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Foreign exchange market

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Foreign exchange market

  1. 1. FOREIGN EXCHANGE MARKET The foreign exchange market is the place where one currency is bought or sold for another currency12/15/12 lecture - 1, IFM III unit 1
  2. 2. BASIC CONCEPTS/TERMINOLOGIES Foreign Currency vs. Foreign ExchangeAs per Foreign Exchange Act, (Section 2), 1947.•(c) "Foreign Currency" means any currency other thanIndian currency;•(d) "Foreign Exchange" means includes any instrumentdrawn, accepted, made or issued under clause (8) ofsection 17 of the Banking Regulation Act, 1956, alldeposits, credits and balance payable in any foreigncurrency, and any drafts, traveler’s cheques, letters ofcredit and bills of exchange, expressed or drawn in Indiancurrency but payable in any foreign currency;12/15/12 lecture - 1, IFM III unit 2
  3. 3. FOREIGN EXCHANGE MARKET TYPES & PLAYERS WHOLESALE MARKET RETAIL MARKET OR INTERBANK MARKET COMMERCIAL BANKS FOREX BROKERS TRAVELLERS CENTRAL BANKS TOURISTS MNCs INDIVIDUALS AND SMEs12/15/12 lecture - 1, IFM III unit 3
  4. 4. PLAYERSRETAIL MARKET• THE TRAVELLERS AND TOURISTS EXCHANGE ONE CURRENCY FOR ANOTHER IN THE FORM OF CURRENCY NOTES OR TRAVELLERS CHEQUES.12/15/12 lecture - 1, IFM III unit 4
  5. 5. PLAYERSWHOLESALE MARKET• COMMERCIAL BANKS– participates in foreign exchange on behalf of their clients- At retail level enters through inter bank market or through specialized brokers.- At bulk level enters through inter-bank wholesale market or international banks and brokers12/15/12 lecture - 1, IFM III unit 5
  6. 6. PLAYERSWHOLESALE MARKET• FOREX BROKERS– They act as agents who facilitate trading between dealers.12/15/12 lecture - 1, IFM III unit 6
  7. 7. PLAYERSWHOLESALE MARKET• CENTRAL BANKS– Central banks frequently intervene in the foreign exchange market to maintain the exchange rate at desired level12/15/12 lecture - 1, IFM III unit 7
  8. 8. PLAYERSWHOLESALE MARKET• MNCs– MNCs are participating in forward exchange market12/15/12 lecture - 1, IFM III unit 8
  9. 9. PLAYERSWHOLESALE MARKET• INDIVIDUAL– They took part in foreign exchange market for their investment and commercial activities12/15/12 lecture - 1, IFM III unit 9
  10. 10. PLAYERSWHOLESALE MARKET• INDIVIDUAL– They took part in foreign exchange market for their investment and commercial activities12/15/12 lecture - 1, IFM III unit 10
  11. 11. What is an Exchange Rate ? Exchange Rate is the price of one countrys currency expressed in another countrys currency. In other words, the rate at which one currency can be exchanged for another. e.g. Rs. 48.50 per one USD Major currencies of the World USD EURO YEN12/15/12 lecture - 1, IFM III unit 11
  12. 12. What is a Foreign Exchange Transaction ? – Any financial transaction that involves more than one currency is a foreign exchange transaction. – Most important characteristic of a foreign exchange transaction is that it involves Foreign Exchange Risk12/15/12 lecture - 1, IFM III unit 12
  13. 13. Value Date ConventionsCurrencies are traded both in Ready and forward value dates.1) Ready: Settlement on the deal date. e.g. India2) Value Tom : Settlement on next day. e.g. Canada3) Spot Transaction : Settlement usually in two working days. In International FX transactions, Spot is the Standard value date.Forward Transaction: Settlement at some future date ahead of the spot1, IFM III unit12/15/12 lecture - 13
  14. 14. Price maker Vs. Price TakerThe bank quoting the price is ‘price maker’ or ‘market maker’.The bank asking for the price or ‘quote’ is the ‘price taker’ or ‘user’.12/15/12 lecture - 1, IFM III unit 14
  15. 15. FORWARD TRANSACTIONS1. Out right sale/purchase of a currency against the other for settlement at a future date at the predetermined exchange rate.2. Forward rates are quoted as premium or discount over spot rate.3. Forward rates depend upon interest rate differential between the two currencies.4. Currency with higher interest rates is at discount wrt currency having lower interest rate.5. Currency with lower interest rates is at premium wrt currency having higher interest rate.12/15/12 lecture - 1, IFM III unit 15
  16. 16. FX SWAP Transaction“An FX swap is a contract to buy an amountof currency for one value date at an agreedrate, and to simultaneously resell the sameamount of currency for a later value date,also at an agreed rate, to the same counterparty”.FX swap is essentially a ‘funding’ or ‘MoneyMarket’ transaction and does not involveexchange risk.12/15/12 lecture - 1, IFM III unit 16
  17. 17. – Foreign exchange transactions are settled through Nostro and Vostro accounts. • Nostro: our account with banks abroad. Reserve Bank of India (RBI) maintains various Nostro accounts in a number of countries. • Vostro: their account with us. Many multilateral agencies (e.g. IMF, World Bank) maintain their Nostro accounts at Reserve Bank of India (RBI).12/15/12 lecture - 1, IFM III unit 17
  18. 18. RBI’s Role in the Forex Market• To manage the exchange rate mechanism.• Regulate inter-bank forex transactions and monitor the foreign exchange risk of the banks.• Keep the exchange rate stable.• Manage and maintain countrys foreign exchange reserves.12/15/12 lecture - 1, IFM III unit 18
  19. 19. INTERVENTIONTo keep exchange rate in line with macroobjectives RBI has to intervene from time totimeIntervention is a process where FX is sold orpurchased to keep the right amount ofliquidity available in the FX market so thatdemand / supply equilibrium is maintainedIntervention can be in READY orFORWARD12/15/12 lecture - 1, IFM III unit 19

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