Foreign Exchanga Mkt
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The Foreign Exchange Market
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The Foreign Exchange market, also referred to as the
"Forex" or "FX" market is the largest financial market inthe world, with a daily average turnover of US$1.9
trillion 30 times larger than the combined volume
of all U.S. equity markets.
"Foreign Exchange" is the simultaneous buying of one
currency and selling of another. Currencies are traded in
pairs, for example Euro/US Dollar (EUR/USD) or US
Dollar/Japanese Yen (USD/JPY).
Foreign Exchange Market:The market where one
countrys currency is traded for anothers.
Foreign Exchange Market
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International Foreign Exchange Market
It is the oldest and largest financial market in the worldmorethan $1 trillion.
Participants: importers, exporters, traders, foreign exchangebrokers, speculators, portfolio managers.
FEM is essentially OTC market: No central location FEM has no central trading floor where buyers and sellers
meet. FEM extends from Tokyo and Sydney in the East to New
York and San Francisco in the West. Is open twenty-four hours a day, except for short gaps on
weekends.
Global banks account for about two-thirds of the marketvolume, while foreign exchange brokers and dealers accountfor approximately 20 percent.
Speculative transactions account for more than 95 percent of the turnover of FEM.
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Foreign Exchange Market in India
Very small market Key participants: RBI, authorized Banks, and Business
undertakings.
FEM in India is a Controlled market by RBI
Business undertakings can participate in the FEM in India
only to the extent that they need cover for exchange exposure
arising from merchant transaction (can not involve in
speculative transactions)
Banks are permitted to have net overbought or oversold
subject limits notified by the RBI.
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How a Foreign Exchange Transaction is
Conducted
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1. OTC-type: no specific location
2. Most trades by phone, telex, or SWIFT
SWIFT: Society for Worldwide Inter-bank Financial
Telecommunications
Location of the Foreign Exchange Market
1. Wholesale Level (95%) - major banks
2. Retail Level - business customers.
Participants in the Foreign Exchange
Market
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Participants in the Foreign Exchange Market
Commercial & Investment Banks (Inter-bank market)
amounts > $1m, typically $10m liquid market (vis--vis loans) with limited credit exposure
for clients and themselves
allows bit players to economize on transactions costs
Central Banks non-commercial motives relatively small portion of trading volume may intervene to address perceived economic/financial imbalances
Hedge Funds partnership of high net-worth individuals highly leveraged global investing add liquidity, flexibility, and sometimes instability to FX markets
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Corporations mostly act through intermediaries
Individuals tourists ~ insignificant volume
Intermediaries Brokers mostly service commercial banks and trading houses
anonymous
connected to many banks ~ shop for best price (exchange rate)
Direct Dealing through dealing system
quotes valid for 20 sec.
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Exchange Control Regimes
Fixed Exchange Rate vis--vis One Currency (Official parity)
This was adopted under Bretton-woods Agreement in 1945
allows bit players to economize on transactions costs
Fixed Exchange Rate vis--vis a Basket
This system adopted after 1972
A target parity for a basket of currencies was adopted
European Currency Unit (ECU)
Basket is revised every five years
Flexible Exchange Rates
Form 1996 most of the countries adopted
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Exchange Rates
Exchange Rate = Relative Price of Currencies Exchange Rate: The price of one currency expressed in terms of
another.
Direct Quote (Natural or Right Quote/American Terms): The
exchange rate for a foreign currency is quoted in terms of the
number of units of local currency that are equal to a unit of the
foreign currency. (Rs.45 for one dollar)
dollar price of 1 unit foreign currency; $/FX1 = dollars perunit foreign exchange
used in futures market
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Indirect Quote (Reverse or Left Quote/European Terms): The
exchange rate for a foreign currency is quoted in terms of the
number of units of foreign currency that are equal to a unit of the
local currency. ($2.25 for Rs. 100)
foreign currency price of $; FX/$1
used in Cash market. Most currencies quoted this way,except
Spot Exchange Rate: The rate applicable to transactions in
which settlement (delivery) is made in two business days after the
date of transaction.
Forward Exchange Rate: The exchange rate fixed today but the
settlement is at some specified date in the future.
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How to Read a Currency Quote
Currency Pair
Base Currency
Quote Currency
Bid Price Ask Price
SIMPLE !!
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Foreign Exchange Exposure (Risk)
Foreign Exchange Risk:The risk that the value ofa future receipt or obligation will change due to
variations in foreign exchange rates.
Types of Foreign Exchange (Risk) Exposure
Transaction exposure
Translation exposure
Economic exposure (Operating)
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Types of Foreign Exchange Risk Exposure
Transaction Exposure: The risk that the revenues
or costs associated with a transaction expressed in terms
of the domestic currency changes due to exchange rate
variations.
Translation Exposure: Foreign exchange riskresulting from the conversion of a firms foreign-
currency-denominated assets and liabilities into the
domestic currency value.
Economic Exposure: The risk that changes inexchange values might alter todays value of a firms
future income streams
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Hedging Foreign Exchange Risk
Hedging:The act of offsetting or eliminating riskexposure.
Covered Exposure:A foreign exchange risk that
has been completely eliminated with a hedging
instrument.
Forward contract for foreign exchange
Derivative instruments
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Foreign Currency Accounts
Nostro Account (our account with you): The foreign
currency account maintained by banks in India with
banks aboard.
The currency of the account depends on the currency
of the country where the account is maintained
All foreign exchange transactions are routed throughNostro accounts.
Maintenance of minimum balance is necessary.
It is just like current account
Vostro Account (your account with us): Foreign banks
may open rupee accounts with Indian banks.
The account is also known as non-resident account.
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Vostro Account (your account with us):
Foreign banks may open rupee accounts with Indianbanks.
The account is also known as non-resident account.