Forex & Economy

2021
International
Payments
Part-VIII
Classroom Deliberations
CA. Dr. Prithvi Ranjan Parhi
1
© CA Dr Prithvi R Parhi
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703- INTERNATIONAL TRADE AND BUSINESS
MODULE- I
International Trade: Concept, Importance, Benefits of International Trade, international
Marking vs. Domestic Marking (differences).
Theory of International Trade: theory of comparative Cost, factor proportion Theory.
MODULE-II
Multinational corporations (MNCs): Definition, Role of MNCs in International marking.
International Trade barriers: Meaning, tariff and non-Tariff Barriers, Impact of Non-tariff
barriers.
MODULE-III
Organizational and Agreements: WTO (Functions, Principle, agreements), IMF (Purposes,
Facilities Provided by IMF), World Bank (Purpose, Principle, Policies).
MODULE-IV
Foreign Trade of India: Organizational Setup (Autonomous Bodies, Attached and
subordinate offices), Major Export and Imports, Concept of Export House, EXIM Policy
(2002-2007) of India (Features and Objectives of the Policy).
MODULE-V
Foreign Exchange market: Concept, Functions, Methods of international Payment, concept
of Balance of Payment, Concept of Fixed and Flexible Exchange Rate and Convertibility of
Rupee.
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International Payment
• An international payment is a business
transaction between a buyer and a seller that
crosses national borders and often involves at
least two currencies.
• When money moves across a border into a new
country, that money needs to be converted from
the original currency to the currency of the new
country.
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How to Accept International Payments
• Small businesses can use a variety of methods to accept payments from clients
based overseas. Familiarize yourself with the cross-border payment methods
listed below to learn how to accept international payments:
1. Online Payments
• You can accept online payments from international clients through a variety of
online service providers, including PayPal, Stripe, Transferwise and Amazon
Payments.
2. Letter Of Credit
• A letter of credit is an official document issued by one bank and sent to a
second bank that’s based in a foreign country. The letter of credit guarantees a
person will make a payment for a certain amount by a certain date. The Export-
Import Bank of the United States offers more details about Letters of Credit:
3. International Money Order
• An international money order is a document that looks similar to a check.
Money orders are a prepaid payment option, so your customer will need to pay
upfront for a money order using cash or credit card.
4. International Wire Transfer
• International wire transfers are a common overseas payment method. A wire
transfer is an electronic exchange of money between two bank accounts, using
a network like SWIFT.
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• How to Accept International Payments
• Small businesses can use a variety of methods to accept payments from clients based overseas. Familiarize yourself with the cross-border payment methods listed below to learn how to accept
international payments:
• ONLINE PAYMENTS
• You can accept online payments from international clients through a variety of online service providers, including PayPal, Stripe, Transferwise and Amazon Payments.
• Advantages of Online Payments:
• Ease of use: Most online payment services are simple to navigate and require just your basic banking details to begin processing payments.
• Quick processing times: Most international online payment services boast quick processing times. Often, the money will land in your account within just a few days.
• Strong security: With heavy security and encryption used for every international transfer, online payments are one of the most secure methods of accepting payments from overseas.
• Disadvantages of Online Payments:
• Transaction fees: Most online payment services charge transaction fees for the use of their service. While the cost per transaction usually ranges from two to five percent, those fees can add
up if you accept international payments regularly.
• Limited availability: Online payment services aren’t available in all countries, so do your research and make sure your preferred provider offers its services in the country where your client is
based.
• 2. LETTER OF CREDIT
• A letter of credit is an official document issued by one bank and sent to a second bank that’s based in a foreign country. The letter of credit guarantees a person will make a payment for a
certain amount by a certain date. The Export-Import Bank of the United States offers more details about how letters of credit are used for international payments.
• Advantages of Letters of Credit:
• Low risk: Your payment is guaranteed by the client’s bank, so if there’s a problem, the bank is responsible for sending you the money owed.
• Secure payment: A letter of credit involves a payment transferred between two banking institutions, so it’s a secure form of payment.
• Disadvantages of Letters of Credit:
• Subject to fees: Banks tend to charge high transaction fees for letters of credit.
• Payment expires: A letter of credit will include a specific timeline for the bank’s payment guarantee, so it’s important that the payment requirements are fulfilled before the letter expires.
• 3. INTERNATIONAL MONEY ORDER
• An international money order is a document that looks similar to a check. Money orders are a prepaid payment option, so your customer will need to pay upfront for a money order using cash
or credit card.
• Advantages of International Money Orders:
• Low cost: Money orders are cheap to purchase and you won’t be charged any processing fees.
• Payment up front: You’re guaranteed that your client has the money to cover the invoice amount, because they pay up front for the money order.
• Disadvantages of International Money Orders:
• Long processing times: Money orders can take several days to arrive at their destination and it can then take up to ten days for your bank to process the money order.
• Used for scams: Because money orders are easy to buy and difficult to trace, they’re often used in scams. If you accept money orders, just be sure to watch for red flags that could point to a
scam. It’s best to only accept money orders from clients you know and trust.
• 4. INTERNATIONAL WIRE TRANSFER
• International wire transfers are a common overseas payment method. A wire transfer is an electronic exchange of money between two bank accounts, using a network like SWIFT.
• Advantages of Wire Transfers:
• Fast processing time: When a client sends you money through a wire transfer, the funds will usually be made available in your bank account almost immediately.
• Highly secure: Because the transactions are made directly between two banking institutions, wire transfers are a secure payment method for international transfers.
• Disadvantages of Wire Transfers:
• Expensive: Banks charge high fees, sometimes as much as sixty dollars per transaction, for international wire transfers.
• Not easily traceable: Wire transfers aren’t easy to trace, so it can be difficult to settle any payment disputes that might arise between you and a client.
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6
The Basics
Understanding the Quotes
• Domestic Currency & foreign Currency
• Exchange rate, Direct Quote, Indirect Quote, American term,
European Term
• Bid and Ask, Two way quote, Spread, Converting two way quotes
• Cross Rate, Straight Rate, Spot Rate, Forward Rate, Appreciation
& Depreciation
• Computation Appreciation and depreciation, Swap points
• Forward rate, premium and discount
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Currency
Domestic Currency Foreign Currency
Currency in which the CFO
reports companies performance
to stakeholders.
Referred to as home currency.
$, £, Ұ, €
Any currency other than domestic
currency.
$, £, Ұ, €
Foreign currency is not only a medium of exchange but a store of value_ an asset
as well.
As an asset foreign currency has purchasing power, at times greater and at times
less than domestic currency.
This affects exchange rate. Hence it is necessary to know about its price.
This price is called as exchange rate.
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Exchange Rate
• Rate at which one currency is exchanged i.e. bought and sold for another
currency.
• The price of one currency viewed in relation to another currency.
• For any currency, there is an exchange rate for every other traded currency in
the forex market.
• Rule #1 : In any transaction involving forex you are selling one currency and
buying another.
• Rule #2 : In an exchange rate 2 currencies are involved ( pair)
• Rate is generally in terms of the first currency for the 2nd currency.
© CA. Prithvi R Parhi, M Com, FCA,DISA(ICAI)
FX rates:
Normally not given beyond 4 decimals.
Some times in whole number or in fraction or up to 2 decimals.
There is no standardization in the jungle of Intl. Fin.
E,g.
SGD 5.2508 / KWD
Or SGD / KWD = 5.2508
Rs 75 / $
Or Rs / $ = 75
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Rule-3
Direct Quote :
• Expresses exchange rate as “home currency per unit of foreign
currency”
• i.e. the number of home currency required to buy / sell 1 unit of
foreign currency.
• In direct quote price comes 1st, commodity next.
• In direct quote foreign currency is the commodity which is bought
& sold.
• Rs.75/$ or Rs / $ =75 ~ Direct Quote for the Indian
• Internationally people prefer Direct Quote.
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Rule-4
Indirect Quote :
• Expresses exchange rate as “foreign currency per unit of home
currency”
• i.e. the number of foreign currency required to buy / sell 1 unit
of home currency.
• In indirect quote commodity comes 1st, price next.
• In indirect quote home currency is the commodity which is
bought & sold.
• 0.0133$ / Re or $ / Re =0.0133 ~Indirect Quote for the Indian
• A London quote is an indirect quote.
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Rule-5
• What is direct quote for 1 country is indirect
quote for another country & vice versa.
• 30p / ¥ is a direct quote for Indian & an
indirect quote for Japanese .
• Indirect quote is the reciprocal of direct quote.
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Rule-6
• Indirect quote is the inverse of direct quote & vice
versa.
• Indirect Rate = 1/ Direct Rate
Rs 75/ $ ~ Direct Rate
Indirect = 1/75=0.0133
So 0.0133 $/Re ~ Indirect rate
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Q1
• Identify whether the following quotes given
by a Mumbai banker is direct or indirect.
• Compute direct quote for indirect quotes &
vice versa.
1. 1$ = Rs.75
2. Rs.100/- = 1.6 £
3. Rs.100 = DM 4.70
4. 1 ¥ = Rs.0.30
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A1
1. Direct for Indian ; Corresponding indirect quote
=0.0133 $/Re.
2. Indirect for Indian ; Corresponding direct quote
=62.5 Rs/£.
3. Indirect for Indian ; Corresponding direct quote
=21.28 Rs./ DM.
4. Direct for Indian ; Corresponding indirect quote
=3.33 ¥/Re.
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Q#2
• Column 1 gives the nature of the quote for currency named in
column 3 in the city named in column 4.
• Find the quote named in column 5 for the city named in column
6
1 2 3 4 5 6
Quote Rate For City Quote City
Direct 1.6944 Sterling New York Direct London
Direct 52.35 € Chennai Indirect Rome
Indirect 13.13 Pound London Indirect Hong-Kong
Indirect 4.7269 NZ dollar Auckland
(NZ)
Direct Oslo
(Norway)
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A#2
1. 1/1.6944 =0.5902
2. 52.35
3. 1/13.13 =0.0762
4. 4.7269
Currency for Norway : Norwegian krone (Kr)
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Rule-7
European / American Terms
• Now what’s the quote u r satisfied with ? Direct / Indirect ?
• Approximately 150 currencies in global market. So if all quotes will be direct
quote ,then 150*(150-1)*2=44,700 quotes. Hence FX rates r marked with
reference to $.
• A quote which is direct for American is in American Terms.
• A quote which is indirect for American is in European Terms.
• European Terms mean Currency per unit of US$.
• American Terms mean US$ per unit of foreign currency.
• International quotes r generally expressed in European Terms ( except £, €, SA
Rand, AU$, NZ$)
• For a non-American international rates r in direct mode.
• For an American international rates r in indirect mode.
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Q3
• Compute nature of quotes in respect of following
spot rates.
• For each American term give corresponding
European term & vice versa.
1. 1.75 US$ per pound.
2. 1.95 SGD per $
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A3
1. Direct for American, Indirect for British,
American terms for both. Corresponding
European term = 1/ $1.75 =0.571£
2. Indirect for American, direct for Singapore
citizen, European terms for both. Corresponding
American term = 1/ SGD 1.95 =0.51$
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BID – ASK- SPREAD
BID
• Price @ which bank is willing to buy foreign currency.
ASK
• Price @ which bank is willing to sell foreign currency.
SPREAD
• The difference between ASK & BID. Size of the spread depends on;
1. Stability of xch rate : If stable spread is narrow.
2. Depth of Market : Volume is more means spread is narrow.
MIDDLE RATE
(Bid + Ask) / 2
If bank is buying a currency from u, U will be selling that currency to bank.
Bank always wins.
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Rule #8
• A direct quote, which is a bid quote is a bid on
foreign currency.
• A direct quote, which is an ask quote is an ask on
foreign currency.
• An indirect quote, which is a bid quote is a bid on
domestic currency.
• An indirect quote, which is an ask quote is an ask on
domestic currency.
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Rule #9
• The normal practice is to write the currency of
home country in LHS
• Rs.68 =1 $ means, quote is from India.
• Ұ 33 = Re 1 means quote is from Japan.
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Rule # 10
• Bid on one currency is ask on another & vice
versa.
• E.g. Bid rate Rs.68/ $.
This is buying rate of $. i.e. bank is buying $ &
selling INR.
68 INR is sold for 1$.
1 INR is sold for 1/68 $.
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Rule #11
• In a 2 way quote, Bid precedes Ask.
• Eg. In a quote such as Rs.67 - 68 per $
represents Rs. 67 as bid & 68 as ask.
• Spot Bid < Spot Ask
• Spread = Ask - Bid
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Q4
a) The quote by a bank is Rs. 61-62 / $.
Compute Bid, Ask & Spread.
b) Spread is 0.43. Middle rate is 22.195. Find
Bid / ask rate.
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A4
a) Rs. 61-62 / $ is a direct quote in India for $. Since in a
2 way quote bid precedes ask, Rs. 61 is the buying rate
& Rs.62 is selling rate. Spread = 62-61=1.
b) A-B =0.43
So, B= A-0.43
(B+A)/2 =22.195
(A-0.43+A)/2=22.195
B=21.98
A=22.41
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Q5
• INR 47.10 - 47.25 per US$ is a direct quote.
• Another direct quote is Ұ /£ 179-180.
• Identify ;
a) The country from where quote is made ?
b) The bid, ask, spread
c) For the ask price (i) currency bought by the bank
and (ii) currency bought by you.
d) For the bid price (i) currency bought by the bank
and (ii) currency bought by you.
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A #5
SL Particulars Rs/$ Ұ/ £
a Country India Japan
b i Bid 47.10 179
ii Ask 47.25 180
iii Spread (ii-i) 0.15 1
c i Bought by Bank Rs Ұ
ii Bought by you $ £
d i Bought by Bank $ £
ii Bought by you Rs Ұ
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Cross or Straight ?
Cross Rate :
• Rate between 2 currencies not involving home
currency.
E.g. $.1.5 / £
Straight Rate :
• Rate between 2 currencies involving home
currency.
E.g. Rs. 89 / £
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Covering 2 way quotes
Rule #12 : Rules for cross multiplications
• Where exchange is given in numerator- denominator form, it is
the denominator currency which is bought or sold with reference
to numerator currency.
• Direct quote can be converted to indirect quote simply by taking
inverse. This holds good when bid & ask are equal. Else the
following formula will be used.
• Bid (X/Y) * Bid (Y/Z) = Bid (X/Z)
(Bid on B w.r.t. A * Bid on C w.r.t. B = Bid on C w.r.t. A)
•Ask (X/Y) * Ask (Y/Z) = Ask (X/Z)
•Bid (X/Y) = 1/ Ask (Y/X)
•Ask (X/Y) = 1/ Bid (Y/X)
Bid Ask
Rs/$ 75 76
$/Rs ? ?
1/76 1/75
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Points for Attention
In a one-way quote
Direct = 1/ Indirect
In a 2way quote
Direct Bid = 1/ Ask ( Indirect)
Direct Ask = 1/ Bid ( Indirect)
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Q6
• Spot rate is 1.817 shekel to USD. Spot rate is
7.15 yen per $. Compute ¥ per shekel.
• Sh ~ Israel currency
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A6
• Sh/$ =1.817
• ¥/ $ =7.15
• ¥/ sh = ¥/ $ * $/ sh
=7.15 * 1/1.817
=7.15 * 0.55
=3.9346
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Q7
• Spot rate is $ 1.771 per £. Spot rate is $ 0.544
/DM. Compute £/DM .
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A7
1.771 $=1 £
0.544 $ = 1 DM
£/ DM = £/ $ * $/ DM
= 1/1.771 *0.544
= 0.3071
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Q8
• Spot rates are;
DM=$ 0.35 ;
FF1 = DM 0.31.
Compute $ per FF
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A8
$ 0.35 = DM
DM 0.31 = 1 FF
$/FF = $/DM * DM/FF
= 0.35 * 0.31
= 0.1085
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Q # 9
• The rate quoted by a Mumbai banker is Rs. 70-
72 per pound.
• Compute relevant pound per Rupee rate.
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A 9
• Bid (GBP/INR) = 1/ Ask (INR/GBP) = 1/72 =0.0139
• Ask (GBP/INR) = 1/ Bid (INR/GBP) = 1/70 =0.0143
• So the rate is 0.0139-0.0143
• Here the Mumbai banker is bidding & asking for
Rupee.
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Q10
Spot rate is DM = $ 0.3302 -10.
Spot Rate is FF= $ 0.1180-90.
Compute direct quote for FF in Germany.
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A10
DM = $ 0.3302 - 0.3310
FF = $ 0.1180 - 0.1190
Required DM for FF
B (DM/ FF) = B (DM/$) * B ($/FF)
= 1/ A ($/DM) * B ($/FF)
= 1/0.3310 * 0.1180
= 0.3564
A (DM/ FF) = A(DM/$) * A ($/FF)
= 1/ B ($/DM) * A ($/FF)
= 1/0.3302 *0.1190
=0.3604
Direct Quote for FF in Germany is 0.3564 - 604.
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Q11
Given the following quotes at what rate you
can buy Yen against Rs. ?
Rs.47.50 - 53 per pound
$1.5200 - 10 per pound
Yen 123.50 - 60 per $
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A11
Yen to be bought against Re.
Hence the applicable rate is bank’s selling rate
i.e. the ask rate
A (Re/¥) =A (Re/£) * A (£/$) * A($/¥)
= 47.53 * 1/ B($/£) * 1/ B(¥/$)
= 47.53 * 1/1.5200 * 1/123.50
= 47.53 * 0.6579 * 0.008
= 0.2533
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Q12
• In spot market 1 $ can be exchanged for
1498.2 Italian Lira or for 111.23 ¥ .
• What is the rate between ¥ & Lira ?
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A12
1 $ =1498.2 Lit
1 $ = 111.23 ¥
1498.2 Lit = 111.23 ¥
1 Lit = 111.23 / 1498.2
= 0.0742 ¥
1 ¥ = 1498.2 / 111.23 or 1/0.0742
= 13.46 Lit
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No Single Exchange Rate
There is no static exchange rate.
The rate would depend upon when the underlying asset( Forex) could be
converted into domestic currency.
Illustrative Rates :
SL INR/SGD Rate
01 Export Bills 26.59
02 TT Buying 26.61
03 TT Selling 27.15
04 Import Bills 27.20
05 TCs - Buy 27.16
06 TCs - Sell 27.22
07 Currency - Buy 26.56
08 Currency- Sell 27.24
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Spot Rate
• Is the rate applicable for immediate settlement.
• Both in India and Internationally, by convention spot rate
means the exchange rate at which transaction will be settled
on the 2nd Working day.
• Its the rate @ which currencies are exchanged within next 2
working days. ( t+2 days)
• 2-day time cushion is reasonable for actual movement of
funds through banking channel involving different time zones.
• Spot rate is driven by market forces .
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Q 13
• On 9th September, a Thurs day, a garment exporter
in Delhi has received intimation from his customer
in London about a TT remittance of € 1,25,000/-.
1. If INR/ € spot rate is 71.19 -72.00, how much and
when the garment exporter will receive Rupees ?
2. As a banker when would you credit the exporter’s
account ?
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A # 13
• Exporter will receive € , sell it to bank and buy INR.
• The bank buys € .
• Hence relevant rate is Bid rate for €.
• Rupee receipt on sale of € = 1,25,000 * 71.19 =88,98,750;
Subject to deduction of bank charges, if any.
• Exporter will get INR on the 2nd working day viz. 13th September,
Mon day.
• The banker will credit the amount to exporter’s account only
after verifying that funds have in fact been received in their
account.
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Forward Rate
• Is the rate contracted today for exchange of currencies at a
specified future date.
• Once the rate is contracted, both the parties viz. the customer
and dealer-banker are obliged to perform on the specified
future date irrespective of exchange rate prevailing on that
date.
• Since bank can buy a currency in forward market there is a
forward bid price for the currency.
• Similarly when a bank can sell a foreign currency in the
forward market there is a forward ask price.
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Forward exchange rate
• This involves delivery of the foreign exchange
in one, three or six months after the contract
is agreed upon.
• Is driven by market forces as forecasted by the
buyers and sellers of foreign exchange of the
period of contract maturity.
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Forward discount and forward premium
Forward Discount
• The difference between a higher spot and a lower
forward rate;
Forward Premium
• The difference between a lower spot and a higher
forward rate.
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Appreciation & Depreciation
• Relative to “Spot Rates”, forward rates can
either be favorable or adverse.
• Favorable phenomenon is referred to as
“premium”. ~ Appreciation
• Adverse phenomenon is referred to as
“discount”.~ Depreciation
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Rule # 13
• In a direct quote, since foreign currency is the commodity, if
Forward rate is > Spot rate , foreign currency is appreciating and
home currency is depreciating.
• Foreign currency is @ premium & home currency is @ discount.
Spot Rs. 78/$
Forward Rs.80/$
• $ is appreciating & INR is depreciating
• In a direct quote, if Forward rate is < Spot rate , foreign currency
is depreciating and home currency is appreciating.
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Rule # 14
• In an indirect quote, since home currency is
the commodity, if Forward rate is > Spot rate ,
home currency is appreciating and foreign
currency is depreciating.
• In an indirect quote, if Forward rate is < Spot
rate , home currency is depreciating and
foreign currency is appreciating.
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To Sum up…
• If 1 currency is @ a premium to the other, the other
currency is @ a discount to the first.
R’ship Direct Indirect
F > S FX FX
Home Home
F < S FX FX
Home Home
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Q # 14
• In the following cases identify which currency
is appreciating and which currency is
depreciating.
• Spot 140 Ұ per $ 1 ; Forward 142 Ұ per $ 1
• Spot 1 £ =Rs.70 ; Forward 1 £ =Rs.68
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A # 14
LHS Country Given Hence R’ship Hence
Ұ Japan Home/ FX
Ұ/ $
Direct F >S USD is
appreci
ating
£ England FX / Home
Rs./ £
Indirect F < S INR is
appreci
ating
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How to compute Appreciation / Depreciation ?
• Spot : Rs/$= 70
• 1 year Forward : Rs/$= 77
• Whether $ become costlier ? Or Rupee become
cheaper ?
• Direct Quote for $. Commodity has become costlier
by 10%. $ appreciated by 10%.
• The formula = (F-S) / S * 12/ m * 100
• How much INR has depreciated ?
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How much INR has depreciated ?
• Spot : $/ Rs = 1/70= 0.0143
• Forward : $/ Rs = 1/77= 0.0129
• The formula = (F - S) / S * 12/ m * 100
• (0.0129 -0.0143)/ 0.0143 *12/12 *100 = (-)9.79 %
We can revise the formula without changing mode;
The revised formula = (S - F) / F * 12/ m * 100
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To sum up…
Steps minus formula ;
1. Compute difference between Spot & Forward
2. Identify the time period in the contract
3. Identify commodity & price.
4. Decide the base ; Spot is the denominator for the “
commodity” & Forward is the denominator for the “ price”
5. Annualize the percentage
Quote Commodity Currency Formulae
Direct Foreign Home (F - S) / S * 12/ m * 100
Indirect Home Foreign (S - F) / F * 12/ m * 100
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Q #15
• Spot rate for INR/ AUD is 29.36 & 3 months forward rate is
29.45.
a) Which currency is appreciating and which currency is
depreciating.
b) Which currency is trading at a discount and which at a
premium ?
c) Which currency is more expensive ?
d) Compute the annual % premium or discount.
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A # 15
a) Exchange rate is a direct quote on AUD. AUD is the commodity. Since
F>S, AUD is appreciating & INR is depreciating.
b) AUD is appreciating & hence said to be trading at a forward premium to
Rupee. The Rupee is depreciating and hence said to be trading at a
forward discount.
c) AUD is more expensive.
d) % Appreciation of AUD = (F - S) / S *12/3 *100
= (29.45-29.36)/29.36 * 12/3 *100 =1.226%
% Depreciation of INR = (S - F) / F *12/3 *100
= (29.36 - 29.45)/ 29.45 * 12/3 *100 =1.222%
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Outright - Swap
Forward rate can be quoted as ;
a) Outright Forward
• E.g. Spot rate is Rs 72/ $
• Forward rate is Rs. 74/ $
b) Adjustment to Spot Rates (Swap rate)
• E.g. Spot rate is Rs 72/ $
# (Forward rate is Rs. 74/ $)
• Swap Rate is 74 - 72 = 2
The forward differentials are called as Swap Rate.
Bid Swap is the difference between Forward Bid $ Spot bid .
Ask Swap is the difference between Forward Ask $ Spot Ask .
Swap points are not same as spread.
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66
Q # 16
• The spot rate for € is Rs. 80-82. The forward
rate is Rs. 83-86.
• Compute swap points, spot and forward
spread.
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A # 16
Swap Bid Forward Bid –Spot Bid 83 - 80 = 3
Swap Ask Forward Ask –Spot Ask 86 – 82 = 4
Spot Spread Spot Ask – Spot Bid 82-80 =2
Forward Spread Forward Ask – Forward Bid 86-83 =3
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68
Rule #15
• Swap rates normally do not carry + /- sign.
• If Bid swap in points is less than Ask swap in points,
forward rate of foreign currency is @ premium , i.e.
foreign currency is appreciating & home currency is
depreciating.
Rs/$ Bid Ask Spread
Spot 46 48 2
Forward 47 50 3
Swap 1 < 2
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69
Rule #16
• If Bid swap in points is greater than Ask swap in
points, forward rate of foreign currency is @ discount
, i.e. foreign currency is depreciating & home
currency is appreciating.
Rs/$ Bid Ask Spread
Spot 46 48 2
Forward 44 47 3
Swap 2 > 1
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Rule #17
Swap rate can be converted into outright rate by,
a) Adding swap rate to spot rate, if FX is appreciating.
b) Deducting swap rate from spot rate, if FX is depreciating.
c) Swap A > Swap B = Add
d) Swap A < Swap B = Deduct
Assumptions :
Rule is based on the assumption that,
1. Bid < Ask
2. Forward spread > Spot spread
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71
Q17
Spot = $ 0.006879 / ¥.
3 months forward = $ 0.006902 / ¥.
Compute status of the quote, % appreciation /
depreciation & Swap.
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72
A17
Status :
This is a direct quote for ¥ (In US) with $ as home currency.
Forward > Spot
FX is appreciating & home currency is depreciating.
Appreciation/ Depreciation :
=(Forward – Spot) / Spot * 100 * 12 / 3
=(0.006902- 0.006879)/ 0.006879 * 100 * 12 / 3
=1.34 %
Swap:
= 0.006902- 0.006879 = 0.000023 = 23 points
(Zeros after decimal will b ignored)
( Indirect quote for 1 country is direct quote for another. So similar formula
will apply)
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73
Q18
Spot = $ 1.7015 / £.
3 months forward = $ 1.6745 / £.
Compute status of quote , % appreciation /
depreciation & Swap.
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74
A18
Status :
This is a direct quote for £ ( in US ) with $ as home currency.
Forward < Spot
FX is depreciating & home currency is appreciating.
Appreciation/ Depreciation :
=(Forward – Spot) / Spot * 100 * 12 / 3
=(1.6745- 1.7015)/ 1.7015 * 100 * 12 / 3
=6.3473 %
Swap:
= 1.6745 - 1.7015 = 0.0270 = 270 points
(Swap to be computed up to 4 decimals & then zeros after decimal will b
ignored)
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75
Q19
Identify forward rate.
Indicate whether the currency is quoting at a
premium or discount.
Spot Forward Swap
$ Rs.45.50 -60 1M 20 / 30
£ Rs.75.30 -80 2M 25 / 15
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A19a
Swap points (20 / 30) are in ascending order.
Hence they must be added to spot rate to arrive at forward rate
Spot 45.50 - 45.60
Swap points .20 - .30
Forward rate 45.70 - 45.90 Rs/$
Appreciation/ depreciation is always for commodity.
So (F-S)/S *12/M *100 = 5.28%
Re is depreciating & FX is appreciating.
So 5.28 is appreciation
Appreciation on Ask :=(45.90-45.60)/45.60*12/1*100=7.89%
….Contd
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77
A19 b
Swap points (25/15) r in descending order.
Hence they must be deducted to spot rate to arrive at forward rate
Spot 75.30 - 75.80
Swap points (.25) - (.15)
Forward rate 75.05 - 75.65 Rs/£
Appreciation/ depreciation is always for commodity.
So (F-S)/S *12/M *100 = 1.99%
Re is appreciating & FX is depreciating.
So 1.99 is depreciation
Appreciation on Ask :=(75.65-75.80)/75.80*12/2*100=1.18%
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78
Journey so far…
Exchange Rate
(Price of 1 currency in relation to another
Home Currency Foreign Currency
Cross rate Straight rate
•Exchange rate indicative of both buying and selling rate is a two way quote .
•The difference between buying and selling is called spread.
•The difference between spot and forward is called swap.
European Terms American Terms
Direct Quote Indirect Quote
Bid rate :
for buying by a banker
Ask rate :
for selling by a banker
Spot rate Forward rate
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79
Journey so far…
There is a verity of rate depending on the nature of txn & cost attributable to
investment in foreign currency asset till it is converted into home currency
Spot rate is the rate for
immediate settlement
Internationally 2 days
Forward Exchange contract
helps in fixing a rate today
For exchanging currencies
at a Future date.
Rate may be higher or
lower than Spot rate.
Spot buying for a bank is
<
Spot selling rate
Bank or AD always wins
Not for all Currencies
Binding Contract
Standard Period, 1,3,6 months.
Cancellation leads to loss.
Affords protection
Difference between Spot
& Forward may be premium
or discount ~ Spread.
5:55 PM

2021
Drivers
of
Exchange Rate
Classroom Deliberations
CA. Dr. Prithvi Ranjan Parhi
80
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81
Journey so far…
Exchange Rate
(Price of 1 currency in relation to another
Home Currency Foreign Currency
Cross rate Straight rate
•Exchange rate indicative of both buying and selling rate is a two way quote .
•The difference between buying and selling is called spread.
•The difference between spot and forward is called swap.
European Terms American Terms
Direct Quote Indirect Quote
Bid rate :
for buying by a banker
Ask rate :
for selling by a banker
Spot rate Forward rate
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5:55 PM

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Cross Rates
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88
Exchange Rate Drivers
International
Trade
Speculation
Balance of
Payment
Intervention by
Central Bank
Economic
Fundamentals
Political
Stability
Interest rate
Parity
Inflation rate
Self fulfilling
prophesy
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89
What drives Xch rate ?
• Currency is a commodity ~ Forces of demand & supply determine the price of
a commodity. Factors that drive exchange rates are;
1. International Trade : Demand & supply of currencies emanates from import
& export of goods & services, raising money from global market.
2. Speculation : Players in Forex market wait to seize opportunities to buy or sell
foreign currency. Thrust of movement of rates comes more from speculators
than from international trade. This may have stabilizing/ dis-stabilizing effect.
3. Balance of Payment : Healthy BoP leads to strengthening of the currency,
Levered BoP would lead to weakening of the currency. A very adverse BoP
would mean the country have to buy foreign currency to meet its obligation
which would lead to greater demand for foreign currency , pushing its price
up. This would mean weakening domestic Currency.
4. Intervention by Central Bank : Central bank of the country would be
interested in some kind of stability in the exchange rate.~ If INR strengthens it
would be adverse for the exporter & if INR weakens it would be adverse for
the importer. RBI may step in to keep the currency rate within a certain
zone.~ Pure floating rate / Dirty floating rate.
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90
What drives Xch rate ?
5. Economic Fundamentals : Country blessed with rich natural resources
would automatically benefit from a net surplus on its current account.
Further it would attract long term capital investment from overseas. Hence
on account of advantageous fundamentals, the currency of such country
going to be strong.
6. Political Stability : Uncertain political stability or an uncertain economic
future would weaken countries currency since international investors
would not be showing interest in investing in these countries.
7. Interest rate Parity : According to IRPT, a high interest rate ( in real terms)
in one country would lead to depreciation in the currency of that country.
8. Inflation rate : According to IRPT, if inflation is higher in 1 country than
another, the former currency will tend to weaken against the other
country’s currency.
9. Self fulfilling prophesy : Expectations of the players in the market also
drives the exchange rate.
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91
Case # 2
• You have just joined as a Finance manager of M/s Mayfair Hotels and Resorts Ltd, a company
that runs a chain of hotels located at Bhubaneswar, Puri, Rourkela, Goa, Darjeeling and
Gangtok.
• You are not overloaded with work . On your 1st meeting, D(F) told you to study the foreign
exchange operation of the company.
• You observed, that the company during the course of its operation buys foreign exchange and
TCs from its foreign guests. Internal control system on such activities is weak.
• You found that the company has an agreement with M/s Thomas Cook, an authorized money
changer, who informs the its buying rate everyday morning.
• The company deducts 10 paisa in its rate and publishes it as its own buying rate.
• Company collects foreign currency( mostly $) at its published rate and sells it to M/s Thomas
cook on daily basis. Company does not sell any foreign currency to any one else.
• The company was earning a good profit from this activities. However recently profit from
such activities have drastically come down at Bhubaneswar.
• Can you give some suggestion to improve the situation ? Give a presentation to D (F)
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92
Possible Improvements
• To strengthen internal control. Hotel business might have become
personal business.
• To compare the rates of Thomas Cook with others.
• To consider directly selling of currency to banks.
• To consider intra day variation of exchange rate.
• Possibility of loss in case variation beyond 10 paise.
• Consider retaining for the currency for some period.
• To consider to be registered as an authorized money changer.
5:55 PM

93
?
FX Thoughts
How to react a change ?
RBI Reference Rate
13th Nov 2011
• INR / 1 USD : 50.2795
• INR / 1 Euro : 68.4460
• INR / 100 Jap. YEN : 64.8300
• INR / 1 Pound Sterling : 80.0776
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Date USD GBP EURO YEN
11/11/2011 50.2795 80.0776 68.4460 64.8300
09/11/2011 49.7810 80.1051 68.8169 64.1600
08/11/2011 49.3800 79.1981 67.8411 63.2700
04/11/2011 49.0840 78.6522 67.7910 62.8500
03/11/2011 49.3748 78.4961 67.5920 63.2600
02/11/2011 49.2508 78.7348 67.6445 63.0600
01/11/2011 49.0775 78.7817 67.7597 62.8200
31/10/2011 48.8730 78.1137 68.3616 61.5100
28/10/2011 48.8210 78.5676 69.2853 64.3600
25/10/2011 49.6598 79.3862 69.1510 65.2800
24/10/2011 49.8745 79.7294 69.5253 65.3700
21/10/2011 50.0670 79.1559 69.0350 65.2600
20/10/2011 49.7110 78.0860 68.0541 64.7800
19/10/2011 49.1775 77.4939 67.9645 64.0700
18/10/2011 49.1360 77.5833 67.5815 63.9700
17/10/2011 48.8925 77.3113 67.7880 63.3900
14/10/2011 49.0675 77.4187 67.7248 63.7800
13/10/2011 49.0228 77.1276 67.5553 63.61
94
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95
Balance of Payment
• Is the summary of flow of economic
transactions between the residents of a
country & the rest of the world, during a
given time period, usually a year.
• Same as a Source & Application of funds to
a Company.
• Measures the flow of international
payments & receipts.
BoP format.xls
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96
Economic Txns
• Includes all activities whereby 2 countries
exchange something of economic value.
• 2 parties involved
• In reality or implication (NRs fund tfr to migrating
country)
• Exception:
• Txns with only 1 sided eco value is also
recorded (Aids, grants, gifts etc.)
5:55 PM

97
BoP Vs. BoT
• BoT
• Refers to
merchandise exports/
imports
(visibles)
• BoP
• Refers all eco txns
including invisibles
like banking,
insurance, services
etc.
• Wider
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98
A/cn’ Principles
• Double entry system
• When no compensation involved ~ treated as
goodwill to satisfy the principle of double entry.
• Outflow ~ Purchase of goodwill
• Inflow ~ Sale of goodwill
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99
Debit- Credit
• Txn which creates demand for domestic currency in
forex mkt ~ Credit (Export)
• Txn increasing supply of domestic currency in forex mkt
~ Debit (Import)
• Sources of Forex ( Export ) ~ Credit
• Application of Forex (Import) ~ Debit
• Credits r recorded with + sign & Debits - sign
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100
Current Account
• Records txns in merchandise &
invisible with rest of the world.
• Exports~ f.o.b. basis
• Imports ~ c.i.f. basis
• However IMF manual provides both expt &
impt should b on f.o.b
• Gnie ~ Govt not included elsewhere~ credit~ fund received from foreign Govts.
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101
Capital Account
• Increase in Countries Foreign Financial Asset ~ Debit
• Decrease in Countries Foreign Financial Asset ~ Credit
• Increase in Countries Foreign Financial Liability ~ Credit
• Decrease in Countries Foreign Financial Liability ~ Debit
• Rupee Debt Service is defined as the cost of meeting interest payments of principal
loan + admn charges
• Monetary movements ~ India’s txn with IMF & India’s forex reserve.
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102
Trade Balance
• Difference between merchandise export &
merchandise import.
• Changes in TB indicates efficiency of the
country in producing & exporting goods.
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103
Terms of Trade
• Ratio of countries export prices to import
prices.
• Constructed by taking an index of prices
for exports & imports
=Index of Export / Index of Import
• Improvement in ToT indicates faster rise of
export prices than imports.
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104
ToT
Year 2009 2010
Index of Export 100 150
Index of Import 100 125
Terms of Trade Index 100 120
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105
Current Account Balance
• Represents the difference between domestic
saving & domestic investment.
• Deficit ~ Domestic saving insufficient to fund
domestic investment.
• Surplus ~ Comfortable.
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106
Current A/c Study
• Growth in export accompanied with high rate
of Investment indicates is a +ve sign.
• High deficit accompanied with high growth
rate in imports is a –ve sign.
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107
Capital Account Balances
• Shows how the balances in the current A/c has been financed.
• If balance in current a/c & Capital A/c taken together is -ve ,
~ BoP deficit.
• This has 2b managed by matching surplus on official reserve
account (i.e. reduction of foreign exchange & gold reserve)
• Txn in current A/c & Capital A/c are autonomous txns,
responding to economic situation, while official reserve txns
are compensating in nature.
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108
The Balance
• How BoP always balances ?
• Same as Household exp =
Income + Withdrawals from SB a/c +
borrowings
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109
The equation
• Balance in Current A/c +Balance in
Capital A/c + Change in monetary
movements = Zero
• Change in Monetary Movements
reflects the overall BoP position.
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110
Monetary Movements
• Increase in Forex Reserve or net repurchase from
IMF ~ Surplus.
• Decrease in Forex Reserve or net purchase from IMF
~ Deficit.
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111
If no monetary movement :
• Surplus/ Deficit in Current A/c = Deficit/ Surplus in
Capital A/c
• Country neither borrows nor lends.
• In reality BoP seldom balances ‘coz – Imperfect
nature of data, different data sources, different
exchange rates applied to receipts & payments
• E & O inserted.
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Exchange Rate Regimes
• Fixed Exchange rate – the exchange rate tends to remain fixed
for considerable time and closely monitored by regulating
authority.
• Floating Exchange rate is market determined and influenced by
demand and supply of the Currency. Government has no
responsibility to peg the exchange rate.
• Managed Float – Government seeking to alter market valuation
by influencing economic fundamentals to maintain desired
range.
• Clean Float
• Dirty Float
112
5:55 PM

Impact of
Exchange
Rate
On National
Economy
BoP Position
Borrowings
Forex
Reserve
On Inflation
: Purchasing
Power
Parity
Theory
On Interest
Rate :
Interest Rate
Parity
Theory
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Purchasing Power Parity Theory / Inflation Theory
• If a product in India, quotes a certain price, the
product in a foreign country, say US should quote an
identical price, in order to ensure that there is no
arbitrage. The exchange rate should therefore be
determined by equating the price of 2 products.
• Eg. A bike costs Rs.60,000/- in India & 1,000$ in US .
The xch rate should therefore be Rs. 60/$.
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Purchasing Power Parity Theory /Inflation Theory
• If the xch rate is not in line with purchasing power parity
theory, arbitrage opportunity will open up.
• The theory is to be used with inflation index (i.e. a basket
of commodities), rather than with individual products.
• High inflation rate in 1 country is offset by depreciation
in the currency of that country.
• Conversely Depreciation in Currency of a country shall
lead to increase in inflation reduction of purchasing
power in a country.
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Weaknesses
• The index of 2 countries may not consists of
identical products with identical weightages .
• The products themselves may be different in 2
countries.
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Interest Rate Parity Theory
• High interest rate in 1 country is offset by
depreciation in the currency of that country.
• Conversely Depreciation in Currency of a
country shall lead to increase in interest rate,
Cost of capital in a country.
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Pegging of Currency
• Developing countries peg their currencies
either to a strong currency or to a currency of
the country with which it has large share of
trade.
• This system provides a fixed exchange rate
between 2 currencies.
• It may float with respect to other currencies.
118
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Crawling peg
• It’s the hybrid of fixed & floating rate system.
• The exchange rate of a currency which is fixed
is stable in short run but it changes gradually
over a period of time. In order to reflect
changes in the market.
• The system has advantage of stability &
flexibility.
119
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Target Zone Arrangement
• Exchange rates are fixed with respect to
currencies of countries of a particular zone &
exchange rate floats with respective countries
outside the zone.
120
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Competitive & Technological Environment
• Refers to factors, activities those surround/ encircle
international business.
• Means factors that affect / influence international business.
• Extremely competitive & technology driven.
• Such factors include; ~ STEPIN
1. Socio Cultural Factors (S)
2. Techno-Logical Factors (T)
3. Economic Factors(E)
4. Political / Governmental Factors (P)
5. International Factors (I)
6. Natural Factors (N)
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International Competition : Advantages
1. High living Standard
2. Increased socio economic welfare
3. Wider market
4. Reduced effect of business cycle
5. Reduced Risks
6. Large scale economies
7. Potential untapped market
8. Opportunity for & Challenges to domestic business
9. Division of labour & specialization
10. Economic growth of the world
11. Optimum & proper utilization of world resources
12. Cultural transformation
13. Knitting the world into a closely interactive Traditional Village
122
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International Competition : Problems
1. Political factors
2. Huge foreign indebtedness
3. Exchange instability
4. Entry requirements ~ eg. Only thro’ JV
5. Tariffs, quotas & trade barriers
6. Corruption
7. Bureaucratic practices of Govt
8. Technological pirating
9. Quality maintenance ~ Failure to confirm
standards.
10.High cost
123
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Technological Environment
1. Influences life
2. Require investment
3. Helps in economic development
4. Helps in competition
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International Technology Transfer
• Thro’ Subsidiaries in developing countries
• JVs in host country
• M & A
• Arranging Technological transfer thro’
alliances
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Technology management in IB
• Study of compatibility of home country technology
with host country.
• If not compatible, select appropriate technology.
• Compare with culture, taste, preference.
• Compare with Governmental policy
• Find out modes of technology transfer.
• Impact of technology on environment .
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127
Thanks
CA. Prithvi R Parhi,
clickprithvi@yahoo.com
8763434746
5:55 PM

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