentsContinents. • Most Deals Are On Spot Basis. • The Market Is Deep, Liquid And Efficient.p, q • Deals Are Screen Based. • Market Is Volatile Because Of Floating Nature Of Exchange RatesExchange Rates Saturday, October 31, 2009 Nitin Kulkarni @ IF 2009 17
  • 18. Foreign Exchange Market Interbank Market-Whole sale Market Central Banks, Commercial Banks, Financial Institutions & Corporate (Union States)& Corporate (Union States) The Average Lot Size - USD 1 - 5 Mn Indian Lot Size - USD 0.25 – 1.0 Mn Retail Market TouristsTourists Individual needs Forex in the form of TC, Drafts Importer ExportersExporters The amount is small in this market Saturday, October 31, 2009 Nitin Kulkarni @ IF 2009 18
  • 19. Wholesale Market Corporates Banks Financial Intermediary Central Banks Hedge Funds Speculators (States) Saturday, October 31, 2009 Nitin Kulkarni @ IF 2009 19 Funds
  • 20. Direct Quotes - Spot Exchange Rates Direct Quotes - Spot USD / INR base currency Friday 10th 2007- NY Closing Friday 21st August 2009- NY Closing 1 USD = 48 6050 INR Closing 1 USD = 40.6400 INR 1 USD = 118.4800 JPY 1 GBP = 2.0234 USD 1€ = 1 3697 USD 1 USD = 48.6050 INR 1 USD = 94.3820 JPY 1 GBP = 1.6508 USD 1€ = 1.4326 USD 1€ = 1.3697 USD€ 3 6 US 1 USD = 1.0583 CHF 1 USD = 1.0812 CAD 1 AUD = 0.8348 USD Saturday, October 31, 2009 Nitin Kulkarni @ IF 2009 20 Quoted currency1 USD = 6.8313 CNY
  • 21. Indirect Quotes Exchange Rates Indirect Quotes INR / USD bbase currency 100 INR = 2.5 USD Saturday, October 31, 2009 Nitin Kulkarni @ IF 2009 21
  • 22. Types of Exchange Rate • Floating Rate – A completely floating exchange rate is one whose level is determined exclusively by underlying balance of supply and demand for the currenciesbalance of supply and demand for the currencies involved with no outside intervention i.e. Cable, Euro/$ • Fixed Rate – A fixed exchange rate is one in which case the government guarantees a stable price for foreign currency This achieved through interventions by centralcurrency. This achieved through interventions by central bank whenever exchange rate varies from a stated % from fixed rate i.e. Kuwaiti Dinar Saturday, October 31, 2009 Nitin Kulkarni @ IF 2009 22
  • 23. Types of Exchange Rate • Managed Float – It is a system where the authorities manipulate the exchange rate to suit their ownp g objectives, sometimes intervening to fix the rate sometimes staying on the sidelines. This type of compromise is known as a Managed or Dirty floatcompromise is known as a Managed or Dirty float i.e. Chinese Yuan, Indian Rupee ,(Yen ) Saturday, October 31, 2009 Nitin Kulkarni @ IF 2009 23
  • 24. Forex Terms • SWIFT-Society for world wide Interbank Financial Telecommunication. It is replaces paper by electronic fund transfer by secure SWIFT Codes ,thereby reduces Transaction costs. It is supported by 6500 professional organizations throughout the world • CHIPS-Clearing House for Interbank Payment system is a US Based electronic payment system • CHAPS-Clearing House for Automated payment system is a UK based electronic payment system Saturday, October 31, 2009 Nitin Kulkarni @ IF 2009 24
  • 25. SWIFT Codes USD United States Dollar INR Indian Rupee JPY Japanese Yen GBP Great Britain Pound CHF Swiss Franc Saturday, October 31, 2009 Nitin Kulkarni @ IF 2009 25
  • 26. Forex Terms • Reuters- Reuter is a London based organization• Reuters- Reuter is a London based organization established in the year 1851.First Electronic trading screen which gives real time quotes was established in the year 1973 by Reutersthe year 1973 by Reuters • Telrate- Telrate is an American organization established in 1969 to deal in screen based trading for foreign exchange • Fedwire – The transactions at NY-Forex market ultimately get settled through Fedwire.It is a communication network that links the computers of aboutcommunication network that links the computers of about 7000 banks to the computers of Federal Reserve Banks Saturday, October 31, 2009 Nitin Kulkarni @ IF 2009 26
  • 27. Foreign Currency Accounts • Nostro Account Nostro account is an account maintained by a bank in IndiaNostro account is an account maintained by a bank in India with a bank abroad i.e.S.B.I. may maintain an account with Citi-Bank New York or with HSBC in London ,for $ operations and £ operations respectively. While corresponding with the Citi or HSBC SBI would refer its account with former two as Nostro account means ourits account with former two as Nostro account, means our account with you. All foreign exchange transactions are routed through Nostro accounts. Saturday, October 31, 2009 Nitin Kulkarni @ IF 2009 27
  • 28. Foreign Currency Accounts • Vostro Account A foreign bank may open rupee account with an IndianA foreign bank may open rupee account with an Indian bank. while corresponding with the foreign bank maintaining an account with it, the Indian bank would refer to the account as Vostro account meaning your account with us .Bank of Baharin and Kuwait may open an account with State Bank of India and draw drafts on the accountwith State Bank of India and draw drafts on the account. On presentation of drafts, the Indian bank would pay to the debit of the foreign bank’s account with it. For exchange control purposes such accounts are known as “non- resident bank accounts” Saturday, October 31, 2009 Nitin Kulkarni @ IF 2009 28
  • 29. One way Quotes - Spot Exchange Rates One way Quotes - Spot Big Figure Big Figure 1 USD = 48.85 INR Pips 1 USD = 93.8150 JPY1 USD = 93.8150 JPY Big Figure Pips 1 GBP = 1.6250 USD g g Saturday, October 31, 2009 Nitin Kulkarni @ IF 2009 29 Pips
  • 30. Exchange Rates Two-way Quotes - Spot Offer Bank sells USD Corporate buys USD USD / INR = 48.38/ 40 Offer Bid Bank buys USD Spread=Offer-Bid Corporate sells USD p =2 Paise /USD Saturday, October 31, 2009 Nitin Kulkarni @ IF 2009 30
  • 31. Quotes – Spot BOB ask Quote (USD/INR 5) to BOIBOB ask Quote (USD/INR 5) to BOI Offer/Ask BOI sells USD BOB buys USD USD / INR = 48.38/ 40 Offer/Ask Bid BOI buys USD Spread=Offer-Bid BOB sells USD p =2 Paise /USD BOB says Your’s 5 USD,BOI Saturday, October 31, 2009 Nitin Kulkarni @ IF 2009 31 y ,
  • 32. Foreign Exchange Transaction BOB CITI CITI BOB’s Nostro. a/c Dr S W I CITI C H I F E D W CITI CITI a/c Dr $5 mn Sells 5 mn $ I F T I P S W I R E AMEX C a/c $5 Amex a/c Cr $5 Mn BOI AMEX E AMEX BOI’s Nostro.BOI s Nostro. a/c Cr Saturday, October 31, 2009 Nitin Kulkarni @ IF 2009 32
  • 33. Basis for Merchant Rates • When the bank buys FE from the customer, it expects to sell the same in the interbank market at a better rate and thus make a profit out of the deal In the interbankthus make a profit out of the deal. In the interbank market, the bank will accept the rate as dictated by the market. • It can,therefore,sell foreign exchange in the market at the market buying rate for the currency concerned Thusthe market buying rate for the currency concerned. Thus the interbank buying rate forms the basis for quotation of buying rate by the bank to its customer. Saturday, October 31, 2009 Nitin Kulkarni @ IF 2009 33
  • 34. Basis for Merchant Rates • When the bank sells FE to the customer, it meets the commitment by purchasing the required foreign h f th i t b k k t It i FEexchange from the interbank market. It can acquire FE from the market at the market selling rate.Therefore,the interbank selling rate forms the basis for quotation of selling rate to the customer by the bank. Th i t b k t th b i f hi h th b k• The interbank rate on the basis of which the bank quotes its merchant rate is known as base rate Saturday, October 31, 2009 Nitin Kulkarni @ IF 2009 34
  • 35. Merchant Buying Rates Interbank Market Rate 48.3800/4000Bank first sell to Market Market will buy at 48.3800 Bank will $ sell high to market at Market b i tBank Bank will deduct their margin and give quote to customer buying rate hence buy $ low from customer C stomer Customer wants to sells FE (Applicable rate will be Saturday, October 31, 2009 Nitin Kulkarni @ IF 2009 35 Customer (Applicable rate will be 48.3800 less margin)
  • 36. Merchant Selling Rates Interbank Market Rate 48.3800/4000Bank first buys from Market Market will sell at 48.4000 Bank will buy low from market at Bank Bank will add their margin and give quote to customer market at market selling rate and sell to customer at hi h t C stomer Customer wants to buy FE higher rate ( Applicable rate will be Saturday, October 31, 2009 Nitin Kulkarni @ IF 2009 36 Customer ( Applicable rate will be 48.4000 plus margin)
  • 37. Cross Currency Rates • We know that USD being the currency of intervention only USD/INR exchange rate is available in the Indian F M k t d h t f ith ll thForex Market and exchange rates of rupee with all other foreign currencies are derived from this rate • Suppose MBT earned £ 1mio in Briton ,now they want toSuppose MBT earned £ 1mio in Briton ,now they want to remit the same to India then first they have to sell these £ 1mio in London against the $ and those $ will be sold in Mumbai against INRin Mumbai against INR • Suppose London quotes1£=1.6000 USD and Mumbai quotes 1$= 48.8000 INRq Saturday, October 31, 2009 Nitin Kulkarni @ IF 2009 37
  • 38. Chain Rule How Many INR = 1£ ? If 1£ = 1.6000 $ A d if 1$ 48 8000 INRAnd if 1$ = 48.8000 INR Then 1£ = 1.6000 $ = (1$ *1.6000)=48.8000*1.6000 INR Hence 1£ = 78.0800 INR Saturday, October 31, 2009 Nitin Kulkarni @ IF 2009 38
  • 39. Chain Rule How Many INR = 1 CAD $ ? If 1.0880 CAD $ = 1 $ A d if 1$ 48 8000 INRAnd if 1$ = 48.8000 INR $ $Then 1.0880 CAD $ = 1 $ = 48.8000 INR Then 1 CAD $ =48.8000/1.0880=44.8530 INR Saturday, October 31, 2009 Nitin Kulkarni @ IF 2009 39 $
  • 40. Chain Rule How Many INR = ¥100 ? If 93.10 ¥ = 1 $ A d if 1$ 48 8300 INRAnd if 1$ = 48.8300 INR $Then 93.10 ¥ = 1 $ = 48.8300 INR Then ¥100 =48.8300/93.10*100=52.44 INR Saturday, October 31, 2009 Nitin Kulkarni @ IF 2009 40