The document discusses the concepts and principles of finance, focusing on financial management, international finance, and the balance of payments (BOP). It elaborates on the risks and complexities involved in international business, defines BOP in terms of economic transactions, and outlines methods for correcting BOP disequilibrium through both monetary and non-monetary measures. Additionally, it highlights the importance of an international monetary system in facilitating global trade and investment.

1. Finance
The term "finance" in our simple understanding it is perceived as
equivalent to 'Money‘.
Finance is often defined simply as the management of money
or “funds” management.
But finance exactly is not money, it is the source of providing
funds for a particular activity.
Definitions of the word 'finance', both as a activity and as source-
1:"The science of the management of money and other
assets.”
2:"To provide or raise the funds or capital for a activity.”

2. Financial Management
Financial Management means planning, organizing,
directing and controlling the financial activities such
as procurement and utilization of funds of the
enterprise.
The financial management is generally concerned
with procurement, allocation and control of
financial resources of a concern.
It means applying general management
principles to financial resources of the enterprise.

3. International Financial Management
International finance is the branch of financial economics broadly concerned with
monetary and macroeconomic interrelations between two or more countries.
International Financial Management refers to management of finance function of
overseas business or international business.
Here International business means carrying of business activities beyond national
boundaries.
From the perspective of International financial management the definition of International
business by implication means all activities on which management must make
financial taking into account simultaneously-
• The conditions prevailing in two or more financial markets
• Regulatory and institutional barriers to the international movements of fund and
• The changes in the exchange rates of national monies.
The concept relevant for all firms that are involved in International business to the extent
taking into account the complexities of a multi market, multi currency environment.

4. Finance function of International business deals with-
Investment Decesion: Decesion about what activity to
Finance
Financing Decesion: Decesion about how to finance those
activities.
The basic principles of financial management viz., raising of
funds on most economical terms and their effective utilization;
are same, both for domestic as well as international
concerns.

5. What’s Special about “International” Finance-FPMO
1.Foreign Exchange Risk: The risk that foreign currency profits may evaporate in home
currency terms due to unanticipated unfavorable exchange rate movements. e.g.
Recent decrease of Indian rupee against US dollar.
2.Political Risk: Sovereign governments have the right to regulate the movement of
goods, capital, and people across their borders. These laws sometimes change in
unexpected ways.e.g. Chinese ban on canola imports from Canada
3.Market Imperfections: Legal restrictions on movement of goods, people, and money
like-Transactions costs, Shipping costs, Tax arbitrage.
4.Expanded Opportunity Set: It doesn’t make sense to play in only one market.
True for corporations as well as individual investors.
Investor’s perspective
Risk reduction through international diversification.
Corporation’s perspective
Access to cheaper production inputs
Access to consumers
Access to capital

6. Balance of Payment
The Balance of Payments (BOP) is “a systematic record of all economic
transactions between the residents of the reporting country and the
residents of foreign countries during a given period of time.”
It thus follows that:
• Balance of payment is a statement of a systematic record of all
economic transactions between the residents of the reporting
country and rest of world.
• An economic transaction is an exchange of value. It involves a receipt
and a payment of money in exchange for economic goods and
services.
• It is a record pertaining to a period of time.
• It includes all transactions, current as well as capital

7. Balance of Payments Accounting
• Like other accounting statements, the BOP
conforms to the principle of double entry
bookkeeping. This means that every international
transaction should produce debit and credit
entries of equal magnitude.
• It is important to mention here that BOP is neither
an income statement nor a balance sheet.
• It is a sources and uses of funds statement that
reflects changes in assets, liabilities and net worth
during a specified period of time.

8. Balance of Payments Accounting
• Thus in that sense, a country’s balance of payments accounts for
any given year always balances.
• In terms of actual receipts and payments, a country may be faced
in any given year with one of two situations.
(a) A surplus or favourable balance on the
BOP accounts.
(b) A deficit or unfavourable balance on the
BOP accounts.
• Any item which gives rise to a sale of foreign exchange (an inflow)
is recorded as a credit item (+) in the accounts e.g. export of goods
and services
• Any item which gives rise to the purchase of foreign exchange (an
outflow) is recorded as a debit item (-) in the accounts e.g imports
of goods and services.

9. • Debits and Credits
• Every credit in the account is balanced by a matching debit and vice versa. Credit
transactions are those that earn foreign exchange and are recorded in the balance of
payments with a plus (+) sign. Selling either real or financial assets or services to
nonresidents is a credit transaction.
• The BOP’s accounting principles regarding debits and credits can be summarised
as follows.EUC&IUC
1. Credit Transactions (+)
a. Exports of goods or services
b. Unilateral transfers (gifts) received from foreigners
c. Capital inflows
2. Debit Transactions (-)
a. Import of goods and services
b. Unilateral transfers (or gifts) made to foreigners
c. Capital outflows

10. The Balance of Payment of a country is classified into three well-defined categories –
• the Current Account,
• the Capital Account and
• the Official Reserves Account.
1.The Current account measures the net balance resulting from-MSUI
• merchandise trade,
• service trade,
• unilateral transfers
• investment income
The rules for recording a transaction as debit and credit in the current account are:
Debit(outflow) Credit(inflow)
Goods Buy Sell
Services Buy Sell
investment income Pay Receive
unilateral transfers Give Receive

11. Entries in this account is current as they do not
give rise to future claims. Surplus represent
inflow and Deficient represent outflow.
• Exports of good effects flow of foreign exchange
into the country while import causes outflow of
foreign exchange.

12. 2.The Capital account in the BOP records the capital transactions – purchases and sales of assets between
residents of one country and those of other countries. The capital account records all movement of
capital from both private sources as well as official government sources between a country and the
rest of the world.
• The Capital Account deals primarily with short term and long term flows/movements of capital, that is,
it is concerned with international loans and investments.
• It may consist of transfer of ownership of a fixed asset; direct investments, portfolio investments,
other investments and reserve assets.
That is the Capital account include-DPC
1. Direct investment occurs when the investor acquires equity such as purchases of stocks, the acquisition of entire
firms, or the establishment of new subsidiaries.
This is generally taken to take advantage of market imperfection and when expected return exceeds
expectation.
2. Portfolio investments represent sales and purchases of foreign financial assets such as stocks and bonds that do not
involve a transfer of management control.
This is generally undertaken to safety, liquidity and diversification of risk. Short-term portfolio investments are
financial instruments with maturities of one year or less e.g., Long-term portfolio investments that have
maturities greater than one year and are held for purposes other than control.
3. Capital flows represent the third category of capital account and represent claims with a maturity of less than one
year.
This is quite sensitive to interest rate, exchange rate. Such claims includes bank deposits, short term loans and
money market instruments less than a year

13. 3.The Official Reserve Account
–Official reserves are government owned assets. The official reserve
account represents only purchases and sales by the central bank of
the country.
• It must be noted that when the balances of both sections
are added there can be a surplus or a deficit.
• In terms of actual receipts and payments, a country may
be faced in any given year with one of two situations.
(a) A surplus or favourable balance on the
BOP accounts.
(b) A deficit or unfavourable balance on the
BOP accounts.

14. Difference between Balance of trade and Balance of Payment:
• When you hear balance of trade you are usually hearing about is
the merchandise trade balance, which is the difference between a
nation's exports and imports of merchandise.
• A "favorable" merchandise balance of trade, or trade surplus,
occurs when a country's exports exceed its imports. A "negative"
balance of trade, or trade deficit, occurs when a country's imports
exceed its exports.
• The balance of trade, however, is not the whole picture; it includes
only purchases and sales of merchandise. The complete summary
of all economic transactions between a country and the rest of the
world--involving transfers
of merchandise, services, financial assets and tourism--is called
the balance of payments.

15. • Balance of payments deficits, where the amount of money
leaving the country is greater than the amount flowing in, need
to be financed; extra money has to come from somewhere.
Usually, payments deficits are financed by borrowing money
from overseas.
• The balance of payments for a country is separated into two
main accounts: the current account and the capital account.
• The current account records sales and purchases of goods,
services and interest payments. The entire merchandise trade
balance is contained in the current account.
• The capital account deals with investment items, like whole
companies, stocks, bonds, bank accounts, real estate and
factories.

16. 1. Definition:
Balance of trade may be defined as difference between export and import of goods and services.
Balance of payment is flow of cash between domestic country and all other foreign countries. It
includes not only import and export of goods and services but also includes financial capital
transfer.
2. Formula:
BOT = Net Earning on Export - Net payment for imports
BOP = BOT + (Net Earning on foreign investment - payment made to foreign investors) +
Cash Transfer + Capital Account +or - Balancing Item
or
BOP = Current Account + Capital Account + or - Balancing item ( Errors and omissions)
3. Meaning of Debit and Credit:
Credit means total export of different goods and services and debit means total import of
goods and services in current account.
Credit means to receipt and earning both current and capital account and debit means total
outflow of cash both current and capital account and difference between debit and credit will
be net balance of payment.

17. Balance of
Payments Disequilibrium
• A deficit or an unfavourable balance exists when the
value of autonomous debit items exceeds the value of
autonomous credit items.
• A surplus or a favourable balance exists when the
value of autonomous credit items exceeds the value of
autonomous debit items.
• Reasons:
– Economic factors
– Political factors
– Sociological factors

18. Economic factors
1. Development Disequilibrium:
Large scale development expenditure =
increase in purchasing power + increase in
demand & prices.
--Leads to huge imports (also of Capital
Goods)
--Hence adverse BOT adverse BOP.

19. • 2. Capital Disequilibrium
• Due to cyclical fluctuations in general business
activity.
• If domestic economy experiences a boom,
while the rest of the world not so
--then more purchasing power & demand and
higher prices
--hence more imports
• But exports difficult because of slackness in
world economy.
• Hence……

20. • 3. Secular Disequilibrium:
• If long term BOP problem, then it is due to
some secular trends in the economy.
• If domestically: persistent high demand and
high domestic prices (eg.USA) then imports
will always be more than exports.
• ( if high production costs locally: but high disposable
incomes and hence very high aggregate demand and
high prices….)

21. • 4.Structural Disequilibrium
Affects exports & imports
• Because of development of alternative sources
of supply,
• discovery of better substitutes,
• exhaustion of productive resources,
• changes in transport routes and costs etc.

22. II. Political factors
• Continuous political instability, wars, etc., will
lead to capital outflows and inadequacy of
domestic investment and production
• Hence BOP problems.

23. III. Social factors
• Changes in tastes, preferences, fashions etc.,
will affect the exports and imports.
• Hence BOP…

24. Methods of correcting Disequilibrium in BOP
• Automatic Correction & Deliberate Measures
• Automatic: If adverse BOP fall in the
external value of the domestic currency
--So, exports will become cheaper and imports
will become costlier
--this will restore …
Deliberate Measures--------

25. Monetary Measures for Correcting the BoP ↓
The monetary methods for correcting disequilibrium in the balance of payment
are as follows :-
1. Deflation: Deflation means falling prices. Deflation has been used as a
measure to correct deficit disequilibrium. A country faces deficit when its
imports exceeds exports.
Deflation is brought through monetary measures like bank rate policy, open
market operations, etc or through fiscal measures like higher taxation,
reduction in public expenditure, etc.
Deflation would make our items cheaper in foreign market resulting a rise in
our exports. At the same time the demands for imports fall due to higher
taxation and reduced income. This would built a favourable atmosphere in
the balance of payment position. However Deflation can be successful when
the exchange rate remains fixed.
a) Contraction in money supply —will reduce purchasing powerreduce
demand
-- so less imports
b) fall in prices cheaper—so more exports

26. 2. Exchange Depreciation: Exchange depreciation means decline in
the rate of exchange of domestic currency in terms of foreign
currency. This device implies that a country has adopted a
flexible exchange rate policy.
Suppose the rate of exchange between Indian rupee and US dollar
is $1 = Rs. 40.
If India experiences an adverse balance of payments with regard to
U.S.A, the Indian demand for US dollar will rise. The price of
dollar in terms of rupee will rise. Hence, dollar will appreciate in
external value and rupee will depreciate in external value. The
new rate of exchange may be say $1 = Rs. 50. This means 25%
exchange depreciation of the Indian currency.
Exchange depreciation will stimulate exports and reduce imports
because exports will become cheaper and imports costlier.
Hence, a favourable balance of payments would emerge to pay
off the deficit.

27. • 3. Devaluation: Devaluation refers to deliberate attempt made by
monetary authorities to bring down the value of home currency
against foreign currency.
• While depreciation is a spontaneous fall due to interactions of market
forces, devaluation is official act enforced by the monetary authority.
Generally the international monetary fund advocates the policy of
devaluation as a corrective measure of disequilibrium for the
countries facing adverse balance of payment position.
• When devaluation is effected, the value of home currency goes down
against foreign currency,
• Let us suppose the exchange rate remains $1 = Rs. 10 before
devaluation. Let us suppose, devaluation takes place which reduces
the value of home currency and now the exchange rate becomes $1 =
Rs. 20. After such a change our goods becomes cheap in foreign
market. This is because, after devaluation, dollar is exchanged for
more Indian currencies which push up the demand for exports. At the
same time, imports become costlier as Indians have to pay more
currencies to obtain one dollar. Thus demand for imports is reduced.

28. 4. Exchange Control: It is an extreme step taken by the
monetary authority to enjoy complete control over the
exchange dealings.
Under such a measure, the central bank directs all
exporters to surrender their foreign exchange to the
central authority. Thus it leads to concentration of
exchange reserves in the hands of central authority. At
the same time, the supply of foreign exchange is
restricted only for essential goods. It can only help
controlling situation from turning worse.
In short it is only a temporary measure and not
permanent remedy.

29. Non-Monetary Measures for Correcting the BoP ↓
A deficit country along with Monetary measures may
adopt the following non-monetary measures too which
will either restrict imports or promote exports.
1. Tariffs
Tariffs are duties (taxes) imposed on imports. When
tariffs are imposed, the prices of imports would
increase to the extent of tariff. The increased prices will
reduced the demand for imported goods and at the
same time induce domestic producers to produce more
of import substitutes. Non-essential imports can be
drastically reduced by imposing a very high rate of
tariff.

30. • 2. Quotas: Under the quota system, the government may fix and
permit the maximum quantity or value of a commodity to be imported
during a given period. By restricting imports through the quota system,
the deficit is reduced and the balance of payments position is
improved.
Merits of Quotas :-
Quotas are more effective than tariffs as they are certain.
They are easy to implement.
They are more effective even when demand is inelastic, as no imports are
possible above the quotas.
More flexible than tariffs as they are subject to administrative decision.
Tariffs on the other hand are subject to legislative sanction.
Demerits of Quotas :-
They are not long-run solution as they do not tackle the real cause for
disequilibrium.
Under the WTO quotas are discouraged.
Implements of quotas is open invitation to corruption

31. 3. Export Promotion
The government can adopt export promotion measures to correct disequilibrium in the balance of
payments. This includes substitutes, tax concessions to exporters, marketing facilities, credit and
incentives to exporters, etc.
The government may also help to promote export through exhibition, trade fairs; conducting marketing
research & by providing the required administrative and diplomatic help to tap the potential markets.
4. Import Substitution
A country may resort to import substitution to reduce the volume of imports and make it self-reliant.
Fiscal and monetary measures may be adopted to encourage industries producing import substitutes.
Industries which produce import substitutes require special attention in the form of various
concessions, which include tax concession, technical assistance, subsidies, providing scarce inputs, etc.
Drawbacks of Import Substitution :-
Such industries may lose the spirit of competitiveness.
Domestic industries enjoying various incentives will develop vested interests and ask for such concessions
all the time.
Deliberate promotion of import substitute industries go against the principle of comparative advantage.
Non-monetary methods are more effective than monetary methods and are normally applicable in
correcting an adverse balance of payments.

32. International Monetary System
• An international monetary system is a set
of internationally agreed rules, conventions and
supporting institutions that facilitate international trade,
cross border investment and generally the reallocation of
capital between nation states.
• Reserve currencies are often international pricing
currencies for world products and
services. Current reserve currencies are the US dollar, the
euro, the British pound, the Swiss franc, and the Japanese
yen. A main currency that many countries and institutions
hold as part of their foreign exchange reserves.

33. Features that IMS should possess
• Efficient and unrestricted flow
of international trade and investment.
• Stability in foreign exchange aspects.
• Promoting Balance of Payments adjustments
to prevent disruptions associated.

34. International Monetary System
•
Evolution of the International Monetary System can be analysed in four stages as follows:
1. The Gold standard, 1876-1913
• In the early days, gold was used as a storage of wealth and as a medium of exchange.
• The gold standard, as an International Monetary System, gained acceptance in Western
Europe in the 1870s and existed as a historical reality during the period 1875-1914.
• The majority of countries got off gold in 1914 when World War I broke out. The classical
gold standard thus lasted for approximately 40 years. The centre of the international
financial system during this period was London reflecting its important position in
international business and trade.
• The three important features of the gold standard were,
First, the government of each country defines its national monetary unit in terms of
gold.
Second, free import or export of gold and
third, two-way convertibility between gold and national currencies at a stable ratio.
The above three conditions were met during the period 1875 to 1914.

35. • The US for example declared the dollar to be
convertible to gold at a rate of 20.67/ ounce of
gold.
• The British pound was pegged to gold at a rate of
4.2474/ ounce of gold.
• Thus the dollar pound exchange would be
determined as-
• 20.67/ounce of Gold/ 4.2464/ounce of
gold=dollar4.86656
• Now the value of pound in relation to dollar is -
4.86656

36. • Now the value of pound in relation to dollar is -4.86656.
• If the cost of moving gold between countries was two per
cent per British pound the fluctuation would be 2 cents
above or below the par value.
• The upper limit is known as gold export point and the lower
limit is known as gold import point.
• The pound could not have risen from the gold export point
because than the US importer would find economical to buy
gold with dollar and ship the gold as a payment to british
creditor instead of paying higher unnecessary to buy pound.
• At the same time the pound could not have fallen from 4.84
the gold import point because than the british importer
would find better to convert pound into gold for payment.
The cost of shipping gold would be less than the high cost of
buying dollar for payment.

37. • Decline of the Gold standard
• There are several reasons why the gold standard could
not function well over the long run. One problem
involved the price-specie-flow mechanism. For this
mechanism to function effectively, certain “rules of the
game” that govern the operation of an idealised
international gold standard must be adhered to.
• One rule is that the currencies must be valued in
terms of gold. Another rule is that the flow of gold
between countries cannot be restricted. The last rule
requires the issuance of notes in some fixed
relationship to a country’s gold holdings.

38. 2. The Inter-war Years, 1914-1944
• The gold standard as an International Monetary System worked well
until World War I interrupted trade flows and disturbed the stability of
exchange rates for currencies of major countries. There was
widespread fluctuation in currencies in terms of gold during World
War I and in the early 1920s. The role of Great Britain as the world’s
major creditor nation also came to an end after World War I. The
United States began to assume the role of the leading creditor nation.
• As countries began to recover from the war and stabilise their
economies, they made several attempts to return to the gold
standard. The United States returned to gold in 1919 and the United
Kingdom in 1925. Countries such as Switzerland, France and
Scandinavian countries restored the gold standard by 1928.

39. 3. The Bretton Woods System, 1945-1972
• The negotiators at Bretton Woods made certain recommendations in 1944:
 Each nation should be at liberty to use macroeconomic policies for full
employment.
 Free-floating exchange rates could not work.
 A monetary system was needed that would recognise that exchange rates
were both a national and an international concern.
The main points of the post-war system evolving from the Bretton Woods
Conference were as follows:
1. A new institution, the International Monetary Fund (IMF), would be
established in Washington DC.
2. The US dollar would be designated as reserve currencies, and other nations
would maintain their foreign exchange reserves principally in the form of
dollars or pounds.
3. Each Fund member would establish a par value for its currency and
maintain the exchange rate for its currency within one per cent of par value.

40. –The Breakdown of the Bretton Woods System
–The Bretton Woods System worked without major changes from 1947 till
1971. During this period, the fixed exchange rates were maintained by official
intervention in the foreign exchange markets. International trade expanded in
real terms at a faster rate than world output and currencies of many nations,
particularly those of developed countries, became convertible.
–The Smithsonian Agreement
–From August-December 1971, most of the major currencies were permitted to
fluctuate. The US dollar fell in value against a number of major currencies.
Several countries imposed some trade and exchange controls causing major
concern. It was feared that such protective measures might become
sufficiently widespread to limit international commerce. In order to solve
these problems, the world’s leading trading countries, called the “Group of
Ten,” produced the Smithsonian Agreement on December 18, 1971. The
Agreement established a new set of parity rates. These parity rates were
called central rates because they lacked the approval of the IMF.

41. • The Flexible Exchange Rate Regime, 1973 – Present
• The turmoil in exchange markets did not cease when major
currencies were allowed to float since the beginning of March
1973. Since 1973, most industrial countries and many developing
countries allowed their currencies to float with government
intervention, whenever necessary, in the foreign exchange market.
The alternative exchange rate systems which followed are as
mentioned below.
• Alternative Exchange Rate Systems
Crawling Peg (Sliding or Gliding Parity)
Flexible (Floating) System

42. • Crawling Peg (Sliding or Gliding Parity):Crawling peg is an
exchange rate regime usually seen as a part of fixed exchange rate
regimes that allows depreciation or appreciation in an exchange rate
gradually. The system is a method to fully utilize the key under the fixed
exchange regimes as well as the flexibility under the floating exchange
rate regime.
• The system is shaped to peg at a certain value but at the same time is
designed to “glide” to response to external market uncertainties.
• The main key advantages under the crawling peg system as opposed to
conventional exchange rate regimes are:
• Avoid economic instability as a result of infrequent and discrete
adjustments (fixed exchange rate)Minimize the rate of uncertainty and
volatility since the fluctuation in the exchange rate is kept minimal
(floating exchange regime)

43. • Evaluation of Floating Rates
• The fixed rate and floating rate systems have diverse natures and characteristics.
• Therefore, both of the systems cannot meet the same goals of certainty, stability
and inflation control. Advocates of the fixed rate plan believe that the certainty
and rigidity of exchange rates can promote economic efficiency, public
confidence and inflation control. In recent years, several US public officials have
been encouraging the return of some kind of gold standard. If this system could
indeed work as intended, there would probably be no need to have more than
one world currency.
• Classification of Currency Arrangements
• More flexible exchange rate systems
• Pegged exchange rate systems
• Limited Flexibility Exchange Rate Systems

44. The Foreign Exchange Market
In a typical foreign exchange transaction, a party purchases a quantity of one
currency by paying a quantity of another currency i.e. currencies are bought and
sold against each other. The foreign exchange market determines the relative
values of different currencies.
According to C.P.Kindleberger-“The foreign exchange market is a place where foreign
currencies are brought and sold”.
It is a mechanism through which payments are effected between two countries
having different currency system is called foreign exchange.
In narrow sense it is sell and purchase of foreign currencies and the rate at which
currencies are converted.
In broader sense it includes all those methods and mechanism which facilitates
foreign payment.
The following are the function of foreign Exchange market-
Transfer Function
Credit Function
Hedging Function

45. It broadly comprises of:
Customer Market – It comprises of transactions
between banks (authorized dealers) and their
customers.
Such transactions are of two types, viz., Ready delivery
& Forward delivery.
Interbank Market – It comprises of:
• Transactions between different banks in the same
center/country.
• Transactions between banks in a country and their
correspondents and overseas branches.
• Transactions of the central bank of one country with
central banks of other countries.

46. The foreign exchange market is unique because of
• its huge trading volume representing the largest
asset class in the world leading to high liquidity;
• its geographical dispersion;
• its continuous operation: 24 hours a day except
weekends, i.e. trading from 20:15 GMT on Sunday
until 22:00 GMT Friday;
• the variety of factors that affect exchange rates;
• the low margins of relative profit compared with
other markets of fixed income; and
• the use of leverage to enhance profit and loss
margins and with respect to account size.

47. • Market size and liquidity
• According to the Bank for International Settlements,
the preliminary global results from the 2016
Triennial Central Bank Survey of Foreign Exchange
and OTC Derivatives Markets Activity show that
trading in foreign exchange markets averaged $5.1
trillion per day in April 2016.
• The amount of money traded in a week is bigger
than the entire annual GDP of the United States!
The main currency used for forex trading is the US
dollar.

48. • The leading foreign exchange market in India is Mumbai, Calcutta, Chennai and
Delhi is other centers accounting for bulk of the exchange dealings in India. The
policy of Reserve Bank has been to decentralize exchages operations and
develop broader based exchange markets. As a result of the efforts of Reserve
Bank Cochin, Bangalore, Ahmadabad and Goa have emerged as new centre of
foreign exchange market.
• The business in foreign exchange markets in India has shown a steady increase
as a consequence of increase in the volume of foreign trade of the country,
improvement in the communications systems and greater access to the
international exchange markets. Still the volume of transactions in these
markets amounting to about USD 2 billion per day does not compete favorably
with any well developed foreign exchange market of international repute.
• The reasons are not far to seek. Rupee is not an internationally traded currency
and is not in great demand. Much of the external trade of the country is
designated in leading currencies of the world, Viz., US dollar, pound sterling,
Euro, Japanese yen and Swiss franc. Incidentally, these are the currencies that
are traded actively in the foreign exchange market in India.

49. • Market participants
The participants in the foreign exchange market
comprise;
(i) Corporates
(ii) Commercial banks
(iii) Exchange brokers
(iv) Central banks

50. • Structure of Indian Forex:
• First tier: The first tier covers the transaction between
the Reserve Bank(RBI) and authorized dealers(AD’S)
• As per FERA the responsibility and the authority of
foreign exchange administration is vested with
RBI.They have formed the foreign exchange dealers
association of India which frames rules regarding the
conduct of business coordinates with RBI in the proper
administration of foreign exchange control.
• In the first tier of the market RBI buys and sell foreign
currencies from the AD’S.AD’S sells foreign currency
which they acquired them in primary market at the
rate administered by the RBI.

51. • Second Tier Market: The second tier market is the interbank
market where AD’S transact business among themselves. They
normally do their business within the country. They do it
normally through a recognized broker.
• Third Tier Market: The third tier of the forex is represented by
the primary market where AD’S transact in foreign currency
with the customer. The tourist exchange currency,expoters
and importer exchange currency and all these transaction
comes under the primary market.
• st tier(AD’s &RBI)
• II nd tier(AD&AD)
• III rd tier(ad and customer)

52. Currency Futures Contract:-
A future contract is a standardized agreement that calls
for delivery of a currency at some specified future date.
A currency future is the price of a particular currency
for settlement at a specified future date. Currency
futures are traded on future exchanges and the
exchanges where the contracts are fungible (or
transferable freely) are very popular.
These are tailor-made contracts and sold in an organized
exchange, such as, Chicago International Money
Market. All the transactions are done through clearing
house of the Exchange. A future buyer is said to be in
long position and a future seller is said to be in short
position.

53. Major Features of Futures (Forward v/s. Future): -
(1) Organized Exchange: - Unlike forward contracts which are traded in an OTC market, futures are
traded on organized exchanges (just like stock market) which provides liquid market of futures.
(2) Standardization: - Forward contracts are tailor-made to the buyer’s requirements. In the futures
contract, the amount of currency covered by one future contract and maturity day, both are
standardized by the exchange on which that future is traded.
(3) Clearing House: - The clearinghouse of the futures exchange interacts itself between the buyer and
the seller. Thus, all transactions are with clearinghouse, not directly between the purchaser and the
seller. While in case of forwards, the transaction is between the buyer and seller, the A.D. being one
party to the contract. There is no clearinghouse involved.
(4) Margins: - Only member of clearinghouse of the futures exchange can trade in futures on the
exchange. The general public uses the services of such members as brokers to trade on their behalf.
The member is required to deposit a margin with the clearinghouse to perform trading. A member
acting on behalf of a client, in turn requires the client to deposit a margin with the member.
(5) Marking to Market: - At the end of each working day, the futures contract is marked to market, i.e.,
valued at closing price. Margin accounts of those who made losses are debited and those who earned
gains are credited. Accordingly, losers have to bring more margin and gainers can draw off excess
margin.
E.g.- X buys a June delivery £ future on 14th
April at a price of $1.60 per£. The futures contract is for
$1,00,000. On April 15th
, at the end of the day, the settlement price is $1.62 = £1. X made a gain of 2
cents per £ or $1250 per contract. This will be credited to X’s margin a/c. Obviously; someone with a
short position lost a matching amount. As against the above, in forwards, the gain or loss arise only on
maturity. There are no intermediate cash flows.