The document discusses foreign exchange management. It provides information on the foreign exchange market including that it is a worldwide decentralized market for trading currencies. Some key currencies that are traded are listed such as USD, EUR, GBP, JPY, etc. The foreign exchange market has two main segments - the spot market and forward market. Exchange rates for immediate delivery and future dates are discussed. Factors that influence exchange rates and transactions in the foreign exchange market are also summarized.

1. By:
Srikant Gupta (86)
Zaki Azfar (107)
Manushi Mishra (116)
2/3/2014
Foreign Exchange Management
1

2. 
The
foreign
exchange
market
(FOREX)
is
a
worldwide decentralized over-the-counter financial
market for the trading of currencies

In simple words, it is a place where one currency is
exchanged
with
another
currency
based
on
fluctuation rates

For
every
international
sale
or
purchase
of
commodities, services or assets, there corresponds
an internationalExchange Management
Foreign sale or purchase of currencies
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3. 
USD – US Dollar
EUR – Euro

GBP – British Pound
IEP – Irish Pound

JPY – Japanese Yen
CHF – Swiss Franc

CAD – Canadian Dollar AUD – Australian Dollar

SEK – Swedish Kroner MEP – Mexican Peso

DKK – Danish Kroner
NZD – New Zealand $

INR – Indian Rupee
SAR – Saudi Riyal
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4.  Only market open 24 hours: FX Market is a 24 hour
market

It starts when a calendar business day opens in Sydney,
Tokyo,
Hong Kong, Singapore and then moves to
Middle East to Europe to New York to the West Coast of
United States where the calendar business comes to a
close

FX Market operates seven days a week (Middle East
Markets function on Saturdays and Sundays)

Effectively it is a 24 hour a day / seven days a week / 365
days a year Market!

Size : Daily turnover of over $3.98 trillion
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6. 
Increase in foreign currency price

From Rs.60.80 to Rs.65.12/ USD

Foreign currency appreciation

Home currency depreciation

From USD 0.0164 to USD 0.0163/ Re
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7. A Day of Foreign-Exchange Trading
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8. 
Organizational setting within which
individuals, governments and banks buy
and sell foreign currencies.

Only a small fraction of daily transactions
in foreign exchange involve trading of
currency.

Most foreign exchange transactions
involve transfer of bank deposits.
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9. The foreign exchange market has mainly two
segments:


Spot markets
Forward markets
The rate at which one currency is traded for
another is called exchange rate
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10. 
The exchange rate for immediate delivery
is called Spot Exchange Rate and is
denoted by S (.) e.g. S (Rs./$) =
Rs.60.80/$

Here immediate delivery means delivery
after two business days

The market where the purchase and sale
of currencies is contracted for spot delivery
is called the Spot Market
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12. 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. 60.6978/8060
Spot (bid) = Rs. 60.6978/$
Spot (ask) = Rs. 60.8060/$
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Rule : “ Buy low: Sell high”
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13. 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
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Rule : “ Buy high: Sell low”
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14. 
Sometimes the quotes are made against 100
units of a currency instead of a unit of the
currency

European quotes are indirect quotes

Indian quotes are direct quotes
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15. Ask and bid differential is called the spread
When quotes are direct :
Spread = Ask – Bid
When quotes are indirect :
Spread = Bid – Ask
 Spread represents cost of transaction
 It is represented by the percentage of spread and is
given by:
1.[( Ask- Bid)/ Ask] x 100 when quotes are direct
2. [(Bid – Ask)/ Bid] x 100 when quotes are indirect

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16. Forward contracts are bought and sold
at forward exchange rates
Hedging and speculation are the main
activities which pertain to forward
markets
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17.  The exchange rates for delivery and payment
at specified future dates are called Forward
Exchange Rates and is denoted by F(.)
 For example, 60 days F (Rs./$) : forward rate
between rupees and dollar is the rate at which
the foreign exchange dealer can arrange a
transaction between rupees and dollar 60 days
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18.  Forward
exchange rates are determined by
forward demand and forward supply of
various currencies

A foreign currency is said to be at a forward
premium if its future value exceeds its
present value in terms of domestic currency
and it is said to be at discount if the converse
is true
For example : S (Rs./$) = Rs. 60.70
F (Rs./$) = Rs. 60.90
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19. These rates are also quoted in the form of ‘bid’
and ‘ask’ rates and the spread also depend on
approximately the same factors as spot rates
plus:
Rate of Interest
Demand and Supply
Speculation about Spot Rates and
Exchange Regulations
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20. 
In Indian forex market, not all currencies are
bought or sold

For non-traded currencies, the banks use
London, New York or Singapore markets

Exchange Market Segments:
1.
2.
3.
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RBI and ADs( Commercial Banks)
Interbank market
Retail segment – ADs with corporate
clients and other retail customers
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21.  The
rates quoted by authorised dealers
(ADs) are merchant rates at which trading
can take place in the Retail segment
 Merchant
rates are different than interbank rates and contain administrative cost,
cover for exchange fluctuation and some
profit on the transaction for the Bank
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22. 
In India, the official rate is determined by the
RBI on the basis of the multi-currency basket

The official buying and selling rates are
announced

FEDAI announces indicative free market rate on
every business day

The RBI has the discretion to enter the market
so as to stabilize the exchange rate
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23. Foreign exchange market
Retail
wholesale
Interbank
(Bank account
or deposits)
Bank and money
changes
(currencies and bank
note, cheques)
Direct
Spot
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Forward
Foreign Exchange Management
Central bank
Indirect
(Through broker)
Derivatives
(Future options etc.)
23

24. About 90% of foreign exchange
trading is in the Interbank part
of the market.
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25. Provides continuous information
on the foreign exchange
market—

Talking with traders at other banks.

Observing prices (exchange rates)
being quoted.
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26. 
What is a forward foreign
exchange contract?
An agreement to exchange one
currency for another on some
date in the future at a price set
now [the forward exchange rate].
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27. The participants in the foreign exchange
market are:




Individuals
Corporate/Firm
Commercial Banks
Central Bank/Governments
International Agencies/Exchange Brokers
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28. 
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B of P – is a record of the value of all economic
transactions between residents of a country
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29. 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
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30. 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
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31. The currency being traded
The volume of currency being traded
The nature of organization making quotes
Overall perception of the Dealer about the
conditions of the economy and forex market

Usually these spreads are regulated by foreign
exchange dealers associations such as FEDAI
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32. Balance of Payments
Inflation
Interest Rates
Money Supply
National Income
Resource Discoveries
Capital Movements
Political Factors
Psychological Factors and Speculation
Technical and Market Factors
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33. Foreign exchange markets represent by faron the
Ready/cash- Settlement of funds the most
important financial markets in the world. Their role is
of paramount importance in deal).
same day (date of the the system of
international payments. In order to play their role
 effectively, it is necessaryfunds takes place on
Tom- Settlement be reliable. Reliability essentially
of that their
opera-tions/dealings
is concerned with contractual obligations being
the next working day of the date entered into
honored. For instance, if two parties have of the
a forward sale or purchase of a currency, both of them
deal. be willing to honors their side of contract by
should
delivering or taking delivery of the currency, as the
 Spot- Settlement of funds takes place on
case may be.


the second working day following the
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34. Types of rates are quoted:
1.
2.
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TT( Telegraphic Transfer) rate
Bill rate
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35. Transactions where TT rate is applied:
Issue/ Payment of demand drafts, mail
transfers, telegraphic transfers etc.
Foreign bill collected and amount received in
Nostro account
Cancellation of foreign exchange sold/
purchased earlier
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36. 

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
usage period –Exchange margin

Bill selling rate = TT selling rate + service
margin
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37. FOREX
IMPORT
physical
Merchandise
and software
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EXPORT
nonphysical
Outright
sale basic
Foreign Exchange Management
REMITTANCE
import
export
Consignment
basic
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38. 
The prices of tradable goods, when expressed in a
common currency, will tend to equalize across
countries as a result of exchange rate changes

Occurs because process of buying goods in a cheap
market and reselling them in expensive market
affects demand for (and price of) the foreign
currency and the market price of the good in the
two product markets in question
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39. 2/3/2014
Foreign Exchange Management
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40. McDonald’s Corporation is the world’s leading global food
service retailer, with nearly 29000 restaurants in 120
countries
 Today more than 65% of total revenue is derived
internationally which is increasing its foreign exchange &
interest rate risks
THE NEED:
 Further increase the effectiveness of the interest rates and
foreign exchange hedging programs
 Wanted to implement a leading-edge solution that would
help achieve this goal while containing costs.
 Needed to maintain consistency with the long-standing risk
management to policy requiring Treasury to be able to price
and manage every derivative they transact

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41. They used ‘basket option strategies’ to hedge their
interest rate & foreign exchange risks
 A basket option is an option whose payoff depends
on the value of a portfolio(or basket) of assets
 McDonald’s was looking for an upgrade in
technology to help the Treasury build the currency
basket option, so….

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42. SOLUTION:
 It hedges their interest rate & foreign exchange
exposures, which are made up of foreign income &
assets & their domestic & foreign debt portfolio, by
using following approaches:
1. Qualitative Analysis: uses the underlying economic
fundamentals for each country, and the currency is
analyzed to determine when it is necessary to
hedge
2. Quantitative Analysis: relies on mathematical
models to analyze assets vs. liabilities implies using
different weightings of different baskets
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43. 


McDonald’s evaluated several system based software
solutions to evaluate hedge effectiveness but they
lacked the flexibility & the analytical coverage needed
to price many of the complex derivatives
In 1996, they choose FINCAD’s Microsoft Excel based
financial engineering software as a pricing tool which
allows them to price their derivatives portfolio,
enabling them to work more efficiently with
instruments such as baskets, average rate & double
average rate options.
Those exotic currency option allow them to hedge
their exposures in a more cost-effective manner
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44. 


McDonald’s also uses FINCAD Analytics to
analyze their portfolio of interest rate swaps,
currency swaps & swaptions.
They built spreadsheet templates for these
instruments and linked them to live market data
from Reuteurs & Bloomberg which enables them
to calculate mark-to-market values in real time
It saved their lot of time. FINCAD listens to its
customers & continues to improve its product
based on user feedback & industry trends
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45. 2/3/2014
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