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FOREIGN EXCHANGE FOREIGN EXCHANGE MARKETMARKET

The foreign exchange market is the place where one currency is bought or sold for another currency

BASIC CONCEPTS/TERMINOLOGIESBASIC CONCEPTS/TERMINOLOGIESForeign Currency vs. Foreign ExchangeForeign Currency vs. Foreign Exchange

As per Foreign Exchange Act, (Section 2), 1947.

•(c) "Foreign Currency" means any currency other than Indian currency;

•(d) "Foreign Exchange" means includes any instrument drawn, accepted, made or issued under clause (8) of section 17 of the Banking Regulation Act, 1956, all deposits, credits and balance payable in any foreign currency, and any drafts, traveler’s cheques, letters of credit and bills of exchange, expressed or drawn in Indian currency but payable in any foreign currency;

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FOREIGN EXCHANGE MARKETFOREIGN EXCHANGE MARKETTYPES & PLAYERSTYPES & PLAYERS

RETAIL MARKETWHOLESALE MARKET

OR INTERBANK MARKET

TRAVELLERS TOURISTS

COMMERCIAL BANKSFOREX BROKERSCENTRAL BANKS

MNCsINDIVIDUALS AND SMEs

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PLAYERSPLAYERS

RETAIL MARKET

• THE TRAVELLERS AND TOURISTS EXCHANGE ONE CURRENCY FOR ANOTHER IN THE FORM OF CURRENCY NOTES OR TRAVELLERS CHEQUES.

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WHOLESALE MARKET• COMMERCIAL BANKS – participates in foreign exchange on behalf

of their clients- At retail level enters through inter bank

market or through specialized brokers.- At bulk level enters through inter-bank

wholesale market or international banks and brokers

PLAYERSPLAYERS

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WHOLESALE MARKET

• FOREX BROKERS

– They act as agents who facilitate trading between dealers.

PLAYERSPLAYERS

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WHOLESALE MARKET

• CENTRAL BANKS

– Central banks frequently intervene in the foreign exchange market to maintain the exchange rate at desired level

PLAYERSPLAYERS

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WHOLESALE MARKET

• MNCs

– MNCs are participating in forward exchange market

PLAYERSPLAYERS

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WHOLESALE MARKET

• INDIVIDUAL

– They took part in foreign exchange market for their investment and commercial activities

PLAYERSPLAYERS

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WHOLESALE MARKET

• INDIVIDUAL

– They took part in foreign exchange market for their investment and commercial activities

PLAYERSPLAYERS

What is an Exchange Rate ?What is an Exchange Rate ?

Exchange Rate is the price of one country's currency expressed in another country's currency. In other words, the rate at which one currency can be exchanged for another. e.g. Rs. 48.50 per one USDMajor currencies of the World

USDEUROYEN

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What is a Foreign Exchange What is a Foreign Exchange Transaction ?Transaction ?

– Any financial transaction that involves more than one currency is a foreign exchange transaction.

– Most important characteristic of a foreign exchange transaction is that it involves Foreign Exchange Risk

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ValueValue Date ConventionsDate Conventions

Currencies are traded both in Ready and forward value dates.

1) Ready: Settlement on the deal date. e.g. India

2) Value Tom : Settlement on next day. e.g. Canada

3) Spot Transaction : Settlement usually in two working days.

In International FX transactions, Spot is the Standard value date.

Forward Transaction: Settlement at some future date ahead of the spot

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Price maker Vs. Price Taker

The bank quoting the price is ‘price maker’ or ‘market maker’.

The bank asking for the price or ‘quote’ is the ‘price taker’ or ‘user’.

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FORWARD TRANSACTIONSFORWARD TRANSACTIONS

1. Out right sale/purchase of a currency against the other for settlement at a future date at the predetermined exchange rate.

2. Forward rates are quoted as premium or discount over spot rate.

3. Forward rates depend upon interest rate differential between the two currencies.

4. Currency with higher interest rates is at discount wrt currency having lower interest rate.

5. Currency with lower interest rates is at premium wrt currency having higher interest rate.

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FX SWAP TransactionFX SWAP Transaction

“An FX swap is a contract to buy an amount of currency for one value date at an agreed rate, and to simultaneously resell the same amount of currency for a later value date, also at an agreed rate, to the same counter party”.

FX swap is essentially a ‘funding’ or ‘Money Market’ transaction and does not involve exchange risk.

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– Foreign exchange transactions are settled through Nostro and Vostro accounts.

• Nostro: our account with banks abroad. Reserve Bank of India (RBI) maintains various Nostro accounts in a number of countries.

• Vostro: their account with us. Many multilateral agencies (e.g. IMF, World Bank) maintain their Nostro accounts at Reserve Bank of India (RBI).

RBI’s Role in the Forex MarketRBI’s Role in the Forex Market

• To manage the exchange rate mechanism.

• Regulate inter-bank forex transactions and monitor the foreign exchange risk of the banks.

• Keep the exchange rate stable.• Manage and maintain country's foreign

exchange reserves.

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INTERVENTIONTo keep exchange rate in line with macro objectives RBI has to intervene from time to timeIntervention is a process where FX is sold or purchased to keep the right amount of liquidity available in the FX market so that demand / supply equilibrium is maintainedIntervention can be in READY or FORWARD