This document discusses the foreign exchange market. It covers the meaning of the forex market as a market where currencies are bought and sold. It describes key features like operating round the clock and involving major currencies. Major participants are listed as individuals, firms, banks, and others like hedgers, speculators, and arbitragers. Exchange rate quotations and the concept of spread are defined. Finally, several factors that can affect exchange rates are outlined, such as inflation, interest rates, intervention by monetary authorities, terms of trade, and government debt.

1. Dr. Sunita Sukhija
Foreign Exchange Market

2. Topics Covered
• Meaning
• Distinctive Features
• Major Participants
• Exchange Rate Quotations
• Spread
• Factor Affecting Exchange Rate

3. Meaning
• The Foreign Exchange Market is a
market where foreign currencies are
bought and sold.
E.g. Indian Importer has to pay in
Dollar($) if he imports from USA
Rs.67.01/$1

4. Features of Forex Market
• Over-the-counter market
• Operates round-the-clock
• Involves the transactions in stable and
strong currency

5. Major Participants
• Individuals
• Firms
• Banks
• International Organisations
• Others – Hedgers
»Speculators
»Arbitragers

6. Exchange Rate Quotations
• Direct Quote places domestic currency
on the numerator of the quote, while
Indirect quote is just the opposite.
• Direct Quote -Rs.67.01/$1
• Indirect quote-$.0149/Rs.1

7. Spread
• The Difference between ask and bid
rate which forms the bank’s profit, is
known as spread.
• ASK rate at which bank sell foreign
currency to customer.
• BID rate at which banks purchase the
foreign currrency from customer.

8. • Spread = (Ask-bid)/ ask *100
• Ask rate= 67.01
• Bid rate= 66.99
• Spread = (67.01- 66.99)/ 67.01 *100
= .0298
= 2.98%

9. Factor Affecting Exchange Rate
• Impact of Inflation
• Interest Rate
• Intervention by Monetary Authorities
• Bandwagon Effect
• Country’s Current Account / Balance of
Payments
• Government Debt
• Terms of Trade

10. Impact of Inflation
• Changes in market inflation cause changes in currency
exchange rates. A country with a lower inflation rate
than another's will see an appreciation in the value
of its currency. The prices of goods and services
increase at a slower rate where the inflation is low. A
country with a consistently lower inflation rate exhibits a
rising currency value while a country with higher inflation
typically sees depreciation in its currency and is usually
accompanied by higher interest rates.
• PPP Theory- Purchasing Power Parity theory -shows
exchange rate determined by the Purchasing power
of two currency.

11. Year
Exchange rate
(INR per USD)
1947 1
1948 3.30
1949 3.67
1950 - 1966 4.7
1966 7.50
1975 8.39
1980 7.86
1985 12.38
1990 17.01
1995 32.427
2000 43.50
2005 (Jan) 43.47
2006 (Jan) 45.19
2007 (Jan) 39.42
2008 (October) 48.88
2009 (October) 46.37

12. 2010 (January 22) 46.21
2011 (April) 44.17
2011 (September 21) 48.24
2011 (November 17) 55.3950
2012 (June 22) 57.15
2013 (May 15) 54.73
2013 (Sep 12) 62.92
2014 (May 15) 59.44
2014 (Sep 12) 60.95
2015 (July 15) 63.55
2016 (July 15) 67.07
2017 (May 15) 64.04
2018(Jan 31) 63.58
2018(June 7) 67.01

13. • If more Inflation in country A, the
currency of that country will depreciate.
• Et=E0((1+Ia)t/(1+Ib)t)
• E2=65(1+.05/1+.03)2
• = 67.52

14. Interest Rate
• Changes in interest rate affect currency value and dollar
exchange rate. Forex rates, interest rates, and inflation
are all correlated. Increases in interest rates cause a
country's currency to appreciate because higher interest
rates provide higher rates to lenders, thereby attracting
more foreign capital, which causes a rise in exchange
rates.
Theory of Fisher Effect explains that nominal interest
rate is sum of real interest rate and inflation.
• If interest rate is 10% and Inflation is 10%, then real
rate of return will be Zero

15. • If intt. Rate in USA is 4% and Inflation in
India is 10% then investor will invest in
india when nomial intt. in India is more
than 14.4%
• 1.04*1.10-1= 14.4%

16. Intervention by Monetary
Authorities
When the market forces do not influence
the exchange rate in country’s favour,
then monetary authoritiez intervene in
forex market through buying and
selling of foreign currency and
influence the exchange rate.

17. Bandwagon Effect
If a country's currency value is expected to rise, investors
will demand more of that currency in order to make a
profit in the near future. As a result, the value of the
currency will rise due to the increase in demand. With
this increase in currency value comes a rise in the
exchange rate as well. When a speculator being
dominant in the forex market expects drop in value
of particular currency and start selling the currency,
the others follow the lead.
Ultimately the currency depreciates.
In 1992, depreciation of British pound.
In 1997, depreciation of Indian Rupees.

18. Terms of Trade
• Related to current accounts and balance
of payments, the terms of trade is the ratio
of export prices to import prices. A
country's terms of trade improves if its
exports prices rise at a greater rate than
its imports prices. This results in higher
revenue, which causes a higher demand
for the country's currency and an increase
in its currency's value. This results in an
appreciation of exchange rate.

19. Country’s Current Account / Balance
of Payments
• A country’s current account reflects balance of
trade and earnings on foreign investment. It
consists of total number of transactions including
its exports, imports, debt, etc. A deficit in current
account due to spending more of its currency on
importing products than it is earning through
sale of exports causes depreciation. Balance of
payments fluctuates exchange rate of its
domestic currency.

20. Government Debt
• Government debt is public debt or national
debt owned by the central government. A
country with government debt is less likely
to acquire foreign capital, leading to
inflation. Foreign investors will sell their
bonds in the open market if the market
predicts government debt within a certain
country. As a result, a decrease in the
value of its exchange rate will follow.

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