1.International Finance

2. Module No V(Balance of Payment) It is a systematic record of all economic transactions between the residents of a given country and the residents of other countries-rest of the world-carried out in a specific period of time, usually a year. 3. Components of BOP Item/Year 2009-10Credit Debit NetA. Current account1. Merchandise182163299491 -1173282. Invisibles (a+b+c) 161245 82328 78917a) Services93791 59586 34205i) Travel1185993422517ii)Transportation11147 11934-787iii) Insurance16001286 314iv) G.n.i.e. 440 526 -86v) Miscellaneous 68744 36499 32245of which: Software services497051469 48236Business services11645 18626 -6981Financial services37364736 -1000Communication services12291389-160b) Transfers 544322318 52114i) Official532 47359ii) Private539001845 52055c) Income13021 20425 -7404i) Investment income 12107 18720 -6613ii) Compensation of employees9141705-791Total Current account (1+2) 343408381819-38411 4. A) Current accountIt captures the effect of trade link between the economy and rest of the world.1) Merchandise Trade :It includes exports and Imports.2) InvisiblesGnie: Government not included elsewhere: It relates to receipt and payments on government account not included elsewhere as well as receipts and payment on account of maintenance of embassies and diplomatic missions and offices of international institutions such as UNO,WHO,etc.Credits includes allocation made for the embassy expenditure in India out of rupee proceeds of sales in India of US surplus agricultural commodities 5. A) Current account Transfers: It represent all receipts and paymentswithout a quid pro quo. They include items like aidand grants received from /extended to foreigngovernments, migrants transfer, repatriation ofsavings, remittances of family maintenanceContribution and donations to religious organizationsand charitable institutions etc. Investment Income: Remittances, receipts, andpayments on account of profits, dividends, interestand discounts including interest charges andcommitment charges on foreign loans including thoseon purchase from the IMF 6. A) Current account Compensation of Employees: It covers wages, salaries and other benefits, in cash or in kind, and include those of border, seasonal and other nonresidents workers(e.g. local staff of embassies) 7. Item/Year 2009-10Credit DebitNetB. Capital account1. Foreign investment (a+b)19808914596452125a) Foreign direct investment (i+ii) 37920 1819119729i) In India 37182550031682Equity27149424222907Reinvested earnings8080 0 8080Other Capital19531258695ii) Abroad738 12691 -11953Equity7388057-7319Reinvested earnings 01084-1084Other capital 03550-3550b) Portfolio investment16016912777332396i) In India15989712752132376of which: Flls 15657012752129049GDRs/ADRs3328 0 3328ii) Abroad272 252 202. Loans (a+b+c)73204 6098212222a) External assistance 49652917 2048i) By India52 420 -368ii) To India 49132497 2416b) Commercial borrowings (MT & LT)14674 12152 2522i) By India 9741505 -531ii) To India13700 10647 3053c) Short term to India53565 45913 7652i) Suppliers Credit >180 days & Buyers Credit 48571 43914 4657ii) Suppliers credit up to 180 days 49941999 2995 8. Item/Year 2009-10CreditDebit Net3. Banking capital (a+b) 61499 594152084a) Commercial Banks60893 589661927i) Assets17097 152591838ii) Liabilities43796 4370789of which: Non-resident deposits41356 384322924b) Others606449 1574. Rupee debt service 097 -975. Other capital 11209 23941 -12732Total capital account (1 to 5)344001290399 53602C. Errors & omissions 0 1746-1746D. Overall balance (A+B+C)687407673966 13441E. Monetary movements (i+ii)013441 -13441i) I.M.F.ii) Foreign exchange reserves (Increase-/ 013441 -13441 9. Banking capital: It is the changes in assets andliabilities of commercial banks, This includes government banks, private banks, co-operative banks. Assets are held by foreign branches of Indian banks. Liabilities are deposit balances held by foreign banksin India. So increase in asset is debit and increase inliabilities is credit. Decrease in asset is credit and decrease in liabilitiesis debit. 10. Rupee Debt Service is the payment underrupee/rouble agreement with Russia.It is definedas the cost of meeting interest payments andregular contractual repayments of principal of aloan along with administration charges in rupeesby India Errors and omissions: It indicates the value ofdiscrepancies. Recording of transaction in theBOP statement is made according to theprinciple of double entry book system, certaindiscrepancies in estimating and timing may resultin a situation where debits are not exactly equalto credits. Receipts are either overstated or 11. Monetary movements:a) Indias transaction s with the IMFb) RBIs foreign currency reservesc) Drawings(essentially type of borrowing) from the IMF or drawing down of reserves credit items whereas repayments made to IMF or addition made to existing reserves are debit items.d) It measures the effect of transactions on current and capital account on the official reserves of the country 12. IMF account: It contains purchase (credits) and re-purchases (debits) from IMF. SDR are a reserve account created by IMF andallocated from time to time to member countries. It can be used to settle international paymentsbetween monetary authorities of two differentcountries. An allocation is a credit and retirement is the debit. Foreign exchange reserves are in the form ofbalances with the foreign central banks andinvestment in foreign government securities. 13. Changes in official reserves Official gold reserves (Monetary gold) Official foreign exchange holdings ( For e.g.Reserves) Reserve position in IMF and (IMF Quotas) 14. Overall Balance Balance on current accounti)Balance of Trade: Difference between valueof exports and imports.ii) Balance of payment: Balance of trade +Invisibles. Balance on Capital account: It is the netinflows and outflows on capital transactions.It is more of private capital account becoz itexcludes movement in official reserves. 15. BASIC BALANCE AND OVERALLBALANCE Basic Balance: This is the total of balance oncurrent and long term items in capital account It is overall balance less shortterm capitalmovements Overall balance: It is total of balance oncurrent account and balance on capitalaccount. It is also called as official settlements balancesince it must be financed by official reservesor by other non-reserve transactions that aresubstituted for reserve transaction 16. Balance of payment alwaysbalances In accounting sense ,a BOP account alwaysbalances, because it is prepared on the principle ofdouble entry of book-keeping. The total of the credit and debit entries must beequal to each other Balance in current A/C + Balance in capital A/C +Change in Movements = Zero The change in Monetary Movements reflects theoverall BOP position. 17. Increase in foreign exchange reserves indicatesBOP Surplus Decrease in foreign exchange reserves indicatesBOP deficit. No change indicates (Surplus/Deficit in Current A/C = Surplus/Deficit inCapital A/C) 18. However , actual recording of entries can rarelybe complete and accurate. Some transaction are bound to be left out (fore.g. illegal transactions like smuggling andhavala do not appear in official records ) Some discrepancies is bound to persist in thetotals of credit and debit entries. These discrepancies are more likely to arise inthe short run, particularly because actual deals,shipment of goods, and the payments do nottake place simultaneously. For this reason the balancing item E & O isinserted. 19. Concept of Autonomous andAccommodating Autonomous flows: This takes place in theordinary course of foreign trade. These aretransaction above the line. Accommodating flows (induced): These flowstakes place to equalize the BOP. These aretransactions above the line. 20. CreditsAmt (Rs) Debits Amt (Rs)Current A/C Current A/CAutonomous 800Autonomous 930TransactionsTransactionsExport of550Imports of 500goods goodsExport of150Imports of 280servicesservicesUnrequitedUnrequitedreceiptspaymentsGifts75 Gifts20Indemnity25 Remittances60Capital A/C Capital A/CAccommodatinAccommodating transaction g transactionBorrowings200 Loans 70 21. CAUSES OF DISEQUILIBRIUM IN BOP Change in foreign Demand: Inflationary or deflationary pressure: Inflation willincreases the imports as the goods becomerelatively cheaper and vice-versa, making itfavorable or unfavorable Development expenditure: Increase in cost structure of export sector:Higher wages, higher prices of raw materials, orhigher rate of inflation. 22. Decrease in supply: Agir.production falls due to the failurein monsoon, IND. Prod. Falls due to labour strike, shortageof raw materials. Appreciation of exchange rate: Increased debt Burden: Increase in capital inflows lead todebt servicing like interest. Demonstration Effect: Population Pressure: Political factors: political turmoil and instability majorly inAfrican, Gulf countries, Afghanistan etc. 23. MEASURES TO CORRECT THEDISEQUILIBRIUM IN BOP Depreciation: Under flexible exchange rate,changes in exchange rate will automaticallyadjust the BOP. Devaluation: It is used under the fixed exchangerate system, it means fall in the value of homecurrency. It is used to wipe out the deficit. If theelasticity is high then definitely the devaluationwill work. Import control: By Imposing quotas and tariff. 24. MEASURES TO CORRECT THEDISEQUILIBRIUM IN BOP Export promotion: Reducing export duties ,subsidies for exports, provision of marketinformation, arranging exhibition, providingfinance ,raw material at relatively less cost Exchange control: Buying and selling theforeign exchange through central Bank to restrictthe foreign exchange. Production of Import substitutes: Monetary Policy: Tight monetary policy can beused to reduce expenditure to reduce deficit andvice-versa. 25. Foreign Exchange rate The foreign exchange rate is the rate at which the currency of a country is exchanged against the currency of another country. 26. Factors affecting Foreign Exchange Rates GDP: It is the primary indicator of the strength of the economicactivity. The growth in GDP positively influences the foreignexchange prices of the currency and vice-versa. Trade Balance: A positive BOT (appreciation in the domesticcurrencies) and vice-versa. Inflation: It reduces the purchasing power of the currency which willlead to depreciation of the exchange rate. Employment levels: It reflect the development and stability in theeconomy. Increase in empt increases the consumption and savingswhich leads to increase in investment and leads to the appreciationof the domestic currency. Interest rate differential: Exchange rate policy: Political factors: These events may be anticipated or unforeseen.Some of the political developments are election, publicannouncements by central bank or government officials, militarytakeovers, political instability etc can affect the exchange rate. View of Speculators: 27. Concepts of Foreign exchangetransactions FIAT Currencies: Currency that a government has declared to be legaltender, despite the fact that it has no intrinsic valueand is not backed by reserves. Historically, most currencies were based on physicalcommodities such as gold or silver, but fiat money isbased solely on faith. The term derives from the Latin fiat, meaning "let it bedone" or "it shall be [money]", as such money isestablished by government decree. Where fiat moneyis used as currency, the term fiat currency is used. 28. Foreign Currency: It is defined as, the legal tender applicable in acountry outside the domestic area. Foreign Exchange means foreign currency andincludes- Deposits, credits and balances payable in anyforeign currency. Drafts, travellers cheque, letters of credit or billsof exchange expressed in Indian currency butpayable in foreign currency and Drafts, travellers cheque, letters of credit or billsof exchange drawn by banks outside India butpayable in Indian currency. 29. Nostro Account It is the overseas account which is heldby the domestic bank in the foreign bank or with the ownforeign branch of the bank. For example the account heldby state bank of India with bank of America in New York isa Nostro account of the state bank of India. It is ouraccount with you. Vostro Account It is the account which is held by aforeign bank with a local bank, so if bank of Americamaintains an account with state bank of India it will be avostro account for state bank of India. It is your accountwith us From the above one can see that the account which isNostro for one bank is Vostro for another so when SBIopens a Nostro account with Bank of America, it is aVostro account for them and vice versa. 30. LORO Account: An account held by a domestic bank in itself on behalf ofa foreign bank. The latter in turn would view this account asa Nostro account. A Loro is our account of their money, held by you. Loro account is a record of an account held by a secondbank on behalf of a third party; i.e, my record of their account with you. In practice this is rarely used, the main exception beingcomplex syndicated financing. Their account with them. Ex.: Just like State bank Of India maintaining anaccount with foreign correspondent say BTC, NewYork, Canara Bank may also maintain a NostroAccount with them. When SBI advises BTC New Yorkfor transfer of funds to Canara Bank Account withthem, Canara Bank Account is titled as Loro Account"i.e. their account with you". 31. Correspondent banks are used by domestic banks inorder to service transactions originating in foreigncountries, and act as a domestic banks agent abroad.This is done because the domestic bank may have limitedaccess to foreign financial markets, and cannot service itsclient accounts without opening up a branch in anothercountry. Maintaining the foreign currency a/c and receiving andmaking payments on behalf of the counterparty (principal)bank. Providing temporary overdrafts as and when necessary. Providing credit reports on companies located in thecountry of the correspondent bank. Assisting the principal bank in all agency functions such aspresenting of documents, advising of LC , confirmation ofLC etc. 32. Foreign Exchange Marketa) The foreign exchange market provides the physicaland institutional structure through which the moneyof one country is exchanged for that of anothercountry, the rate of exchange between currencies isdetermined, and foreign exchange transactions arephysically completed .b) A foreign exchange transaction is an agreementbetween a buyer and seller that a fixed amount ofone currency will be delivered for some othercurrency at a specified rate.c) Foreign exchange means the money of a foreign 33. FUNCTIONS Transfer function: It helps the transfer thepurchasing power between the countries. Itutilizes the instrument like bills of exchange, bankdrafts, telegraphic transfers, etc. Credit functions: normally with maturity of 12months. Hedging function: It is undertaken to avoid a riskwith a change in exchange rate. 34. FUNCTIONS Speculating function: It is function whichspeculator undertakes and it is risky. Arbitrage function: It refers to the process bywhich an individual purchases foreign exchangein a low price market for a sale in a high pricemarket for the purpose of making profit. It is theriskless profit. 35. FOREIGN EXCHANGE DEALERS Market Participants: Investment Bankers dealsin inter bank Market. Commercial Bank: These are major players inthe market who buy and sell the currencies. Exchange Brokers: This facilitates dealsbetween the banks. Central Bank Investment Management Firms: An investmentmanagement firm with an international portfoliobuys and sells the currencies 36. FOREIGN EXCHANGE DEALERS Hedge Funds Commercial companies: Often trades in the smallamount Traders and Investors Money Changers: Are authorized by the RBIRestricted Money changers can only buy while otherscan buy as well as sell the currencies. for e.g. somehotels, firms have given the licenses by the RBI. Retail clients 37. Gold Standard This is the oldest system. This was in operation tillfirst world war. It is based on value ofgold There are three kinds ofgold standard that havebeen adopted since 1700. The Gold specie Gold Exchange Gold bullion Standard 38. Gold Specie In this system actual gold coins or coinswith content of gold were in circulation The unit of currency is linked with thegold coins Gold along with silver coins were alsoin use There were fix conversion ratio such as5 silver coins = 1 gold coins Gold were used for trading of goods ofservices. Value of gold coin is same as the goldcontents. Gold should be freely exported andimported. The supply of gold determine theliquidity and consequently its value. Some used only gold for conversion 39. Bimetallism: Before 1875 A double standard in the sense that both gold andsilver were used as money. Some countries were on the gold standard, some onthe silver standard, some on both. Both gold and silver were used as international meansof payment and the exchange rates among currencieswere determined by either their gold or silver contents. Greshams Law implied that it would be the leastvaluable metal that would tend to circulate.2-39 40. Gold Specie Eastern roman empire madeuse of gold coin called Byzant. US dollar was minted as goldand silver coin till 1862 andcontinued along with papernotes till 1933. The four main basic unit wasthe cent, the dime, and aneagle Dime is 10 cents, a dollar is 10dime, and an eagle is 10dollars. The international gold standardwas established by Britain in1821, using the GoldSovereign as their unit. By 1871 Germany established 41. Gold Specie The net trade imbalance between two countrieswould get settled through transfer of goldreserves. This would result in reduced in money supply andcommodity prices in the deficit country andincreased money supply and inflation in thesurplus country. This would make commodities more attractive inthe deficit country leading to a reversal in thetrade imbalance and help to achieve equilibriumof trade. This in-built mechanism for balancing trade in theGold Standard was called Price Specie 42. Gold Points was a term which referred to the rates offoreign exchange likely to cause movements of goldbetween countries adhering to the gold standard. Application In accordance with the law of supply and demand, theconcept determined that the fluctuating limits ofcurrency fixed the cost of money between the placewhere the bill was drawn and that in where it waspayable. In the exchanges rates between gold-standard countries, these limits were known as thegold points, for the reason that, if the price of foreignbills rose above the upper limits determined by theexchange rate, countries would find it cheaper toexport gold than to export bills for the purpose ofsettling international accounts. Conversely, if theexchange rate fell below the lower limit of thedetermined rate, countries would find it cheaper toimport gold than to sell bills to foreign creditors. 43. Gold bullion Standard Gold Bullion Standard The reconstructed fixed exchange rate regime differedfrom the pre-war standard into two aspects. Gold coin no longer circulated as a currency and the inter-convertability of bank notes with gold coins weresubstituted by much more heavier minimum weight of goldbars. In gold Bullion standard, monetary authorities hold stock ofGold. Currency in circulation is a paper currency note. (orsilver coin or low value metal coin). On these paper notes there is written promise that if youdemand , on submission of this note, they would give youspecified quantity of gold. Hence the paper currency ispegged with the gold and is unconditionally converted in togold, on demand. The gold per note was fixed by the issuing authority (goldto bullion ratio). 44. The USA introduced Gold Bullion paper currencynotes in 1862 and they existed along with actualgold eagle coin dollars. Dollar coin or note was equivalent to 1.50 g(23.22 grains) of gold. 45. Mechanism of Exchange of Two currencies(Mint par of Exchange or Par value System) The mechanism of establishing exchange rates betweencurrencies under the gold Standard was the Mint Par ofExchange. The exchange rate between two currencies wasrepresented by the ratio of the official gold prices for thetwo currencies. Example If 1 ounce of gold in USA = USD 400 And 1 ounce of gold in Germany = DEM 600 then 1 USD == DEM 1.5000 Exchange rate established in this manner were calledCENTRAL EXCHANGE RATES or MINT PARITIES. It is basically gold that was getting exchange, eitheractually or through promises. Hence in bullion standard, if one currency is worth 46. In Gold exchange standard system, currency isexchanged for another currency at a specifiedratio, as promised by the monetary authority. Another currency with which it is pegged is calledas reserve currency. Reserve currency (Dollar and Pound) were inturn, convertible to real gold as these were in glldbullion standard. 47. The gold exchange standard (1870-1914) Towards the end of the 19th century, some of theremaining silver standard countries began to peg theirsilver coin units to the gold standards of the UnitedKingdom or the USA. In 1898, British India pegged the silver rupee to thepound sterling at a fixed rate of 1s 4d, while in 1906,the Straits Settlements adopted a gold exchangestandard against the pound sterling with the silverStraits dollar being fixed at 2s 4d. At the turn of the century, the Philippines pegged thesilver Peso/dollar to the US dollar at 50 cents. A similar pegging at 50 cents occurred at around thesame time with the silver Peso of Mexico and thesilver Yen of Japan. When Siam adopted a gold exchange standard in1908, this left only China and Hong Kong on the silverstandard. 48. Classical Gold Standard:1875-1914 Highly stable exchange rates under the classical goldstandard provided an environment that was conduciveto international trade and investment. Misalignment of exchange rates and internationalimbalances of payment were automatically correctedby the price-specie-flow mechanism. 49. Classical Gold Standard:1875-1914 There are shortcomings: The supply of newly minted gold is so restricted that thegrowth of world trade and investment can be hamperedfor the lack of sufficient monetary reserves. Even if the world returned to a gold standard, anynational government could abandon the standard. 50. Advantages Long-term price stability has been described as the greatvirtue of the gold standard. Under the gold standard, highlevels of inflation are rare, and hyperinflation is impossibleas the money supply can only grow at the rate that thegold supply increases. Economy-wide price increases caused by ever-increasingamounts of currency chasing a constant supply of goodsare rare, as gold supply for monetary use is limited by theavailable gold that can be minted into coin. High levels of inflation under a gold standard are usuallyseen only when warfare destroys a large part of theeconomy, reducing the production of goods, or when amajor new source of gold becomes available. In the U.S. one of those periods of warfare was the CivilWar, which destroyed the economy of the South, while theCalifornia Gold Rush made large amounts of gold availablefor minting. 51. The gold standard limits the power of governments toinflate prices through excessive issuance of papercurrency. It provides fixed international exchange rates betweenthose countries that have adopted it, and thusreduces uncertainty in international trade. Historically, imbalances between price levels indifferent countries would be partly or wholly offset byan automatic balance-of-payment adjustmentmechanism called the "price specie flow mechanism. The gold standard makes chronic deficit spending bygovernments more difficult, as it preventsgovernments from inflating away the real value oftheir debts. A central bank cannot be an unlimited buyer of lastresort of government debt. A central bank could notcreate unlimited quantities of money at will, as there is 52. Disadvantages Deflation rewards savers and punishes debtors. Real debt burdenstherefore rise, causing borrowers to cut spending to service their debtsor to default. Lenders become wealthier, but may choose to save some of theiradditional wealth rather than spending it all. The overall amount ofexpenditure is therefore likely to fall. Deflation also prevents a central bank of its ability to stimulatespending. However in practice it has always been possible forgovernments to control deflation by leaving the gold standard or byartificial expenditure. The total amount of gold that has ever been mined has been estimatedat around 142,000 metric tons. Assuming a gold price of US$1,000 perounce, or $32,500 per kilogram, the total value of all the gold ever minedwould be around $4.5 trillion. This is less than the value of circulating money in the U.S. alone, wheremore than $8.3 trillion is in circulation or in deposit (M2). Therefore, areturn to the gold standard, if also combined with a mandated end tofractional reserve banking, would result in a significant increase in thecurrent value of gold, which may limit its use in current applications. For example, instead of using the ratio of $1,000 per ounce, the ratiocan be defined as $2,000 per ounce effectively raising the value of goldto $9 trillion. However, this is specifically a disadvantage of return to 53. Many economists believe that economic recessions can belargely mitigated by increasing money supply during economicdownturns. Following a gold standard would mean that the amount of moneywould be determined by the supply of gold, and hence monetarypolicy could no longer be used to stabilize the economy in timesof economic recession.Such reason is often employed to partially blame the goldstandard for the Great Depression, citing that the FederalReserve couldnt expand credit enough to offset the deflationaryforces at work in the market. Opponents of this viewpoint haveargued that gold stocks were available to the Federal Reserve forcredit expansion in the early 1930s, but Fed operatives failed toutilize them. Monetary policy would essentially be determined by the rate ofgold production. Fluctuations in the amount of gold that is minedcould cause inflation if there is an increase, or deflation if there isa decrease. Some hold the view that this contributed to theseverity and length of the Great Depression as the gold standard forced the central banks to keepmonetary policy too tight, creating deflation.[29][38] MiltonFriedman however argued that the main cause of the severity ofthe Great Depression in the United States was the FederalReserve, and not the gold standard, as they willfully keptmonetary policy tighter than was required by the gold standard. 54. Although the gold standard gives long-term price stability, it doesin the short term bring high price volatility. In the United Statesfrom 1879 to 1913, the coefficient of variation of the annualchange in price levels was 17.0, whereas from 1943 to 1990 it wasonly 0.88. It has been argued by among others Anna Schwartz that this kindof instability in short-term price levels can lead to financialinstability as lenders and borrowers become uncertain about thevalue of debt. Some have contended that the gold standard may be susceptibleto speculative attacks when a governments financial positionappears weak, although others contend that this very threatdiscourages governments engaging in risky policy (see MoralHazard). For example, some believe the United States was forced to raiseits interest rates in the middle of the Great Depression to defendthe credibility of its currency after unusually easy credit policiesin the 1920s. This disadvantage however is shared by all fixed exchange rateregimes and not just limited to gold money. All fixed currenciesthat appear weak are subject to speculative attack. If a country wanted to devalue its currency, it would generallyproduce sharper changes than the smooth declines seen in fiatcurrencies, depending on the method of devaluation. 55. SPOT AND FORWARD EXCHANGE RATE Spot Rate: it is the single outright transactioninvolving the exchange of two currencies at arate agreed on the date of the contract for valueof delivery within two business days.For e.g. If AD quotesRs 43.46-48/US$ This is the two way quotes ofthe spot rate. Trade date: The day the deal is struck Value date or settlement date: the day theexchange of currencies takes place is the valuedate. 56. THREE DIFFERENT SETTLEMENTMATURITIES Ready Transactions or a cash transaction: Exchange of currency takes on the day itself. Value TOM: Exchange of currency takes on the next business day. Spot Transaction: Exchange of currency takes on the second business day. 57. BID and ASK Quotation Interbank quotations are given as a bid and ask(also referred to as offer). A bid is the price (i.e., exchange rate) in onecurrency at which a dealer will buy anothercurrency. An ask is the price (i.e., exchange rate) at whicha dealer will sell the other currency. Dealers bid (buy) at one price and ask (sell) at aslightly higher price, making their profit from thespread between the buying and selling prices. 58. BID and ASK Quotation Bid and ask quotations in the foreign exchangemarkets are superficially complicated by the factthat the bid for one currency is also the offer forthe opposite currency. A trader seeking to buy dollars with Swiss francsis simultaneously offering to sell Swiss francs fordollars. Assume a bank makes the quotations for theJapanese yen. The spot quotations on the first line indicate thatthe banks foreign exchange trader will buydollars (i.e., sell Japanese yen) at the bid price of118.27 per dollar. The trader will sell dollars (i.e., buy Japanese 59. Direct quote and Indirect quote A direct quote is a home currency price of a unitof foreign currency. An example, using Mexicoand the United States (home country) is:$0.1050/Peso. An indirect quote is a foreign currency price of aunit of home currency. An example, using Japanand China (home country) is: 14.75/Rmb. 60. European terms and American terms Most foreign currencies in the world are stated interms of the number of units of foreign currencyneeded to buy one dollar. For example, the exchangerate between U.S. dollars and Swiss franc is normallystated SF1.6000/$, read as 1.6000 Swiss francs per dollar. This method, called European terms, expresses therate as the foreign currency price of one U.S. dollar.An alternative method is called American terms. Thesame exchange rate above expressed in Americanterms is $0.6250/SF, read as 0.6250 dollars perSwiss franc. Under American terms, foreign exchange rates arestated as the U.S. dollar price of one unit of foreigncurrency. 61. Reciprocals. Convert the following indirectquotes to direct quotes and direct quotes toindirect quotes:a. Euro: 1.02/$ (indirect quote); 1/1.02 = $0.98/i(direct)b. Russia: Rub 30/$ (indirect quote); 1/30 =$0.0333/Rub (direct)c. Canada: $0.63/C$ (direct quote); 1/0.63 =C$1.5873/$ (indirect)d. Denmark: $0.1300/DKr (direct quote); 1/0.1300 =DKr7.6923/$ (indirect) 62. FORWARD TRANSACTION It is also known as forward outright rate. The forward is the transaction involving the exchange of two currencies at a rate agreed on the date of the contract for a value or delivery at the same time in future (more than two days). 63. FORWARD TRANSACTION Transaction shows the forwarda) Suppose the trade date is April 1b) Value date is calculated one month after the spot date (i.e. April ) ,therefore the value is may 3. If May 3 is holiday then May 4. 64. OUTLINE Defining Exchange Rate Measuring Exchange Rate Movements Appreciation/Depreciation of a currency Exchange Rate Equilibrium Factors that influence Exchange Rate Movements 65. MEANING OF EXCHANGE RATE ANDMEASURING CHANGES IN EXCHANGERATES Value of one currency in units of anothercurrency A decline in a currencys value is referred to asdepreciation and an increase in currencys valueis called appreciation. If currency A can buy you more units of foreigncurrency, currency A has appreciated and foreigncurrency depreciated If currency A can buy you less units of foreigncurrency, currency A has depreciated and foreigncurrency appreciated 66. APPRECIATION/DEPRECIATION Percentage change in value US $- Old value of rupees per $New Value of rupees per unit of $--------------------------------------------------------- X 100Old value of rupees per $ Percentage change in value of Rupees- Old value of $ per unit of RupeesNew Value of $ per units of Rupees-------------------------------------------------------------- X 100Old value of $ per unit of Rupees 67. EXCHANGE RATEEQUILIBRIUM Forces of Demand and Supply Demand for foreign currency negatively related tothe price of foreign currency Supply of foreign currency positively related tothe price of foreign currency Forces of demand and supply together determinethe exchange rate 68. DEMAND FOR ($)Price in ($) Exchange rate Demand for ($)5010040200303002040010500 69. DEMAND FOR ($) 60 50 40Price of ($) EXchange rate 30 20 10 00100 200300 400 500 600 Demand for ($) 70. SUPPLY OF ($)Price in ($) Exchange rate Supply of ($)50 50040 40030 30020 20010 100 71. SUPPLY OF ($) Price in ($) Exchange rate 60 50 40Price in ($) 30 20 10 00100 200300 400 500 600 Supply of ($) 72. EQUILIBRIUM EXCHANGERATE Price in ($)Exchange rate Demand for ($) Supply of ($) 50 100500 40 200400 30 300300 20 400200 10 500100 73. EQUILIBRIUM EXCHANGERATE DSExcessSupply $1=30 Excess S Demand D300Units of Foreign Currency($)