The document provides an overview of essential terms in forward markets, explaining concepts like forward rates, long and short positions, forward premium and discount, and arbitrage. It details the mechanisms of two-point and three-point arbitrage, as well as interest arbitrage, highlighting the differences between uncovered and covered strategies. Additionally, it discusses hedging as a risk management strategy in foreign exchange trading and outlines the role of speculators in the market.

1. Presented by – Mohit Singhal
Bcom Hons (Section – B)
Roll No. 2166
Ramjas College

2. Explaining crucial terms used in forward markets
1 2 3 4 5
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3. Forward rate
Forward rate is the rate quoted by foreign traders for the
purchase or sale of foreign currency in future.
A forward rate is an interest rate applicable to a financial
transaction that will take place in the future. Forward rates
are calculated from the spot rate, and are adjusted for the
cost of carry to determine the future interest rate that
equates the total return of a longer-term investment with a
strategy of rolling over a shorter-term investment.
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4. Long position A long (or long position) is the buying
of a security such as a stock,
commodity or currency with the
expectation that the asset will rise in
value.
With a long position investment, the
investor purchases an asset and owns
it with the expectation that the price
is going to rise.
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5. Short position
A short, or short position, is a
directional trading or investment
strategy where the investor sells
shares of borrowed stock in the
open market. The expectation of the
investor is that the price of the stock
will decrease over time, at which
point the he will purchase the
shares in the open market and
return the shares to
the broker which he borrowed them
from.
In this, first we sell shares and then
we purchase it.
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6. Forward premium and discount
Transactions in foreign exchange market may be spot transactions or forward
transactions.
Spot transactions or exchange in foreign exchange require receipts and payments
to be made immediately, ie within two business days after the transactions are
agreed upon to allow for clearing of cheques and is transacted at spot rate.
On the other hand, forward transactions or exchange involve an agreement
today to buy or sell a specified amount of foreign currency at a specified future
date at a rate mutually agreed upon today. This rate is known as forward rate.
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7. The forward rate may be quoted at a premium or at a discount on the
spot rate.
When forward rate is above the spot rate, it makes foreign currency
more expensive and vice versa.
It may be computed as follows
FD OR FP =
𝐹𝑜𝑟𝑤𝑎𝑟𝑑 𝑅𝑎𝑡𝑒−𝑆𝑝𝑜𝑡 𝑅𝑎𝑡𝑒
𝑆𝑝𝑜𝑡 𝑅𝑎𝑡𝑒
X 100
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8. Arbitrage
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9. What is arbitrage??
Arbitrage is the practice of taking advantage of
a price difference between two or more
markets and considered as an opportunity to
buy an asset at a low price then immediately
selling it on a different market for a higher
price which helps an investor to have a risk free
profit at zero cost or low costs.
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10. Two point arbitrage
When two currencies and two monetary centres
are involved, it is called a two point arbitrage.
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11. Two point arbitrageOnePound
$1.98 in
New York
$2.02 in
London
SBI has idle cash of 10,00,000 pounds
SBI sees that there is an opportunity of
arbitrage gain at current prices by trading in
dollars
SBI purchases 1 pound at 1.98 in New York
market
Then it sells that 1 pound in 2.02 in London
marketMohit Singhal - Ramjas college
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12. ImpactOnePound
$1.98 in
New York
$2.02 in
London
Demand of pounds increases in New
York
Hence, prices start to increase, say till $2
per pound
Also due to heavy selling seen in London
markets, prices tend to fall and reach say
$2 per pound
Gradually, prices in both economies
become same and arbitrage is no longer
$2
$2Mohit Singhal - Ramjas college
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14. Three point arbitrageor triangular arbitrage
Triangular arbitrage is the result of a
discrepancy between three foreign
currencies that occurs when the currency's
exchange rates do not exactly match up.
Triangular arbitrage opportunities are rare.
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15. £ 10,00,000
$20,00,000 ¥ 24,00,000
£ 12,00,000
Net gain = 2,00,000 pounds
Impact - consistent cross rates among all pairs of currencyMOHIT SINGHAL - RAMJAS COLLEGE 15

16. Interest arbitrage
Interest rates vary between countries based on their current economic cycle,
which creates an opportunity for investors. By purchasing a foreign currency
with a domestic currency, investors can profit from the difference between the
interest rates of two countries.
Interest Arbitrage
Uncovered Covered
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17. Uncovered interest arbitrage (No forward
booking)
Uncovered interest arbitrage is an arbitrage trading strategy whereby
an investor capitalizes on the interest rate differential between two
countries
Amount = 1,00,000 rupees
Country Rate of interest Interest received
India 8% 8,000
America 15% 15,000
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18. Country Rate of interest Interest to be received
India 8% Rs. 8,000
America (Rs.64/$) 15% Rs. 15,000
Moreearned
•Rs.
1,25,781
Constantrate
• Rs.
1,15,000
Unavourableposition
• Rs.
89,843
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19. Covered interest arbitrage (forward booking)
We can cover the interest arbitrage as investors of short
term funds generally want to avoid foreign exchange
risk. To cover foreign exchange risk, the investors
exchange domestic currency at the current spot rate so
as to purchase foreign treasury bill and at the same time
he sells forward the amount of the foreign currency.
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20. Country Rate of interest Interest to be received
India 8% Rs. 8,000
America (Rs.64/$) 15% Rs. 15,000
•Rs.
1,15,000
-
charges
• Rs.
1,15,000-
charges
• Rs.
1,15,000-
charges
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22. To save from currency fluctuation risks, people usually sign a forward currency contract so
that they know what exchange rate the would get in future.
For this he must know the spot rate and the forward rate.
When a currency trader enters into a trade with the intent of
protecting an existing or anticipated position from an unwanted
move in the foreign currency exchange rates, they can be said to
have entered into a forex hedge. By utilizing a forex
hedge properly, a trader that is long a foreign currency pair, can
protect themselves from downside risk; while the trader that
is short a foreign currency pair, can protect against upside risk.
WHAT
ACTUALLY
HAPPENS
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23. Interest rate parity
Different interest
rates among
different countries
India 10%
USA 6%
FOREX RATE
TILL IT COMES
TO PARITY
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24. DOEMSTICALLY (INDIA) ABROAD (USA)
Rate 10% 6%
Conversion
rate
- Rs. 63/$
Amount Rs. 63,00,000 $1,00,000
Interest Rs. 6,30,000 $ 6,000
Amount at end Rs. 69,30,000 $ 1,06,000
AMOUNT WE HAVE = Rs. 63,00,000
10% ≠ 6%
IT SAYS when we have two different rates, the forex rate will move in such a manner
that it neutralizes the interest rate
FOREX RATE AFTER ONE YEAR =
maturity value in rupee
maturity 𝑣𝑎𝑙𝑢𝑒 𝑖𝑛 𝑑𝑜𝑙𝑙𝑎𝑟𝑠
=
𝑅𝑠.69,30,000
$ 1,06,000
= 𝑅𝑠. 65.38/$
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26. Hedging
When a currency trader enters into a trade with the intent of
protecting an existing or anticipated position from an unwanted
move in the foreign currency exchange rates, they can be said to have
entered into a forex hedge. By utilizing a forex hedge properly, a
trader that is long a foreign currency pair, can protect themselves
from downside risk; while the trader that is short a foreign currency
pair, can protect against upside risk.
BEST WAY TO DESCRIBE HEDGING IS “INSURANCE OF RISK”
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29. Speculators
The speculators are not genuine investors. They buy
securities with a hope to sell them in future at a profit. They
are not interested in holding the securities for longer period.
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30. Type Time frame Holding period
Scalp trader Very short term Seconds to minutes
– no overnight
positions
Day trader Short term Day only – no
overnight positions
Short term
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31. Type Remark
Outright
position holder
He takes his position in futures market relying on
his belief in the future of the market and may lead
to huge profits or even losses.
Spread position
holder
He focuses on the relative price movement
between two or more commodities where he buys
one and sells other simultaneously.
Long term Also called position trader, holds from
overnight to maximum one month
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32. THANK YOU
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