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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.