Foreign exchange market

T.Y.F.M. FOREX MARKETS
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CHAPTER 1
OVERVIEW OF FOREIGN EXCHANG MARKET
"Forex" stands for foreign exchange; it's also known as FX. In a forex trade,
you buy one currency while simultaneously selling another - that is, you're
exchanging the sold currency for the one you're buying. The foreign
exchange market is an over-the-counter market.
Currencies trade in pairs, like the Euro-US Dollar (EUR/USD) or US Dollar
/ Japanese Yen (USD/JPY). Unlike stocks or futures . All transactions
happen via phone or electronic network.
Historically, Forex has been dominated by inter-world investment and
commercial banks, money portfolio managers, money brokers, large
corporations, and very few private traders. Lately this trend has changed.
With the advances in internet technology, plus the industry's unique
leveraging options, more and more individual traders are getting involved in
the market for the purposes of speculation. While other reasons for
participating in the market include facilitating commercial transactions
(whether it is an international corporation converting its profits, or hedging
against future price drops), speculation for profit has become the most
popular motive for Forex trading for both big and small participants Traders
generate profits, or losses, by speculating whether a currency will rise or fall
in value in comparison to another currency. A trader would buy the currency
which is anticipated to gain in value, or sell the currency which is
anticipated to lose value against another currency.

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Although good instincts and speculatory skills are invaluable trader, there
are also other, more scientific indicators that traders use to decide whether
they will buy or sell a certain currency.
These are found by fundamental factors include economic and political
events (i.e. elections, wars) that occur worldwide. Monetary and fiscal
policy, government reports such as GDP, CPI, PPI, and measures such as the
unemployment rate also fall in this category. A trader that makes his or her
market decisions in response to these releases and events is using
fundamental analysis. The value of a currency in the forex market is
essentially an indication of the state of one nation's economy in comparison
to another nation's
FOREX, an acronym for Foreign Exchange, is the largest financial market in
the world. With an estimated $1.5 trillion in currencies traded daily, Forex
provides income to millions of traders and large banks worldwide. The
market is so large in volume that it would take the New York Stock
Exchange, with a daily average of under $20 billion, almost three months to
reach the amount traded in one day on the Foreign Exchange Market.
The foreign exchange market operates 24 hours a day, and, unlike the stock
market, has no official openings or closings.
Trading volumes in a given region are always highest during its primary
business hours, when traders at financial institutions are busy filling and
placing orders. The most active times, meaning the times of most liquidity
and movement in the markets, is the London open (3 AM EST), and the
overlap between London/Euro close and New York's open (8-11 AM EST).

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The hours below correspond to someone living in the EST time zone.
• New York session opens at 8:00 am and ends around 5:00 pm.
• Sydney session starts at 5:00 pm and ends around 2:00 am.
• Tokyo session begins at 7:00 pm and ends around 4:00 am.
• Frankfurt session opens at 2:00 am and ends around 11:00 am.
• London opens at 3:00 am and ends around 12:00 am.
Below is a figure showing business hours in the various regions, oriented for
someone in the EST time zone. In this figure you can see the overlap
between the European/London session and the New York session, between 8
am and 11 am EST. The currency markets experience the highest volatility
and volume during that overlap, which also coincides with the release of
important US economic figures.
Indirect Quote
Indirect quote is the reporting of foreign exchange rate in terms of units of
foreign currency per unit of domestic currency. For a resident of the United
States intending to buy/sell British pounds, it means exchange rates
expressed in British pounds per unit of US dollar.
Formula
An indirect quote is the inverse of the direct quote.

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When the foreign exchange rate is expressed as a mid-quote, the following
formula can be used to calculate the indirect quote:
Indirect Quote =
1
Direct Quote
Where the foreign exchange rate is expressed in terms of bid and ask spread,
indirect quote can be calculated by finding the inverse of both prices and
switching their positions. It means that the direct bid becomes the indirect
ask and the direct ask becomes the indirect bid. Direct quote of (x − y)
would become indirect quote of (1/y − 1/x)
Direct quote
Direct quote is the convention of expressing currency exchange in terms of
units of domestic currency per unit of foreign currency.
It is 'direct' in the sense that a resident knows the price of the foreign
currency straight away.
What is a direct quote for a domestic resident is an indirect quote for the
resident of the foreign country. An indirect quote is the exact opposite of the
direct quote.
A direct quote can be converted to indirect quote by the following formula:
Direct Quote =
1
Indirect Quote
When a currency exchange rate is expressed in terms of bid-ask spread
instead of a mid-quote, the direct bid becomes the indirect ask and direct ask
becomes the indirect bid

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CHAPTER 2
FEATUER OF FOREX MARKET
No commissions
No clearing fees, no exchange fees, no government fees, no brokerage fees.
Most retail brokers are compensated for their services through something
called the “bid-ask spread“.
No middlemen
Spot currency trading eliminates the middlemen and allows you to trade
directly with the market responsible for the pricing on a particular currency
pair.
No fixed lot size
In the futures markets, lot or contract sizes are determined by the exchanges.
A standard-size contract for silver futures is 5,000 ounces. In spot forex, you
determine your own lot, or position size. This allows traders to participate
with accounts as small as $25 (although we’ll explain later why a $25
account is a bad idea).

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Low transaction costs
The retail transaction cost (the bid/ask spread) is typically less than 0.1%
under normal market conditions. At larger dealers, the spread could be as
low as 0.07%. Of course this depends on your leverage and all will be
explained later.
A 24-hour market
There is no waiting for the opening bell. From the Monday morning opening
in Australia to the afternoon close in New York, the forex market never
sleeps. This is awesome for those who want to trade on a part-time basis,
because you can choose when you want to trade: morning, noon, night,
during breakfast, or in your sleep.
No one can corner the market
The foreign exchange market is so huge and has so many participants that no
single entity (not even a central bank or the mighty Chuck Norris himself)
can control the market price for an extended period of time.
Leverage
In forex trading, a small deposit can control a much larger total contract
value. Leverage gives the trader the ability to make nice profits, and at the
same time keep risk capital to a minimum.

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Low Barriers to Entry
You would think that getting started as a currency trader would cost a ton of
money. The fact is, when compared to trading stocks, options or futures, it
doesn’t. Online forex brokers offer “mini” and “micro” trading accounts,
some with a minimum account deposit of $25.
We’re not saying you should open an account with the bare minimum, but it
does make forex trading much more accessible to the average individual
who doesn’t have a lot of start-up trading capital.
Free Stuff Everywhere
Most online forex brokers offer “demo” accounts to practice trading and
build your skills, along with real-time forex news and charting services.
And guess what?! They’re all free!
Demo accounts are very valuable resources for those who are “financially
hampered” and would like to hone their trading skills with “play money”
before opening a live trading account and risking real money.

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CHAPTER 3
PARTICIPENT FOREX MARKET
At the first level, are tourists, importers, exporters, investors, and
so on. These are the immediate users and suppliers of foreign
currencies. At the second level, are the commercial banks, which
act as clearing houses between users and earners of foreign
exchange. At the third level, are foreign exchange brokers through
whom the nation’s commercial banks even out their foreign
exchange inflows and outflows among themselves. Finally at the
fourth and the highest level is the nation’s central bank, which acts
as the lender or buyer of last resort when the nation’s total foreign
exchange earnings and expenditure are unequal. The central then
either draws down its foreign reserves or adds to them.
CUSTOMERS:
The customers who are engaged in foreign trade participate
in foreign exchange markets by availing of the services of banks.
Exporters require converting the dollars into rupee and importers
require converting rupee into the dollars as they have to pay in

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dollars for the goods / services they have imported. Similar types
of services may be required for setting any international obligation
i.e., payment of technical know-how fees or repayment of foreign
debt, etc.
COMMERCIAL BANKS
They are most active players in the forex market.
Commercial banks dealing with international transactions offer
services for conversation of one currency into another. These
banks are specialised in international trade and other transactions.
They have wide network of branches. Generally, commercial
banks act as intermediary between exporter and importer who are
situated in different countries. Typically banks buy foreign
exchange from exporters and sells foreign exchange to the
importers of the goods. Similarly, the banks for executing the
orders of other customers, who are engaged in international
transaction, not necessarily on the account of trade alone, buy and
sell foreign exchange. As every time the foreign exchange bought
and sold may not be equal banks are left with the overbought or
oversold position. If a bank buys more foreign exchange than what
it sells, it is said to be in ‘overbought/plus/long position’. In case
bank sells more foreign exchange than what it buys, it is said to be

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in ‘oversold/minus/short position’. The bank, with open position,
in order to avoid risk on account of exchange rate movement,
covers its position in the market. If the bank is having oversold
position it will buy from the market and if it has overbought
position it will sell in the market. This action of bank may trigger a
spate of buying and selling of foreign exchange in the market.
Commercial banks have following objectives for being active in
the foreign exchange market:
o They render better service by offering competitive rates to their
customers engaged in international trade.
o They are in a better position to manage risks arising out of
exchange rate fluctuations.
o Foreign exchange business is a profitable activity and thus such
banks are in a position to generate more profits for themselves.
• They can manage their integrated treasury in a more efficient
manner
.

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CENTRAL BANKS
In most of the countries central bank have been charged
with the responsibility of maintaining the external value of the
domestic currency. If the country is following a fixed exchange
rate system, the central bank has to take necessary steps to
maintain the parity, i.e., the rate so fixed. Even under floating
exchange rate system, the central bank has to ensure orderliness in
the movement of exchange rates. Generally this is achieved by the
intervention of the bank. Sometimes this becomes a concerted
effort of central banks of more than one country.
Apart from this central banks deal in the foreign exchange
market for the following purposes:
o Exchange rate management:
Though sometimes this is achieved through intervention,
yet where a central bank is required to maintain external rate of
domestic currency at a level or in a band so fixed, they deal in the
market to achieve the desired objective
o Intervention by Central Bank

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It is truly said that foreign exchange is as good as any other
commodity. If a country is following floating rate system and there
are no controls on capital transfers, then the exchange rate will be
influenced by the economic law of demand and supply. If supply
of foreign exchange is more than demand during a particular
period then the foreign exchange will become cheaper. On the
contrary, if the supply is less than the demand during the particular
period then the foreign exchange will become costlier. The
exporters of goods and services mainly supply foreign exchange to
the market. If there are no control over foreign investors are also
suppliers of foreign exchange.
During a particular period if demand for foreign exchange
increases than the supply, it will raise the price of foreign
exchange, in terms of domestic currency, to an unrealistic level.
This will no doubt make the imports costlier and thus protect the
domestic industry but this also gives boost to the exports.
However, in the short run it can disturb the equilibrium and
orderliness of the foreign exchange markets. The central bank will
then step forward to supply foreign exchange to meet the demand
for the same. This will smoothen the market. The central bank

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value of rupee, Reserve Bank has given the right to intervene in the
foreign exchange markets.
EXCHANGE BROKERS
Forex brokers play a very important role in the foreign exchange
markets. However the extent to which services of forex brokers are
utilized depends on the tradition and practice prevailing at a
particular forex market centre. In India dealing is done in interbank
market through forex brokers. In India as per FEDAI guidelines
the AD’s are free to deal directly among themselves without going
through brokers. The forex brokers are not allowed to deal on their
own account all over the world and also in India.
Banks seeking to trade display their bid and offer rates on their
respective pages of Reuters screen, but these prices are indicative
only. On inquiry from brokers they quote firm prices on telephone.
In this way, the brokers can locate the most competitive buying
and selling prices, and these prices are immediately broadcast to a
large number of banks by means of hotlines/loudspeakers in the
banks dealing room/contacts many dealing banks through calling
assistants employed by the broking firm. If any bank wants to

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respond to these prices thus made available, the counter party bank
does this by clinching the deal. Brokers do not disclose counter
party bank’s name until the buying and selling banks have
concluded the deal. Once the deal is struck the broker exchange the
names of the bank who has bought and who has sold. The brokers
charge commission for the services rendered.
SPECULATORS
Speculators play a very active role in the foreign exchange
markets. In fact major chunk of the foreign exchange dealings in
forex markets in on account of speculators and speculative
activities.
The speculators are the major players in the forex markets.
Banks dealing are the major speculators in the forex
markets with a view to make profit on account of favourable
movement in exchange rate, take position i.e., if they feel the rate
of particular currency is likely to go up in short term. They buy
that currency and sell it as soon as they are able to make a quick
profit.
Corporations particularly Multinational Corporations and
Transnational Corporations having business operations beyond

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their national frontiers and on account of their cash flows. Being
large and in multi-currencies get into foreign exchange exposures.
With a view to take advantage of foreign rate movement in their
favour they either delay covering exposures or does not cover until
cash flow materialize. Sometimes they take position so as to take
advantage of the exchange rate movement in their favour and for
undertaking this activity, they have state of the art dealing rooms.
In India, some of the big corporate are as the exchange control
have been loosened, booking and cancelling forward contracts, and
a times the same borders on speculative activity.
Governments narrow or invest in foreign securities and
delay coverage of the exposure on account of such deals.
Individual like share dealings also undertake the activity of
buying and selling of foreign exchange for booking short-term
profits. They also buy foreign currency stocks, bonds and other
assets without covering the foreign exchange exposure risk. This
also results in speculations.

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Corporate entities take positions in commodities whose
prices are expressed in foreign currency. This also adds to
speculative activity.
The speculators or traders in the forex market cause
significant swings in foreign exchange rates. These swings,
particular sudden swings, do not do any good either to the national
or international trade and can be detrimental not only to national
economy but global business also. However, to be far to the
speculators, they provide the much need liquidity and depth to
foreign exchange markets. This is necessary to keep bid-offer
which spreads to the minimum. Similarly, liquidity also helps in
executing large or unique orders without causing any ripples in the
foreign exchange markets. One of the views held is that
speculative activity provides much needed efficiency to foreign
exchange markets. Therefore we can say that speculation is
necessary evil in forex markets.

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in value of its currency. But, a country prone to political confusions may see
a depreciation in exchange rates.
7. Recession
When a country experiences a recession, its interest rates are likely to fall,
decreasing its chances to acquire foreign capital. As a result, its currency
weakens in comparison to that of other countries, therefore lowering the
exchange rate.
8. Speculation
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.

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CHAPTER 5
TRANSACTION IN FOREX MARKET
Spot Market
The term spot exchange refers to the class of foreign exchange transaction
which requires the immediate delivery or exchange of currencies on the
spot. In practice the settlement takes place within two days in most markets.
The rate of exchange effective for the spot transaction is known as the
spot rate and the market for such transactions is known as the spot market.
Forward Market
The forward transactions is an agreement between two parties, requiring the
delivery at some specified future date of a specified amount of foreign
currency by one of the parties, against payment in domestic currency be the
other party, at the price agreed upon in the contract. The rate of exchange
applicable to the forward contract is called the forward exchange rate and
the market for forward transactions is known as the forward market.
The foreign exchange regulations of various countries generally regulate the
forward exchange transactions with a view to curbing speculation in the
foreign exchanges market. In India, for example, commercial banks are
permitted to offer forward cover only with respect to genuine export and
import transactions.
Forward exchange facilities, obviously, are of immense help to exporters
and importers as they can cover the risks arising out of exchange rate
fluctuations be entering into an appropriate forward exchange contract.

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With reference to its relationship with spot rate, the forward rate may be at
par, discount or premium.
If the forward exchange rate quoted is exact equivalent to the spot rate at the
time of making the contract the forward exchange rate is said to be at par.
The forward rate for a currency, say the dollar, is said to be at premium with
respect to the spot rate when one dollar buys more units of another currency,
say rupee, in the forward than in the spot rate on a per annum basis.
The forward rate for a currency, say the dollar, is said to be at discount with
respect to the spot rate when one dollar buys fewer rupees in the forward
than in the spot market. The discount is also usually expressed as a percentage
deviation from the spot rate on a per annum basis.
The forward exchange rate is determined mostly be the demand for and
supply of forward exchange. Naturally when the demand for forward
exchange exceeds its supply, the forward rate will be quoted at a premium
and conversely, when the supply of forward exchange exceeds the demand
for it, the rate will be quoted at discount. When the supply is equivalent to
the demand for forward exchange, the forward rate will tend to be at par.

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Futures
While a focus contract is similar to a forward contract, there are several
differences between them. While a forward contract is tailor made for the
client be his international bank, a future contract has standardized features
the contract size and maturity dates are standardized. Futures cab traded only
on an organized exchange and they are traded competitively. Margins are
not required in respect of a forward contract but margins are required of all
participants in the futures market an initial margin must be deposited into a
collateral account to establish a futures position.
Options
While the forward or futures contract protects the purchaser of the contract
from the adverse exchange rate movements, it eliminates the possibility of
gaining a windfall profit from favorable exchange rate movement.
An option is a contract or financial instrument that gives holder the right, but
not the obligation, to sell or buy a given quantity of an asset as a specified
price at a specified future date. An option to buy the underlying asset is
known as a call option and an option to sell the underlying asset is known as
a put option. Buying or selling the underlying asset via the option is known
as exercising the option. The stated price paid (or received) is known as the
exercise or striking price. The buyer of an option is known as the long and
the seller of an option is known as the writer of the option, or the short. The
price for the option is known as premium.
Types of options: With reference to their exercise characteristics, there are
two types of options, American and European. A European option cab is

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CHAPTER 6
SETTELMENT IN FOREX MARKET
Foreign exchange markets make extensive use of the latest developments in
telecommunications for transmitting as well settling foreign exchange
transaction, Banks use the exclusive network SWIFT to communicate
messages and settle the transactions at electronic clearing houses such as
CHIPS at New York.
SWIFT
: SWIFT is a- acronym for Society for Worldwide Interbank Financial
Telecommunications, a co -operative society owned by about 250 banks in
Europe and North America and registered as a co -operative society in
Brussels, Belgium. It is a communications network for international
financial market transactions linking effectively more than 25,000 financial
institutions throughout the world who have been allotted bank identified
codes. The messages are transmitted from country to country via central
interconnected operating centers located in Brussels, Amsterdam and
Culpeper, Virginia. The member countries are connected to the centre
through regional processors in each country. The local banks in each country
reach the regional processors through the national net works.
The SWIFY System enables the member banks to transact among
themselves quickly (i) international payments (ii) Statements (iii) other
messages connected with international banking. Transmission of messages
takes place within

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seconds, and therefore this method is economical as well as time saving.
Selected banks in India have become members of SWIFT. The regional
processing centre is situated at Mumbai.
The SWIFT provides following advantages for the local banking
community:
1. Provides a reliable (time tested) method of sending and receiving
messages from a vast number of banks in a large number of locations around
the world.
2. Reliability and accuracy is further enhanced by the built in authentication
facilities, which has only to be exchanged with each counterparty before
they can be activated or further communications.
3. Message relay is instantaneous enabling the counterparty to respond
immediately, if not prevented by time differences.
4. Access is available t a vast number of banks global for launching new
cross border initiatives.
5. Since communication in SWIFT is to be done using structure formats for
various types of banking transactions, the matter to be conveyed will be very
clear and there will not be any ambiguity of any sort for the received to
revert for clarifications. This is mainly because the formats are used all
ove3r the world on a standardized basis for conducting all types of banking
transactions. This makes the responses and execution very efficient at the
receiving banks end thereby contributing immensely to quality service being
provided to the customers of both banks (sending and receiving).

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6. Usage of SWIFT structure formats for message transmission to
counterparties will entail the generation of local banks internal records using
at least minimum level of automation. This will accelerate the local banks
internal automation activities, since the maximum utilization of SWIFT a
significant internal automation level is required.
CHIPS:
CHIPS stands for Clearing House Interbank Payment System. It is an
electronic payment system owned by 12 private commercial banks
constituting the New York Clearing House Association. A CHIP began its
operations in 1971 and has grown to be the world‘s largest payment system.
Foreign exchange and Euro dollar transactions are settled through CHIPS. It
provides the mechanism for settlement every day of payment and receipts of
numerous dollar transactions among member banks at New York, without
the need for physical exchange of cheques/funds for each such transaction.
The functioning of CHIPS arrangement is explained below with a
hypothetical transaction: Bank of India, maintaining a dollar account with
Amex Bank, New York, sells USD 1 million to Canara Bank, maintaining
dollar account with Citibank.
1. Bank of India intimate Amex Bank debuts the account of Bank through
SWIFT to debit its account and transfer USD 1 million to Citibank for credit
of current account of Canara Bank.

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2. Amex Bank debits the account of Bank of India with USD 1 million and
sends the equivalent of electronic cheques to CHIPS for crediting the
account of Citibank. The transfer is effected the same day.
3. Numerous such transactions are reported to CHIPS by member banks and
transfer effected at CHIPS. By about 4.30 p.m, eastern time, the net
position of each member is arrived at and funds made available at
Fedwire for use by the bank concerned by 6.00 p.m. eastern time.
4. Citibank which receives the credit intimates Canara Bank through
SWIFT.
It may be noted that settlement of transactions in the New York foreign
exchange market takes place in two stages, First clearance at CHIPS and
arriving at the net position for each bank. Second, transfer of fedfunds for
the net position. The real balances are held by banks only with Federal
Reserve Banks (Fedfunds) and the transaction is complete only when
Fedfunds are transferred. CHIPS help in expediting the reconciliation and
reducing the number of entries that pass through Fedwire.

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For example, a forex broker may offer 50-to-1 leverage, which means that a
$50 dollar margin deposit would enable a trader to buy or sell $2,500 worth
of currencies. Similarly, with $500 dollars, one could trade with $25,000
dollars and so on. While this is all gravy, let’s remember that leverage is a
double-edged sword. Without proper risk management, this high degree of
leverage can lead to large losses as well as gains.
High Liquidity.
Because the forex market is so enormous, it is also extremely liquid. This is
an advantage because it means that under normal market conditions, with a
click of a mouse you can instantaneously buy and sell at will as there will
usually be someone in the market willing to take the other side of your trade.
You are never “stuck” in a trade. You can even set your online trading
platform to automatically close your position once your desired profit level
(a limit order) has been reached, and/or close a trade if a trade is going
against you (a stop loss order).

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CHAPTER 7
THE GOLD STANDARD
A system of setting currency values whereby the participating countries
commit to fix the prices of their domestic currencies in terms of a specified
amount of gold. The gold standard as an international monetary system
gained acceptance in Western Europe in the 1870s. The United States was
something of a latecomer to the system, not officially adopting the standard
until 1879. The ―rules of the game under the gold standard were clear and
simple. Each country set the rate at which its currency (paper or coin) could
be converted to a weight of gold. The United States, for example, declared
the dollar to be convertible to gold at a rate of $20.67/ounce of gold (a rate
in effect until the beginning of World War 1). The British pound was pegged
at £4.2474/ounce of gold. As long as both currencies were freely convertible
into gold, the dollar/pound exchange rate was:
$20.67/ounce of gold
= $4.8665/£ £4.2474/ounce of gold
Because the government of each country on the gold standard agreed to buy
or sell gold on demand to anyone at its own fixed parity rate, the value of
each individual currency in terms of gold, and therefore the fixed parities
between currencies, was set. Under this system it was very important for a
country to maintain adequate reserves of gold to back its currency‘s value.
The system also had the effect of implicitly limiting the rate at which any
individual country could expand its money supply. The growth in money
was limited to the rate at which additional gold could be acquired by official
authorities. The gold standard worked adequately until the outbreak of

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World War 1 interrupted trade flows and the free movement of gold. This
caused the main trading nations to suspend the operation of the gold
standard

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CHAPTER 8
BRETTON WOOD
In 1944, as World War II drew toward a close, the Allied Powers met at
Bretton Woods, New Hampshire, in order to create a new post-war
international monetary system. The Bretton Woods Agreement,
implemented in 1946, whereby each member government pledged to
maintain a fixed, or pegged, exchange rate for its currency vis-à-vis the
dollar or gold. These fixed exchange rates were supposed to reduce the
riskiness of international transactions, thus promoting growth in world trade.
The Bretton Woods Agreement established a US dollar-based international
monetary system and provide for two new institutions, The IMF and the
World Bank. The IMF aids countries with balance of payments and
exchange rate problems. The International Bank for Reconstruction and
Development (World Bank) helped post-war reconstruction and since then
has supported general economic development.
The IMF was the key institution in the new international monetary system,
and it has remained so to the present. The IMF was established to render
temporary assistance to member countries trying to defend their currencies
against cyclical, seasonal, or random occurrences. It also assists countries
having structural trade problems if they take adequate steps to correct their
problems. However, if persistence deficits occur, the IMF cannot save a
country from eventual devaluation. In recent years it has attempted to help
countries facing financial crises. It has provided massive loans as well as
advice to Russia and other former Russian republics, Brazil, Indonesia, and
South Korea, to name but a few.

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Under the original provisions of the Bretton Woods Agreement, all countries
fixed the value of their currencies for gold. Only the dollar remained
convertible into gold (at $35 per ounce). Therefore, each country decided
what it wished its exchange rate to be vis-à-vis the dollar and then calculated
the gold per value of its currency to create the desired dollar exchange rate.

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CHAPTER 9
FIXED EXCHANGE RATES
The currency arrangement negotiated at Bretton Woods and monitored by
the IMF worked fairly well during the post-World War II period of
reconstruction and rapid growth in world trade. However, widely diverging
national monetary and fiscal policies, differential rates of inflation, and
various unexpected external shocks eventually resulted in the system‘s
demise. The U.S. dollar was the main reserve currency held by central banks
and was the key to the web of exchange rate values. Unfortunately, the
United States ran persistent and growing deficits on its balance of payments.
A heavy capital outflow of dollars was required to finance these deficits and
to meet the growing demand for dollars from investors and businesses.
Eventually, the heavy overhang of dollars held abroad resulted in a lack of
confidence in the ability of the United States to meet its commitment to
convert dollars to gold.
On August 15, 1971, President Richard Nixon was forced to suspend official
purchases or sales of gold by the U.S. Treasury after the United States
suffered outflows of roughly one-third of its official gold reserves in the first
seven months of the year. Exchange rates of most of the leading trading
countries were allowed to float in relation to the dollar and thus indirectly in
relation to gold. By the end of 1971 most of the major trading currencies had
appreciated vis-à-vis the dollar. This change was – in effect – a devaluation
of the dollar.
In early 1973, the U.S. dollar came under attack once again, thereby forcing
a second devaluation on February 12, 1973, this time by 10% to $42.22 per
ounce. By late February 1973, a fixed –rate system no longer appeared

37 | P a g e
CHAPTER 10
RESERVE MANAGEMENT
Reserve management is a process that ensures that adequate official public
sector foreign assets are readily available to and controlled by the authorities
for meeting a defined range of objectives for a country or union. In this
context, a reserve management entity is normally made responsible for the
management of reserves and associated risks. Typically, official foreign
exchange reserves are held in support of a range of objectives including to:
• support and maintain confidence in the policies for monetary and
exchange rate management including the capacity to intervene in support of
the national or union currency;
• limit external vulnerability by maintaining foreign currency liquidity to
absorb shocks during times of crisis or when access to borrowing is curtailed
and in doing so;
• provide a level of confidence to markets that a country can meet its
external obligations;
• demonstrate the backing of domestic currency by external assets;
• assist the government in meeting its foreign exchange needs and external
debt obligations; and
• maintain a reserve for national disasters or emergencies.
2. Sound reserve management practices are important because they can
increase a country's or region's overall resilience to shocks. Through their
interaction with financial markets, reserve managers gain access to valuable
information that keeps policy makers informed of market developments and

38 | P a g e
views on potential threats. The importance of sound practices has also been
highlighted by experiences where weak or risky reserve management
practices have restricted the ability of the authorities to respond effectively
to financial crises, which may have accentuated the severity of these crises.
Moreover, weak or risky reserve management practices can also have
significant financial and reputational costs. Several countries, for example,
have incurred large losses that have had direct, or indirect, fiscal
consequences.4 Accordingly, appropriate portfolio management policies
concerning the currency composition, choice of investment instruments, and
acceptable duration of the reserves portfolio, and which reflect a country's
specific policy settings and circumstances, serve to ensure that assets are
safeguarded, readily available and support market confidence.
3. Sound reserve management policies and practices can support, but not
substitute for, sound macroeconomic management. Moreover, inappropriate
economic policies (fiscal, monetary and exchange rate, and financial) can
pose serious risks to the ability to manage reserves.

39 | P a g e
CHAPTER 11
FOREX MARKET IMPACT ON EXPORT AND
IMPORT
lies in understanding the export – import payment process. When a company
imports any good/service it makes payment in internationally acceptable
currencies, like USD. On the other hand, when a company exports any
good/service, it accepts USD from the buyer. However in both the cases, the
company has to do the rest of the business in domestic currency (INR –
Indian Rupees, as per our example) since, only domestic currency is
considered as a legal tender within a country. Hence, an importer has to first
buy USD from a bank by exchanging equivalent domestic currency, for
making payments to the international supplier and an exporter has to sell
USD to a bank, received from international buyer, and get equivalent
domestic currency in return from the bank.
Let us take an example to understand this,
CASE 1: $1 is equal to 60 INR as on 21st Aug 2015
CASE 2: $1 is equal to 63 INR as on 21st Sep 2015
CASE 3: $1 is equal to 57 INR as on 21st Oct 2015
Now, for an importer, every product that he buys, he has to first buy USD
from a bank. If he buys a good which costs $100 in the international market,
then, as on 21st Aug 2015, the importer will have to buy $100 by giving
6,000 INR (60 X 100) to a bank. However, as on 21st Sep 2015 the INR has

40 | P a g e
depreciated against dollar (lost its value against dollar). Hence, if the
importer now wants to buy $100 from the bank, he will have to pay 6,300
(63 X 100) to the bank. Thus, depreciation of domestic currency results in
the increased cost for an importer. Consider the last scenario, $1 = 57 INR,
so when the importer wants to buy $100 from a bank, he will now have to
pay 5,700 (57 X 100). Thus, appreciation of domestic currency reduces
importers’ cost.
The exact reverse impact happens on an exporter. Consider an exporter,
selling a good worth $100 in the international market. Under first scenario,
the exporter will get $100 for selling a good and will exchange it for INR
with a bank and will get 6,000 INR (100 X 60). However, in the second
case, the exporter will end up getting 6,300 INR (100 X 63) for the same
good sold. Hence, depreciation of domestic currency increases exporters
profit margins. But, in case of last scenario, the export ends up getting only
5,700 INR (100 X 57) for the same good. Hence, exporter loses on profit
margins whenever domestic currency appreciates.
The above example can be shown in a table as –
Case Situation INR position Cost of Good
1 $1 = 60 INRStable$100 – –
2 $1 = 63 INRDepriciation$100 Loss Profit
3 $1 = 57 INRAppreciation $100 Profit Loss
The cost and quality of good remains the same, but the fluctuations in the
currency rates determines the profit and loss extent for the exporter and the

42 | P a g e
CHAPTER 12
CASE STUDY DEVALUATION OF YUAN
CURRANCY
WASHINGTON: China’s currency fell further Wednesday, keeping global
investors on edge. The yuan slid 1.6 percent on top of a 1.9 percent drop
engineered Tuesday by the Chinese government. The currency’s nosedive is
giving investors plenty to worry about:
The risk the Chinese economy, the world’s second-biggest, is weakening
even faster than expected.
The threat that a cheaper yuan poses to exports and economic growth in
other countries.
The possibility that China’s move will trigger a beggar-thy-neighbor
currency war.
And the prospect that it will force the Federal Reserve to rethink a widely
expected U.S. interest rate hike this year — a possibility that creates
uncertainties for financial markets.

43 | P a g e
—HOW DID THIS START?
In a surprise move, China devalued the yuan on Tuesday. Beijing doesn’t let
buying and selling in financial markets set its exchange rate the way the
United States and other developed countries do. Instead, it links the yuan’s
value to a basket of currencies. The composition of the basket is a secret, but
it’s believed to be dominated by the U.S. dollar.
Each day, the People’s Bank of China sets a target for the yuan, then lets the
currency trade 2 percent above or below that level. On Tuesday, the central bank
set the target 1.9 percent below Monday’s — the biggest one-day change in a decade.
—WHAT’S CHINA’S MOTIVATION?
China says the devaluation was part of an effort to give market forces a
bigger say in the exchange rate — something the United States and the
International Monetary Fund have long called for. Chinese people, worried
about the economy and seeking investment opportunities abroad, have been
pulling money out of the country. That exodus has held down the yuan’s
value. But because the yuan was tied to a rising U.S. dollar, it remained at
high levels. By devaluing the yuan, the Chinese government was catching up
to the market, not trying to counteract it.
Or so Beijing says. Many economists also suspect a contributing factor:
Beijing may be desperately trying to boost its economy. A cheaper yuan
gives Chinese exporters a price advantage in foreign markets. And they need
help: Exports dropped a steep 8.3 percent in July year over year.

44 | P a g e
—WHY ARE INVESTORS SO FREAKED OUT?
Plenty of reasons. The surprise devaluation suggests that something is
spooking the Chinese government. Perhaps the Chinese economy is
decelerating even faster than anyone realizes. Already, the IMF is
forecasting 6.8 percent economic growth in China this year, the slowest rate
since 1990. Signs of trouble are accumulating. On Wednesday, for instance,
China reported that auto sales sank 6.6 percent in July.
Investors are also worried about how a weaker yuan will affect exporters in
other countries. Shares in exporters such as Caterpillar and General Electric
fell in the market rout this week, though many economists say the yuan’s
drop so far isn’t significant enough to do much damage.
Then there’s the chance that other countries will adopt copycat devaluations
to help their exporters compete with China, thereby igniting a currency war
that disrupts international trade. On Wednesday, Vietnam allowed its
currency to weaken in response to China’s move.
Finally, the Chinese devaluation complicates the Fed’s decision-making.
The U.S. central bank, increasingly confident in the strength of the U.S.
economy, is expected to raise the short-term rate it controls later this year.
The Fed has kept the rate at zero since December 2008. But a cheaper yuan
poses a threat to U.S. exports and economic growth. It also lowers inflation,
already running below the Fed’s 2 percent annual target. Still, most
economists suspect the yuan’s drop won’t have much of a lasting impact.
They continue to expect the Fed to raise rates at its September meeting.

45 | P a g e
CHAPTER 13
CONCLUSION
Foreign Exchange market bright many more banks and advisors convert
themselves into good service of a forex trade and deliver much more
efficient . There is wide scope in . I look basic nature of Indian forex
exchange market and its growth over the period . Volatility of Indian foreign
exchange market is on rise due to encourage in the cross-border trade . huge
capital flow in and out integration of the international financial market it is
observed the particularly after liberalization of the Indian economy the
market has become voletile and their by affecting the revenue and
expenditure of corporates.

Foreign exchange market

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